Inflation may be easing somewhat but interest rates will continue to move upward, presenting a headwind for markets. Investors are acting on bargains but in restrained ways until an uptrend develops. The Explorer’s Fanuc (FANUY) is up 10% in the last two weeks and Chilean real asset play SQM is up about 25% in the last five weeks. Today, we add another new overseas play, this time from London.

Cabot Explorer Issue: May 26, 2022

Dr. Copper and the Markets
Clearly there’s been a revaluation of growth stocks, and in particular tech stock valuations. It’s hard to know how far it goes, but many of these are significant businesses selling at cheaper prices than they have been trading for over the last year. This is in spite of the fact that Apple, Amazon, Alphabet, Microsoft and Meta brought in more than $60 billion in the first quarter of the year, up from $41 billion in the same period in 2021.

Big tech earnings seem to be meeting expectations and beyond and at some point will rally. Painful as this pullback has been, tech is still way up over the last two years, as you can see from the below chart.

The Congressional Budget Office (CBO) came out with a forecast that sees inflation receding to 4.7% in the fourth quarter of this year. That would reflect an easing from the more than 8% annual inflation in recent months.

Perhaps a better predictor would be copper prices, referred to by Wall Street as Dr. Copper. Closely tied to overall economic activity, copper prices jumped in the last two years, going from about $4,400 a ton in May 2020 to a high of close to $10,000 a ton in May 2021, but has fallen back to around $8,600 a ton on the London Metals Exchange.

What is going on? Could this just be a predictor of lower economic activity across the globe, particularly in China, or a sign that the green revolution is on hold? Regardless, amidst all the chatter about a new commodity “super-cycle,” clean tech copper certainly seems to have one of the stronger bull cases (more on why later).

Not all that long ago, no less than Goldman Sachs predicted that copper prices will rise to $15,000 per ton by 2025, from $8,600 today, as demand for the so-called red metal outstrips supply. Today, the Explorer adds a leading hard asset copper and industrial metal play trading at a discount with a big dividend. It’s a company that’s a hedge on inflation, China coming out of Covid lockdown, electrification of the grid, and an increase in economic growth in 2023.

New Explorer Recommendation
Rio Tinto (RIO)
At first blush, its numbers look like that of a software company, with the latest quarterly earnings up 36%, operating margins of 46%, and a return of equity of 41.6%. Instead, it is a mega-cap mining stock that is based in London with operations all over the world including Brazil, a cash position of $15.3 billion and a giant forward dividend yield of 11.4%.

The company operates mines, mills, refineries, smelters and power stations, including a significant hydropower portfolio. Rio Tinto also owns and operates much of the infrastructure – railways, ships and ports – that takes its goods to customers.

Employing more than 47,000 people across 35 countries on six continents, it supplies the world with gold, diamonds, aluminum, copper, titanium, iron ore and other industrial metals. Of these, the most intriguing is perhaps copper, for all the reasons mentioned above.

Was Goldman Sachs right that copper prices may nearly double in the next three years?

Demand growth will come from the greening of the economy since copper is a cost-effective conductor of heat and electricity and therefore a critical input to greentech.

It takes four or five times as much copper to make an electric vehicle as a regular car. Copper also goes into charging stations, solar panels and wind turbines. However, at present, annual cleantech demand for copper is only about 1 million tons, or just 3% of supply. Goldman thinks this could go up 5X by 2030, which will move markets since they look ahead.

And don’t forget that copper output is far less flexible and inelastic than many economists think. It takes about three years to expand output at an existing copper mine and a decade or longer to get a new one up and running after all the red tape, not to mention enormous buckets of capital.

Over the past five years, Rio has also generated ample cash flow of $5.78 per share, according to Morningstar. The stock has pulled back about 10 points and trades at only five times trailing earnings, which is about half of its historical valuation. BUY A HALF POSITION

Model Portfolio

Portfolio Changes
None

Updates
CVS Health Corporation (CVS) shares are demonstrating relative strength, adding five points this past week as the company ranks #1 among its peers in the Investor’s Business Daily’s Retail-Drug Stores industry group. CVS Health is one of the nation’s leading healthcare companies, with almost 10,000 stores, and is viewed in a different category than retail companies such as Target and Walmart whose stocks have suffered as of late. Nearly 70% of Americans live within three miles of a CVS and it has more than 102 million pharmacy plan members. CVS stock remains a conservative buy as it is still undervalued. BUY A HALF

Fanuc (FANUY) shares are up 10% since being added as an Explorer recommendation two weeks ago. Fanuc is the world’s leading manufacturer of computerized numerical control (CNC) devices that are used in machine tools and also serve as the “brains” of industrial robots. Fanuc is building a new factory near Tokyo to double its domestic output capacity of machine tools to produce parts of smartphones. CSLA estimates Fanuc’s U.S. market share at 50% and in China about 20%. Exports account for 90% of Fanuc’s sales.

