Podcast Episode: Peter Sainsbury

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Transcript:

Podcast intro: ♬ In this episode of the Paul Zimnisky Diamond Analytics podcast, economist and author Peter Sainsbury joins.

Paul Zimnisky: Peter is a leading economist based in the U.K. He's also the author of multiple successful books, two of which have a special focus on commodities. In 2015 a he wrote "Commodities 50 Things You Really Need to Know." Two years later, he wrote “Crude Forecasts: Predictions, Pundits & Profits In The Commodity Casino.” And last year he switched gears a bit, pardon the pun, but he wrote a book on betting on Formula One racing, which is probably actually more related to commodity investing than it would appear.

But most recently, this past March, his fourth book was published. It's called "Pay Attention: 101 Ways To Tame The Narrative Machine, Be A Smarter Media Consumer And Stop Outsourcing Your Thinking”. The book is on how to navigate through the deluge of data and information thrown at us these days and how to be aware when we're outsourcing our decision making. Peter, kind of before we get into the commodity stuff, I just have to say this latest book couldn't be more relevant today. The idea of narratives driving the news cycle, you know, you think in the Internet age we'd all be so much more informed and educated, but all this information, and a lot of this misinformation has just seemed to have made us less informed or more confused.

I just wanted to read a quick quote from the book. You say: "The state, corporate giants, NGOs and vested interests within the media itself. Machiavellian or not, all of them are trying to subvert your decision making, propping up the architecture around you that frame your decisions. It may feel like you are making your own well-informed reasoned decisions. More often than not this is an allusion…(you go on to say) the book is not to make you a cynical media consumer but to make you a more attentive media consumer.”

I think it's a really insightful book. I highly recommend it. And and again, talk about timing. This literally came out in the midst of the early stages of the pandemic. You initially conceived writing the book because of the challenges you personally faced trying to collect and digest news from the standpoint of an investor. But, you know, of course, this runs much deeper than that. We're currently living through perhaps the most poignant example of this right now with the way that information about, you know, the virus is being disseminated to us. So, I am kind of curious, has writing this book personally prepared you to better navigate the news flow of the pandemic and, you know, not just from an investment standpoint, but from a safety/lifestyle balance?

Peter Sainsbury: Thanks for having me on your podcast and thanks for the introduction of books as well. And yeah, absolutely. I think the premise behind writing it was to help virtually from an investment point of view. But that's really kind of a secondary part of the book. It's more about the kind of understanding the media narratives, how they evolve and how they impact you and everyone around you. Yet the news is really designed to help fuel your anxiety. And that's what drives clicks if you use websites and it keeps you engaged into the, into the end of the news broadcasts and keeps you coming back for more.

But you know, that state of mind that the news develops you into affects how you perceive the world. And then the problem we've got now that we perhaps didn't have, maybe 30 or 40 years ago, is that we're all consuming different pieces of information and different news sources at different times. And, so whereas in the past you might have gone back into work after seeing a news to broadcast the night before and everyone had seen the same news broadcast and you'd all interpret it in the same way. And now we all go into our own different kind of filter bubbles and we all have a different perspective on the world.

And, so, it's as you mentioned, it's especially important now because we don't really have a collective feel of what the truth is in the world, whether it's the coronavirus or anything else. We all can and perhaps do have our own view and perspective of what the truth is. And that's ultimately quite divisive to families and society. The whole reason behind writing that book was to help enable people to have the tools to be able to see when that manipulation is taking place and to hopefully come together to find some common ground.

Paul Zimnisky: Yeah, I think somebody needed to say it, I'm glad you did. Then kind of looking at the pandemic's impact on the economy and the financial markets, I think it took, probably most people at least, by surprise that, you know, here we are over six months into this pandemic, we've had the greatest shock to the global supply chain in our lives with the lockdown and the travel restrictions. But the stock market, at least in the U.S. Here, it's just weeks off, you know, an all-time high. And I think that's in part the result of humans being resilient, including a nimble transformation to mainstream digital business. But, of course, we're also seeing record stimulus right now in the form of not only cash payments, but record low interest rates that are actually negative in real terms. You've seen that in Europe as well, which in some cases has forced investors, if you will, into riskier assets like stocks.

