I’ve only subscribed to Geopolitical Futures (GPF) for a short while, but I’ve really enjoyed founder George Friedman’s writing and analysis.
This morning, the GPF article sent to my email was entitled “The Strangeness of an Analytic Life”. In it, Friedman discusses how every profession requires some measure of sacrifice in order to be any good at it.
For most things, what we give up is time.
Personally, I spent countless hours in bullpens and batting cages trying to become a better baseball player. I spent countless hours in a little room practicing chords, scales, and full compositions to become a better guitar player. I spent countless hours in my college library trying to become a better student.
But this morning’s GPF article implies that becoming a good analyst requires a wholly different type of sacrifice.
In essence, there’s a certain level of indifference required for excellence. And achieving that indifference, in Friedman’s words, “demands that I give up the pleasure of having opinions.”
That really hit home.
When I chose to leave the music industry to become, of all things, a coal market analyst, I literally had to check all my preconceived notions at the door. Because you can’t extrapolate trends or knock-on effects if you’re being influenced by what you might want to happen.
In other words, if I’m going to be any good, I can’t take sides.
Over the years, that has often forced me to learn the perspectives of others – many with whom I disagree. And while I can say first-hand that can be uncomfortable, I think it might also be the best way to understand the human condition.
Environmental Perplexity Agency
For a big chunk of my early career, my employer counted EPA amongst their coal data clients. Now, it might seem counterintuitive that an environmental group within the Federal government would require coal production and price projections… it certainly was to me at first.
But as it turned out, these coal forecasts were integral to certain statistical models. Some of these projected future carbon emissions, while others estimated a variety of potential knock-on environmental effects.
At any rate, while I was still way too inexperienced to do much heavy lifting, I did have a front-row seat for the shift in tone from the Bush to the Obama administrations with regard to the coal industry.
Keep in mind that during this period, essentially every single energy research firm was projecting that natural gas prices would decline substantially over the next decade. And as that happened, coal would gradually cede more and more of its share of the power market to gas, eventually speeding up as the older generation of coal-fired power plants retired.
In other words, coal demand was already dying.
Instead of simply allowing that to happen, though, EPA under Obama opted to increase regulatory scrutiny – in a few different ways – which in turn raised costs, squeezed margins, and crushed demand faster.
The net result, essentially, was just a faster version of what was inevitably going to happen anyway. No less a liberal stalwart than the New York Times predicted coal’s decline at the hand of gas all the way back in 2005.
Coal’s decline happened at such a pace that it also decimated the economy in the southern part of my home state of West Virginia.
Because the money from those decent-paying coal jobs had velocity – a concept I’ve talked about here before. The greater the number of transactions in which a single dollar is involved, the greater the number of goods and services it purchases.
Put another way, the more a dollar changes hands, the more jobs it supports.
The dollars earned by those miners also supported local restaurants, convenience stores, truck dealerships, body shops, retail outlets…you name it.
And taking the source of funding away meant those ancillary businesses eventually went away too.
Personally, it was conflicting, as my colleagues and I saw what was going to happen – the writing was on the wall – and I fully recognize both the importance of being a good corporate steward of the environment, and the importance of supporting your fellow citizens in times of economic need.
But as I said above, if I’m going to be any good at predicting, I can’t take sides… I can only focus on the facts and the data, and allow them to guide me toward the final answer.
Get Ready for Gridlock
Although you wouldn’t be able to guess by looking at President-Elect Joe Biden’s transition team – the EPA team lead is from Earthjustice – I do think that the Obama administration learned an important lesson from that debacle.
Namely, that taking people’s livelihood away makes them pretty angry, and that anger often gets directed right back at the source.
In the case of my home state, there now exists a kind of open animosity toward the Federal government that didn’t exist in this form – essentially a populist revolt – when I was growing up.
Moreover, it’s likely President-Elect Biden won’t even be able to implement a fully green power agenda, as Democrats are unlikely to win both Georgia Senate seats in the state’s January runoff election.
That would mean Republicans maintain control of the Senate, and more importantly to Majority Leader Mitch McConnell, control of the agenda.
In other words, get ready for gridlock.
However, there’s still a way forward that McConnell might go for, as it could greatly benefit not just his home state, but Republican-led states at large. And even better, we need it.
It’s true that Biden’s comprehensive infrastructure plan is largely composed of projects related to some sort of a Green New Deal.
But it also calls for rebuilding roads, bridges, and airports, as well as creating new public works like universal broadband – all of which would likely be appealing to Republicans.
Each one is differently investable, but for me the easiest way to capture all the upside here is to look for the common denominator. In this case, that happens to be steel.
Now, most people tend to think that the automotive industry is the most important driver of the market. And it even makes sense when you think about it, as US citizens generally spend a lot of time in the car.
But in fact, it’s the construction sector that really drives steel demand here in the US, comprising roughly 40% of apparent consumption compared to just 26% for automotive according to the American Iron and Steel Institute.
Moreover, it’s important to note that steel isn’t just one product – there are many different products of all different sizes and shapes.
In general, though, analysts lump them into two categories – long products (rebar, structural steel, rail, wire rod) primarily used in the construction sector, and flat products (sheets and plates) typically consumed by the automotive and energy industries.
Also, not all steel is produced the same way. There are two distinctly different types of facilities that produce steel using two distinctly different methods.
The first type of steel facility – and usually the one people are most familiar with – is called a blast furnace. In general, a blast furnace is a large column into which is placed layers of fuel (metallurgical coke, in this case) iron ore (chemical formula FeO2) and flux (limestone), and “blasted” with hot, oxygenated air through pipes at the bottom of the column called tuyeres.
Source: Thermo Fisher Scientific
The other type of facility is called an Electric Arc Furnace, or EAF, which consists of a bowl-shaped vessel lined with a refractory material, and a roof containing several electrodes. During operation, the vessel is loaded with a charge of scrap metal, then the roof closes and the electrodes are lowered in, the heat from which melts the charge.
Now, EAF operations are generally easier to manage, as they don’t require as many employees as a blast furnace, nor do the facilities require any lead time to shut down.
This makes physical sense, as the fuel in a blast furnace burns constantly – thus requiring constant monitoring. And in order to close the facility that fuel must first be spent, which can take days.
In contrast, EAF operations just flip a switch. And the difference is readily apparent just looking at EBITDA over time for a BF producer (purple line) versus an EAF producer (blue line.)
Source: Bloomberg, Company Filings, Seawolf Research
Not only does the EAF producer perform more steadily during those downturns in 2009, 2013 and 2016, but aside from one quarter during the Global Financial Crisis, they always showed positive earnings.
So, when we look for the steel company that will best help America rebuild, we want an EAF-based producer who has the widest possible footprint across all industries. And in this case, it is an easy answer because it also happens to be the largest steel company in America.
I’m talking about Nucor (NYSE: NUE.)
Nucor’s stock price has ranged from as high as $58 to as low as $28 this year, and it’s currently sitting at just below the $50 mark.
Source: Bloomberg, Company Filings, Seawolf Research
Picking up a ¼ tranche at $45 or below seems reasonable, as that was the most recent support point during September’s downturn.
Steel – particularly rebar – is poised to perform well over the next few years regardless of political climate.
And though both George Friedman and I suggested above that analysts themselves can’t take sides… we said nothing about our portfolios.
All the best,