Long before quantitative easing and the existence of central banks, one of the earliest examples of monetary policy was debasement. To fund unsustainably high government spending, a sovereign would collect the nation’s gold and silver coinage, melt them down, incorporate some kind of cheaper metal into the mix and remint them as new coins, thus expanding the money supply. Between 1544 and 1551, King Henry VII and Edward VI systematically debased English coinage to pay for their wars. English silver coins started from 92.5% silver content to 50%, then 33% and finally to 25%. As one can imagine, this trend resulted in a period of particularly high inflation.
While the above is an interesting fact of history, what is most fascinating was what happened afterwards. Under the advice of her ministers, Queen Elizabeth I decided to reverse her father’s policy, removing all the debased English coins from circulation and replacing them with coins made of pure silver. Far from falling, inflation remained high for another 100 years. It turned out that while English money supply shrank, the recovery of the overall population in a post-pandemic world (black death at the time), government enclosure policies and the knock-on effects of Spanish gold and silver imports from South America appeared to offset the effects of “rebasing”. Predicting the future or the consequences of one’s own actions can prove extraordinarily difficult, even when it may appear obvious.
When Russia invaded Ukraine last year, it set off a price spike for many commodities. Oil peaked at $120, Potash peaked at over $1,000 and natural gas peaked at US$10. Calls at the time were for prolonged and higher prices. The basis of these calls was a prediction that the war would last a long time and demand for these commodities would be largely inelastic on top of the supply/demand dynamics for these vital commodities having fundamentally changed. Throughout the fall of last year, fears of an energy crisis gripping Europe for winter became very loud. Energy rationing, people unable to heat their homes, and a shutdown of industrial activity seemed near inevitable as winter approached.
Today however, oil, potash, and natural gas have all fallen to levels at or below when the Ukraine war commenced. To be clear, things could have easily gone the other way, Russia/Belarus accounts for 40% of Potash production and it was perfectly reasonable to expect some form of potash super cycle. It surprised everyone when it turned out that farmers would rather take a lower yield on their crops rather than absorb the higher cost of fertilizer. It also seemed reasonable to assume that if a major source of supply of natural gas was suddenly cut off, there would be an energy crisis in Europe, especially for winter. What was not anticipated was warm weather, renewable power generation being strong, or that imports of natural gas from other locales besides Russia were easier to bring in than the world had thought. From our perspective, our only conclusion is that predicting the future is nearly impossible, especially because the future is influenced by countless factors, most of which we wouldn’t ever consider until they have happened.
Source: Capital IQ, Natural Gas and Oil, 2022
Source: FMB, CRU | Last data point 08-Dec-2022
Source: BMO, 2022-2023
We are often asked if we think there is a coming recession, and whether we could be in for a “soft landing” or something else entirely. Our answer usually feels unsatisfactory – we don’t know, and we’ll probably be wrong if we try to predict it anyways. What we can and will say, however, is that we aim to create a portfolio of companies that can collectively perform better than many in a recession while also being able to thrive in a soft landing.
Within the strategy, we have been trimming our investments with exposure to commodity prices throughout the year, while at the same time generally adding to investments that are users of these commodities. Our top weight in CCL Industries is one such “user” of commodity prices. When commodity and shipping costs spike, the company experiences a lag between the immediate increase in expenses to them, and the resulting rise in revenue when they pass on these costs to customers. We continue to feel strongly that the company has the pricing power to pass on costs (albeit with a lag), and more importantly is well-positioned to manage effectively in a recession and thrive in an expansion (where inflation may not be such an issue). We don’t take a view on the economy when we choose to invest in CCL, other than to say that we are confident in the investment, regardless of the economic outcome. With valuation at multi-year lows as the market shows its concerns over future inflationary forces affecting the company’s profitability, we have taken advantage of the discounted valuation on the company.
Predicting the future is challenging, and in many respects largely futile in our opinion. Our goal is simply to choose the best opportunity set that will deliver a range of outcomes that range from “acceptable” to “good”.