Some Thoughts On Inflation

I often hear commentary about central banks and their “excessive” money printing. More money get’s printed, same amount of goods, inflation comes around, buy gold, protect your purchasing power. Somehow or another Zambia or the Weimar Republic are brought into the conversation. They printed lots of money, they experienced hyperinflation, so now we will. At face value, these comments all appear to make sense and I’ve generally accepted their notions. It’s interesting, given how long the printing press has been going, that there really hasn’t been a material uptick in inflation. What gives? What are we getting wrong about these theories?

What do we know:

  • the fed balance sheet has expanded ALOT.
  • Money supplies are increasing
  • but, interestingly, the money velocity is falling
  • and, inflation is benign:

So what does this mean? We are printing more money. The money that is in the system is changing hands less frequently. For some reason, inflation isn’t occurring.

I stumbled upon this very interesting tweet that talked about inflation in a way I hadn’t heard before:

I thought there were some really interesting points made by the author. To summarize:

  • The consensus is that inflation will occur because money is being printed (what we just discussed)
  • Printing, however, is just one part of the equation.
  • A dollar is “created” by banks. Banks create money by lending it out.
  • The amount they can lend out is a function of their existing collateral.
  • The tweet-storm distinguished between the collateral that the fed is creating and how this doesn’t actually make it into the economy if the banks don’t lend against it.
  • On the opposite end of the spectrum, when debts are paid it works in reverse; the money supply actually decreases
  • Banks are the interface that the central bank uses to increase the money supply. If banks don’t lend, the central bank can’t increase the money supply. This is a very important point given that excess reserves are at all-time highs. Banks aren’t lending the money that they could. Maybe this explains why the money velocity is fallng>
  • Travis highlights the recent inflationary pulse. Higher copper, gold, and other commodity prices. He likens this occurrence to a temporary surge in corporate borrowing. This makes sense. Stock up during COVID in case the worst happens. The question is, what happens when the world calms down? Does this stockpile get drawn down, pushing deflationary forces onto the world?
  • He also thinks that inflationary forces could be occurring because mandated debt payments were removed as part of COVID relief. Very interesting.
  • When people need to start paying their debt, money supply will contract and inflationary tail wind could reverse.
  • There’s also the backdrop of less lending which could also decrease the money supply.
  • If these items occur like Travis is talking about, there will be less dollars in the system which could lead to an increase in demand (and price)

Conversation in the Thread:

  • What is causing all-time-highs in stocks and real estate? It could be fear of inflation vs. the real thing.
  • Do stimulus checks increase the dollars in circulation? No. Maybe they increase the velocity though?
  • How is the Fed buying bonds not creating money? The true bottleneck to the money supply is the lending from banks, not the fed. The fed can continue to buy assets but if the banks don’t lend it doesn’t matter.
  • Great thread! What if Fed buys USTs directly from govt, that would be adding dollars to the system? Yes it would. This is the monetization that most people believe is occurring right now.
  • What about the ongoing monetization of government deficit, ie FED being buyer of treasuries – in the extreme case – FED is the only buyer – isn’t that increasing the dollar amount in circulation? NO

So the main takeaway from this thread is:

The money supply is increasing. The true money supply is based on what the banks ultimately lend out to the world. Because excess reserves are increasing, the true money supply may not be growing as much as the M2 figures would indicate. The fed’s expanding balance sheet really doesn’t influence inflation until bank reserves are reduced.

What is Glencore?

When I read through technical reports and hit the concentrate and marketing section, I’ll often see the name Glencore pop-up. The producer has generally signed a 5-year offtake agreement with Glencore with terms that are not disclosed. This company, Glencore, had always been a bit of an enigma for me. What is it? Is it a miner? A trader? A refiner? How does it make money? Why is it so prevalent within the industry?

The company’s business activities sprawl across: marketing of metals, energy, and products, and the production, refinement, processing, storage, of these products. Glencore also distributes physical commodities from third parties. The original IPO prospectus highlighted the benefits of the commodity marketing business, namely its lack of correlation with the broader market. It was this lack of correlation which was supposed to make “Glencore’s earnings less volatile than those of pure producers of metals”. Unfortunately, this thesis hasn’t really played out too well…

This result is pretty surprising. Glencore literally does everything along the value chain. How could they not be making money. Maybe they’ve just lost less money than everyone else in the commodity space.