But this backdrop has also been fundamentally supportive of gold because the cost of carry is so low and because of currency debasement concerns. Gold made an all-time high in August. But there is a lot of debate that it should be even a lot higher given the conditions, and I think there's many people out there that think the gold price is being manipulated in part because governments probably don't want to see, you know, a strong gold price because it shows relative weakness in the fundamentals of fiat currency.

We've seen banks fined for failing to prevent manipulation, in the London gold fix, for example. So, I don't I don't think it's completely unreasonable to believe that there is some of this going on, meaning, central banks using, you know, derivatives, whether it's swaps or futures, to move the gold markets. And, this is something that really is on people's minds. And, I've been asked more times than once, if diamonds can be a viable alternative to the “hard asset, store value fundamentals” that gold offers without the potential manipulation of government selling pressure. So, I'm just kind of curious what your thoughts are on this? I know you did touch on it in the "Crude Forecasts" book.

Peter Sainsbury: Yeah, I completely agree that I think that there is numerous examples through history of recent times of governments and central banks intervening in the gold market. And that's really to kind of bolster trust in the system as it is. And so when what we've seen particularly in gold and silver is that when that's kind of threatened to break out, you know, the central and bullion banks that tend to be most active in the precious metals markets are able to kind of suppress the price and suppress investor expectations of higher precious metals prices. And what we've seen certainly over the last couple of years is the gold prices reclaim and surpass highs from over a decade ago.

I think what's useful actually is to follow not necessarily what central banks and others say, but it's more about what they do. So if you look at central banks in Russia and places like China and Turkey and elsewhere, they've been building up their central bank gold reserves over numerous years, really back to where they were 20 years ago. And, that kind of really started after the Financial Crisis, when there was that sort of breakdown in trust between governments, institutions -where debts and leveraged obligations were sitting. And so, the whole narrative towards higher gold prices is being clearly supported by, you mentioned lower yield potential of negative interest rates, but it's also been a breakdown in trust that we've seen certainly developed over the last five years specifically. But the five and 10 years as well.

And, so I think as you know, governments build up bigger and bigger debts, economies are much more laden down with debt. That suppression of the gold price has been has been possible in the past, but I don't think that's as possible, as easy for them to to carry out as it was in the past. The governments need to keep re-stimulating the economy in order to achieve the same level of economic growth and add more and more stimulus. And that all adds fuel to the fire of higher precious metal prices.

Paul Zimnisky: Yeah, I think I think we tend to look at this on such a micro fundamental basis, but then I always kind of try to take a step back and think from a broader standpoint. I just always find the psychology behind humans seemingly innate desire to own precious metals and precious stones. You know, these are assets that they don't provide cash flow and there's actually a cost to carry them.

Of course, a lot of people see these kinds of assets as a store of value and perhaps even a currency, if things really go wrong, you know, in say a system of hyperinflation, and I think this kind of relates to the diamond-water paradox, which states that although water is more necessary to humans than diamonds, diamonds command a much higher price. And, of course, this comes down to, you know, scarcity and supply availability. What do you think about the idea that since the beginning of time, mankind has placed such a great value on gold and diamonds. I mean, do you think this is practical?

Peter Sainsbury: Yeah, in that people have always sought protection for their wealth in hard assets and particularly things like gold and diamonds and other items that can't degrade or don't deteriorate in any way, and things like land and copper are prone to deterioration in some way over time. So, they're not as good as gold and diamonds as a form of stored wealth over time. And so, you have things like, you know, those kind of hard assets, saleable goods, in that they hold their wealth over time, and in the end, they will provide a really strong store of wealth. And I think, that again, it comes down to trust and trust in governments not to take control of your assets if you hold your paper money in the nearest bank.