Fanuc’s stock offers investors a solid balance sheet with no debt and $7 billion in cash. Profit margins are high. In summary, Fanuc is a high-quality play on what seems to be an unstoppable trend. Our six-month target for this high-quality, conservative stock is 25. BUY A HALF

Ford (F) shares were flat this week as the company restructures to offer ICE and BEV products to markets in transition. ICE is an acronym for internal combustion engines and BEV is short for battery-electric vehicle and would exclude things such as hybrids, which have gas engines and batteries.

I think Ford is making a smart move in focusing much of its energy on just two BEV products, the Ford F-150 Lightning pickup and the Ford Mustang. This is in line with what Musk has done at Tesla. Trading at about four times trailing earnings, this is perhaps the best value of the leading EV makers so I encourage you to buy if you have not already done so. BUY A FULL

Novonix (NVNXF, NVX) shares were up marginally this week despite a cooling of enthusiasm for electric vehicle-related stocks in general.

We have already taken some profits in this Australian stock that is a strategic provider of U.S. synthetic graphite that is both higher quality and lower priced than Chinese graphite. China has a lock on the production of natural graphite that is a critical electric vehicle battery component. Novonix has a bit of a moat in that it owns patented, innovative technology and benefits from a strong, well-known partner in Phillips 66.

This is an aggressive idea, but Novonix remains a buy recommendation for aggressive investors. BUY A HALF

Oracle Corporation (ORCL) shares were up three points this week as the company is set to gain European Union antitrust clearance for its $28.3 billion acquisition of U.S. healthcare IT company Cerner Corporation. This quality, conservative software company also recently announced that its Oracle Cloud Infrastructure (OCI) product gained U.S. Department of Defense approval, which should lead to more government contracts. This global stock is showing relative strength in the tech sector as it is increasingly seen as a cloud stock rather than a software company. BUY A HALF

Sea Limited (SE) shares were up a point this week as the current bear market has hit many tech and growth stocks hard and contributed to the roughly 80% drop in Sea’s share prices from all-time highs set last fall. This does not sound good but keep in mind we sold into strength a few times during its amazing rise and the company continues to report solid sales growth.

Revenue from Sea’s e-commerce wing Shopee disappointed, but gaming arm Garena’s revenue gained and is still growing fast but at a somewhat slowing rate. Meanwhile, revenue from SeaMoney, Sea’s digital financial services unit, more than quadrupled to $236 million. A Goldman Sachs analyst recently picked up the company with a 196 target and SeaMoney revenue is expected to increase 155% in 2022. This is a buy for aggressive investors. BUY A HALF

Sociedad Química y Minera de Chile S.A. (SQM) shares were up 8 points this week after reporting revenues of more than $2 billion for the quarter, up nearly 4X year over year. Revenues from the lithium segment surged more than tenfold year over year driven by strong lithium sales volumes and prices. SQM has gone from 74 to 101 since being added as an Explorer recommendation.

Lithium demand is expected to outstrip supply by 40X by 2040 and SQM’s lithium output is almost 20% of global lithium output. Lithium demand, sales, and prices have been going in the right direction and Russia’s fertilizer exports that normally account for about 25% of world exports are down sharply. SQM is also the world leader with a 46% market share of potassium nitrate for plant nutrition. BUY A HALF POSITION

The next Cabot Explorer issue will be published on June 9, 2022.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld

Analyst Bio

Carl Delfeld

Carl Delfeld is a member of the Cabot investment team, and chief analyst of Cabot Explorer.

He received his Masters in Law and Diplomacy at the Tufts Fletcher School; worked for the First National Bank of Boston (now Bank of America) in London, serving as director of the Japan and South Korea Group; served as vice president at the investment bank Robert W. Baird & Company, developing new business in Tokyo, Hong Kong and Sydney; was Asia advisor to the U.S. Congressional Joint Economic Committee, the U.S. Finance Committee and the U.S. Department of the Treasury; wrote for Forbes Asia and the Far Eastern Economic Review; served as a member on the U.S. National Committee on Pacific Economic Cooperation and the Japan-U.S. Friendship Commission; was chairman of the Asian Pension Forum and wrote a book, titled, Red, White & Bold; the New American Century.