The IPO prospectus drops this gem:

“Glencore has been consistently profitable since the management buyout in 1994 and has a track record of growth across industry cycles. Since 2001, Glencore has achieved an average annual return on equity of 38 per cent.”

It’s amazing that, despite this boast, Glencore hasn’t achieved an ROE greater than 15.6% since its IPO.

Glencore separates its business structure into marketing and industrial activities amongst the various commodity business units (below). Within each commodity unit, Glencore often owns high quality, long-lived mines (Prodeco, Katanga).

The Origins

The company was originally founded by Marc Rich in 1974. This is the same Marc Rich who is credited with starting the spot oil market and was also a fugitive at large for more than a decade, only to be pardoned by Bill Clinton during the president’s last day in office. The company transferred hands from Rich to other management in 1993 and went public in 2011.

Between 1974 and 1993, Glencore transitioned from being a pure marketer of commodities to a more active role in commodity production with the purchase of smelters and stakes in mines. The ownership of mines and smelters is an interesting strategic decision. I can only assume that having a fixed supply of concentrates would allow you to enter into long-term supply contracts with guarantees provided by Glencore. No doubt, this would come with some sort of premium. This would’ve been one of the “vertically integrated” arbitrage opportunities that an individual miner would not be able to realize.

How does Glencore Make Money Through Marketing?

  • Glencore sources commodities from third-party suppliers or owned mines
  • Glencore provides value added services such as freight, insurance, financing, and storage
  • Glencore’s arbitrage strategies can be grouped into four buckets:
    • Geographic: Glencore can maximize selling prices by shipping a commodity to another jurisdiction. I’m not sure how this would work with spot markets everywhere and “paper” arbitrage. I imagine the geographic arbitrage opportunities have fallen over time. There’s probably some opportunity is smaller markets where you could literally sell something in Ghana at a higher price than in Brazil.
    • Product Related: Product related arbitrage seems much more applicable in today’s environment. Let’s assume the arsenic penalties increase rapidly above a certain point. You could purchase a high arsenic concentrate (just above penalty element thresholds), blend it down, and capture the profit margin.
    • Time-Related: If you have an upward sloping futures curve (contango) you could purchase the product, pay for storage, and sell forward for a profit.
    • Event-Driven: Less related to true arbitrage, event driven marketing activities focus on unique, and often local supply shortages caused by weather, or other factors.
  • Glencore enters into the following types of contractual arrangements:
    • Purchase/off-take agreements: These agreements result in Glencore becoming the legal owner of the commodity and taking full risk in the event that the company is unable to sell the product. Often Glencore will forward sell the commodity in order to manage price risk.

Some Background on Offtake Agreements:

Mines generally sell their products under three scenarios:

  1. Long-term offtake agreements (2-20 years);
  2. Short-term contracts; and
  3. Single cargo spot contracts

Is Asteroid Mining the Next Gold Rush?

Over the year’s I’ve read about a handful of space mining companies. As someone who’s participating in the existing mining ecosystem, there’s always a thought in my mind; could we get disrupted? It happens to everyone eventually, why not mining right now? Despite this thought, it’s impossible to not be skeptical about these sorts of propositions. I mean, mining companies struggle to generate economic returns on earth. How the heck could they pull off anything in space.

I understand the appeal that asteroid mining provides. For those of us that believe humanity’s exponential growth will outpace resource supplies, the unlimited resources of space provide a comforting proposition. I don’t disagree that there are massive resource supplies in space, which some proponents value in the quintillions! It’s worth highlighting, though, that there are a lot of “resources” on earth. The question isn’t how much there is. The question is what can be mined profitably.

I started getting into the weeds on this topic after reading an article recently published in the Journal of Mineral Economics titled “Mineral scarcity on Earth: are Asteroids the answer”. Funny enough, this twitter post jumped up on my feed at the same time. Seems to be a timely question…

What Would it Cost?