There's always that risk. And that has been done, versions of that -the bank going bankrupt or the government stepping in to take some of that money. So, yes, partly about trust, but I think those hard assets all can have one thing in common, which is they don't have a very low stock-to-flow ratio. So if you think about the gold, the stock of gold, it only rises by about 1-1.5% every year. And even when the price of gold goes up, unlike most other commodities, the supply doesn't respond to that higher price. So, you've got little in the way of anything coming back onto the market. And that’s the same for things like gold, diamonds and other hard assets, where holders of the asset tend to hold it for long term. They don't come in and out of the market and take advantage of higher and lower prices.

And, just come back to the narrative around (wanting to own gold related to the concerns of) a complete breakdown of the current system -it's always talked about in disastrous consequences…of course, that could be the case, but it doesn't have to be the anarchy that many people describe, it can just be just a breakdown in trust. I think you only have to go back to 2013, in Cyprus, when deposit holders there faced a cut to their to their bank accounts to help fund the bailout. It's got it's got recent precedent, and I think that those kinds of factors will always be there and driving demand for the hard assets.

Paul Zimnisky: Getting back to diamonds, more specifically, and kind of looking at the way that diamonds are sold: more than half of rough diamonds, on the primary market at least, are sold via long term contract, where the producer essentially sets the price; and I just kind of wanted to ask you what other commodities are sold this way? I know fertilizer, for example, potash, is kind of sold this way and also uranium. But I guess, what's your opinion of commodities that are sold within this type of structure? And fundamentally speaking, do you think a market like diamonds would benefit if the majority of supply was sold according to more real time market dynamics rather than via a long-term contract?

Peter Sainsbury: I think long term contracts tend to suit environments where there are relatively few buyers and sellers. And, once those numbers start to increase, that negotiation becomes a lot more difficult. That was kind of what we saw in the iron ore market. So up until 2010, prices were the result of annual contracts. Up until the early 2000's, Japan was the primary buyer in the market. And then, of course, China comes in and dominates the market into the early part of this century. And, and that increasing complexity meant that those long-term contracts were no longer as applicable for the market. And, that's kind of really what we've seen through history: the oil market in the late-1970's and aluminum in the 80's and then thermal coal as well. They all moved from a situation where annual contracts were used to the development of spot prices.

So, that kind of effect was a result of the changes in the market structure -and you mentioned potash and uranium still remain on long term contracts. The background to those markets, again, there's only a few big sellers and buyers. Potash is really in places like Russia and Belarus, and then the buyers are typically India and China -the two, kind of, big groups that sort of set the market. And, then things like uranium, the contracts between the mines and the power plants last for maybe a decade or so. There's a real sort of incentive to it because the security of supply is so important. It would be very difficult, I think, to move away from a situation where contracts are decided as a result of annual contracts; they need that that guarantee, that security, that the feedstock will always be there.

And, I think in terms of other commodities like cobalt, lithium, rare earth metals, they continue to be negotiated through annual contracts. To take lithium as an example, I think there is some pressure to move away from that kind of arrangement to get more market transparency, more development of what the prices are doing for different grades. And we started to see that in the last year or so. Then, I guess with diamonds, they share some similar characteristics to the other commodities I mentioned. It's a market that you can't break down -it's not a uniform commodity in the same way that some other commodities are. And you've got that specialist knowledge. I can't see giving up that environment. I don't necessarily think moving away from annual contracts is going to happen any time soon, unless there's some big change in the market in terms of new supply coming on or a big source end market demand. I don't think there’s necessarily going to be the demand for a change in the pricing structure (or for) new risk management techniques to be used.

Paul Zimnisky: I think that explains a lot, makes complete sense. You mentioned China. Where do you think we are in the current commodity cycle? For pretty much my entire career, at least the last 15 years or so, you know, the massive growth in China has been the driving force for the commodity market. How much longer do you think this could last for? And, when do you think we another market, say, the continent of Africa, becoming the new demand driver? And then, not to ask you too much at once here, but it looks like we're going to be in a very low global interest rate environment for a very long time, how do you think this will impact the commodity market?