When thinking about the feasibility of space mining, we need to ask ourselves two questions: 1) what will is cost, and 2) what will it provide ($). It’s my opinion that no one truly knows how space mining would occur from an operational perspective. The reality is that the “technology to excavate and refine metals in situ in a near zero gravity setting”1 has not been invented yet. While this is the case, we know how metals are extracted on earth and there are a few interesting points that we can look into.

When I think about space mining, I think about a rocket getting fired into space with some mining equipment that gets dropped off on an asteroid. The mining equipment collects and concentrates the minerals. When a large enough payload is collected, the rocket transports the material back to earth. The first question we need to ask ourselves is, what would it cost to get a reasonable supply of mining equipment onto the asteroid or, much less, outside of Earth’s atmosphere.

Source: https://www.futuretimeline.net/data-trends/6.htm

This interesting chart shows how much it has costed through time to launch 1kg from earth into low earth orbit (LEO). LEO is not an asteroid. For our purposes, however, this cost can be used to illustrate what it would cost to get mining equipment into space.

The picture above is a CAT 930E haul truck. A fairly run-of-the-mill piece of equipment at an operational mine on Earth. Obviously, I don’t expect a haul truck to perform too well in a zero gravity environment. I’m using this example to cost out space mining as it is indicative of the huge amounts of physical resources that are used in mining. While this haul truck may be an egregious example in isolation, the reality is that mining operations (at least on earth) require drills, trucks, shovels, crushers, mills, and refining facilities. The true requirements to convert rock to metal are truly staggering

A 930E haul truck weighs 210 tonnes. As shown in the chart above, the Falcon Heavy can transport material to LEO for $950/kg. Nasa’s goal for 2040 appears to be $90/kg.

If we use the equivalent weight of 10 haul trucks as a proxy for the construction weight of a small mining operation, this would cost about US$2B for launches. Again this ignores the costs of actually getting this material to the asteroid, the equipment costs, space fabrication, etc. For simplicities’ sake, let’s say it costs 3x this amount to get the asteroid mine up and running ~$6B in CAPEX. Large mines on earth cost $1-$2B. For earthly profiteers to go to the hassle of getting to space there’s got to be some sweet metal up there!

What Will It Provide ($$$)?

Let’s ignore the price impact associated with “flooding” the earth with space metals and assume that existing metal prices remain constant. How much value could be on a single asteroid?

The paper that I referenced earlier highlighted grades for a potential asteroid. It is worth noting that the concentration of gold on an asteroid is very low (hardly economic if it was on earth). I imagine that the author’s asteroid prospecting experience is probably lacking so this information should be qualified with a big question mark regarding its validity. It’s interesting, however, that the example that was chosen highlighted that gold grades on asteroids are really unimpressive.

Source: “Mineral scarcity on Earth: are Asteroids the answer”

If we assume 100% recovery of the metals (which is impossible). The in-situ value of a tonne of asteroid rock would be approximately $1.4M. This is a lot! I mean, on Earth, a “good” open pit orebody would have an in-situ value of $100/tonne. This 1400x higher!

Unfortunately, however, I don’t think this cuts it. We haven’t really talked about operating costs or how this material would be making its way back to earth. It’s not like you can just push it into the atmosphere and it’s going to land at a refinery. Remember that cost to transport material into LEO works out to about $950,000 per tonne. If we assume that operating costs of a similar magnitude are required to blast, concentrate, load, and bring this material back to earth are required, then operating profits are reduced to $500,000 per tonne.

We, however, we need to think about transporting this material to smelters and refining the metal. If we assume that 90% of this material is payable (after smelting costs) and a further 20% is costed as part of transportation, the net revenue per tonne falls to US$350,000.

To produce US$1B in free cash flow per annum the operation would need to transport 2,800 tonnes of material back to earth per year. Maybe this is possible. Who knows? Even it was, this would produce an annual return of 15%; not too stellar given the risks.

Takeaways

After looking through the numbers:

– It appears that the economics associated with space mining are pretty poor, even after assuming some very low capital numbers

– Even if space mining was economic, the gold grades on an asteroid really aren’t compelling when compared to the grades on earth

Given these points the prospects of “gold raining down like sand” appear pretty poor. Good luck!

References: 1) Mineral scarcity on Earth: are Asteroids the answer, Dahl et al