Peter Sainsbury: Yeah, I'll take the commodity cycle (question) first. I think that the pattern through history has been roughly sort of 15 to 20 years of rising prices and then perhaps 10 to 15 years of lower prices. And, that doesn't always follow, and different commodities follow different patterns over time. But, if you take prices peaking around 2008 to 2011, that really means we've either kind of hit the bottom or it's going to over the next few years. In the last, certainly last year, we've seen base metals and precious metals prices, of course, jump and part of that's been Covid-related disruptions, but also the expectation that China and others will have to sort of splurge on infrastructure spending to help their economies develop post-Covid. So I think there are some signs there that maybe that's an indication of the spark that will set the stage for the next supercycle.

You know, agricultural commodities, again, they've been in a downward trend for the last decade. But, there's some encouraging signs that they're starting to break out from that trend. And, I think it's really kind of energy prices, particularly oil, that's perhaps going to be a market that lags the other commodities in that we've had this transient narrative that we quite possibly hit peak demand, either and through Covid or through the growth in electric vehicles in coming years -oil demand potentially has peaked.

But, I think with oil and with other commodities, it's really looking at the capital cycle that's important to understand where the pressures are. It's not just about demand, it's about it where supply is at as well. I think what we've seen is the reduction in investment in the energy industry, and I think that's been encouraged by by fears over the future demand and the slowdown in demand. And, I think that will eventually start to rebound for higher prices. Sentiment is so low at the moment, you've got oil majors switching from oil to other forms of energy, reinventing themselves as renewable energy companies. And, I think that this will mean that the supply won't be there when demand does actually recover. So, I think that's probably some of the elements that are going to spark the next rebound in prices.

Then I guess you mentioned about China. You're right, I mean, you know, the last 10, 20 years, China's been really instrumental in the growth in commodities and commodity prices. And, I'm skeptical as to whether we're going to see...I don't think there will be another China. China's unique in that it dominates a number of commodity markets. I think it's about 30% of the world's traded supplies and as much as 60% of copper and iron ore demand. So, it's a massive player, of course. But I think maybe some of the other countries that have come in, of course India, has always been talked about as the next China on the horizon. I think compared with China, it's much lower that kind of S-curve of adoption when you think about fiscal and digital infrastructure. It's going to need to be a lot more investment in transportation and the electricity grid in order to be able to compete on the same scale as China.

So that will drive demand for commodities. And then I think you just get further afield to tap some of the African economies. I think there are some promising signs there. I think that as an economy as a whole, they, so far at least, have missed the worst of the coronavirus for now, and it seems to be those countries where they've got sort of strong and open democracies that have really performed well. So places like Senegal and maybe Rwanda and Nigeria, that have been performing really strongly in the last year or so. But I mean, Africa faces a number of different challenges that maybe some other economies are less at risk of. Rethinking things like climate change and how those economies will adapt. Something that would probably be a key thing to watch out for over the next 5, 10 years is which economies, which places are the most adaptable.

So, what's your last question -you have to remind me?

Paul Zimnisky: I think you did a great job of covering everything there. Just, I guess the low interest rate environment and how that could potentially impact commodities, given that it's probably going to be a medium to even longer-term situation?

Peter Sainsbury: I think to some extent, it's quite easy to think that what's been happening at the moment, the impact from the virus and the lockdown, is going to be inflationary. We can all kind of see the evidence of that -when you go shopping and some of the things you want to buy have definitely gone up in price. But, I think we're probably still in a sort of deflationary stage at the moment, and that includes things like debt, demographics and really new technology as well, that's naturally deflationary. And, what tends to happen in previous recessions is some new technology or new application of that technology is introduced - it's born out of the ashes of a recession and that then acts as a deflationary force going forward. And so I think, perhaps in the short term, short to medium term, those deflationary forces will outweigh those inflationary pressures, at least overall.

What's really interesting is how governments and central banks will have to react to that. Because they want to avoid deflation at all costs and to avoid that debt bubble from getting even bigger. In order to do that, they're going to have to provide even more stimulus to the economy to get the economy going. So even in the U.S., we've seen the Fed is going to target an average rate of inflation and whether that is achievable or not we'll have to wait and see. But yeah, I could see that…that kind of approach is probably going to be seen elsewhere around the world. So once those inflationary pressures start to kick in, once we see the dollar turn over, and I think it will still to continue to be the global reserve currency, as it’s the best of the bad bunch, as it were, but, once the dollar starts to come under pressure, once those inflationary pressures start to emerge, then it will be that commodity prices will really have a good tailwind.

So, whether that's in a year or two years, as always, with markets, people are always looking one step ahead to anticipate when those pressures are going to come up -it'll probably come sooner than we all expect.

Paul Zimnisky: Yeah, I think you mentioned technology, and I think that's the one component of the productivity function that I think we've way underestimated. We've definitely had I think, you know, a parabolic rise in productivity from technology specifically. And I don't know if we can maintain that level of growth and productivity related to technology -at least at that pace we have been. So, I think that's probably going to be the key to this.

I guess maybe just one more question: on the price-elasticity-of-demand. You know, it's a measure of how a price of a commodity, in this case, impacts the demand for the commodity. I would say this measure certainly applies to diamonds. Especially in a developed market, demand for diamonds from the consumer, it's historically been less sensitive to price changes.

And, I think this is in part because diamond engagement rings, for example, are seen as essential, you know, whether they cost $4,000 or $5,000, but also because diamonds are a luxury item. So, you can get into the area of a Veblen good, which is based on the notion that, you know, the higher the price, the more exclusive and the more desired they become. But, then also looking at the tradition of giving a diamond engagement ring, it's essentially a financial sacrifice that the person that is giving the diamond is making a show the person they're giving it to how serious and how committed they are to marrying them. So, if the price isn't high enough, it may not be as much of a sacrifice, and this is referred to as Zahavian signaling in psychology. But, but I'm just kind of wondering, can you think of any other commodities that have as little price elasticity as diamonds?

Peter Sainsbury: Probably not actually. I think diamonds have a very unique property in that respect. I mean, you mentioned about Veblen goods they are diamonds are unique in terms of a commodity and having those kinds of characteristics. You could look at gold, silver and other precious metals, but I'm not so sure that it has the same characteristics, because if you're buying a ring or other piece of jewelry, you've got the option to substitute it from gold to silver to platinum to palladium. So, you've got substitutes there, so that I think the price elasticity isn’t the same. You could look further to other assets like fine wine or art, you'll probably see similar properties...

Paul Zimnisky: Vintage cars and vintage Formula One race cars probably also…

Peter Sainsbury: Indeed.

Paul Zimnisky: Okay, with that we'll wrap it up. In addition to the books, Peter also hosts a website that's actively updated called Materials Risk, it's geared towards commodity market insights. He actually recently interviewed me for the site; that was posted on September 19th. So check that out. Information on his books, links where to buy them, including the audio versions, are all available on the Materials Risk website. I'll provide a link in the description of this podcast. But the website is Materials-Risk.com. Thanks, Peter, and I look forward to getting a pint next time I'm in your neck of the woods.

Podcast outro and disclosure: ♬ Thank you for listening. Please note that the contents of this podcast includes observations and opinions and the information should not be considered investment or financial advice. Consult your investment professional before making any investment decisions. Paul Zimnisky and the guest does not accept culpability for losses and/ or damages arising from the use of this content. Third party use of the content is only permitted with permission. This has been a Paul Zimnisky Diamond Analytics production. More information can be found at www.paulzimnisky.com. At the time of recording Paul Zimnisky held a long equity position in Lucara Diamond Corp, Mountain Province Diamonds Inc, Star Diamond Corp and North Arrow Minerals.