Monetary Policy in in 2024 and the Case for Unranium
Over the last two years, we saw interest rates rise rather dramatically from their very low pre-pandemic levels. When the whole world went into lockdown in early 2020, central banks proactively lowered rates for the last time in an attempt to support the ailing economy, not sure when the pandemic would come to an end and when economic activity would normalize.
A lot has happened since then. Eventually other stories dominated the headlines, for example the Ukraine war or more recently the Israel-Gaza conflict. At this point, the pandemic seems like a distant memory. While the world has fully recovered from the economic effects of the covid crisis, we more and more realize how unique and far reaching its consequences were and still are. We will all remember that extraordinary chapter for the rest of our lives and while all seems to be back to normal, we see now how difficult it was to deal with the economic effects of the pandemic, especially from a monetary point of view.
Although inflation had been hovering around two percent for most of the time before the pandemic, the subsequent rapid surge of consumer prices caught everyone by surprise, simply because it was a situation that nobody had experienced before. As inflation started to move higher and higher (reaching almost 10 percent, or even slightly more, in most countries), central banks could not ignore it anymore and what followed was the most aggressive rate hike cycle of the last 40 years.
Today, with the benefit of hindsight, we are beginning to understand the unique inflationary dynamics that started to develop as the whole world was emerging from the lockdowns at the same time. With a rapid rise in demand and a still restricted supply in many areas, the economy was confronted with a huge shock. Supply simply could not keep up with demand and global supply chains were experiencing a lot of stress and delays. As textbook economics would suggest, when demand outpaces supply, prices should start to rise and that’s exactly what they did. In response, central banks have been hiking interest rates since early 2022 and only paused very recently. Inflation in most markets peaked in late 2022 and early 2023 and since then it is trending lower.
Central banks arguably acted too late to effectively reign in surging prices and thereby failed to limit this last inflationary wave which could have been milder and shorter. They may now be making the same mistake and once again waiting too long to act. With central bank rates still around the highest levels, a consistent downward trend in consumer prices and clear signs of strain beginning to show in the economy, the risk of over-tightening has become very real. Producer prices are falling even faster in many countries - China for example is showing a decline of almost two digits. As we are moving into the final weeks of 2023, it is becoming increasingly clear that we are dealing with a very significant divergence between central bank policies and economic reality.
The problem with monetary policy decisions is that there is a considerable time lag between rate hikes/cuts and their effects on economic activity. There is typically a 6-12 month delay, which means that the full extent of these rate hikes will most likely only be felt in the coming months. The shape of the yield curve is inverted in many countries, i.e. long-term rates are lower than short-term rates. While the Fed funds rate in the U.S. is at 5.5 percent, the 10 year Treasury yield has fallen back to around 4.5 percent in recent days after having hit a peak at around 5 percent.
Financial markets have gone through a volatile phase since late summer, due to the pressure applied by higher and higher yields. Investors have been very focused on central bank decisions and hawkish comments by the Fed put pressure on stock and commodity prices, while on the other hand supporting the U.S. Dollar. The Dollar has held up well in recent months and did so primarily because of interest rates. This suggests that the USD might be in for a very rough ride in 2024, as central bank rates have probably peaked and will at some point start to fall. Given that the effects from rate hikes come with a significant delay, we are expecting growth to slow significantly in 2024 and though a recession might be avoided, we expect lower growth and further easing of inflation. Several factors suggest that inflation might go up again in coming years, but it seems that at least for the next 12-24 months it will likely be trending lower, towards the target level of 2 percent, or at least to levels low enough for central banks to feel comfortable. This will eventually trigger a monetary U-turn with profound and far reaching consequences for investors.
What might these effects be and how would they impact investment and asset allocation decisions? The last couple of trading days in October and the first few days of November are a good indicator of what might happen on a larger scale in the coming months. Most central banks during October communicated that they want to keep interest rates flat for the time being and wait a bit longer in order to see if inflation keeps trending lower without further intervention. Another important indicator is the job market, and that is especially true for the United States, where the Fed has made it clear many times that tight labor data is a primary concern. While it is true that the labor market is strong and tight, we also need to realize that it will be chronically tight for a long time, simply because of changing demographics, as there are fewer and fewer people to fill the jobs left open by the retiring baby boomer generation. This trend will be with us for many more years, which means that the rate of unemployment is not a reliable indicator anymore of how well an economy is doing. In the first week of November, when economic data showed a rise in unemployment and a slowing economy, equity markets immediately started to move higher. Longer-term yields have started to fall and the Dollar came under pressure.
This reaction gives us a taste of what 2024 might look like. Should inflation indeed move towards 3 percent, and possibly even lower, with economic momentum slowing further and the job market becoming weaker, we could see a rather dramatic realignment of central bank policies with economic realities. With currently high interest rates continuing to have a slowing effect on the economy, the need for central banks to adjust rates could become a much higher priority and result in a sharp reversal in monetary policy. Previous economic and interest rate cycles have shown that the Dollar might drop significantly when the rate cycle flips over. For example, when the economy slipped into a recession in 2002, the U.S. Dollar Index lost more than 30% in 36 months.
For us at BFI Infinity, the most important take away is that 2024 could look very different to 2022/23 and that this might bring a lot of opportunities for investors. In order to benefit from these opportunities, investors need to focus on a global and well-diversified portfolio. However, rather than simply buying the market by indexing through ETFs and funds, investors should build a diversified portfolio with a clear focus on specific areas, sectors and themes that will have a significant value creation cycle ahead of them. In previous editions of our investment update, we have discussed several of these ideas. In this edition, we will focus on uranium and the opportunities in the field of nuclear energy.
The investment case is relatively simple: after a few years of difficulties, people have realized that nuclear power might indeed be one of the cleanest sources of energy. This is especially important at a time when global warming seems to be the most pressing problem. With the world urgently searching for viable alternatives to fossil fuels, it seems that nuclear energy is more needed than ever before. This will ultimately increase demand for uranium, which has in recent months started to pick up a lot of momentum. We believe there is much more to come in coming years, as we’ll explain in the second part of this update.
We believe that the outlook for the remainder of the year and especially for 2024 is very interesting and we look forward to taking advantage of the opportunities that will come up. We would like to wish all of our readers the very best for the rest of the year, a happy Thanksgiving for our U.S. clients, and of course, a happy holiday season and a blessed New Year. We will continue to work with the same fervor and toward to the same goals that we have been doing for more than 30 years and we look forward to keep helping our clients protect and grow what is rightfully theirs.
Daniel Zurbruegg CEO BFI Infinity
The case for Uranium
For many investors and for the majority of ordinary citizens, uranium has long held negative associations, stemming from the horrific accidents of Chernobyl and Fukushima. However, the practical challenges the world economy is facing today, together with leaps in innovation and technology, have brought nuclear power back into the spotlight as the only truly efficient, realistic and sustainable solution to today’s energy problems.
The nuclear winter
For decades, the nuclear energy industry had been plagued by public fears and political obstacles. Even as the harrowing memories of Chernobyl began to fade, the 2011 Fukushima accident renewed calls for a total ban and for state divestment. The green energy movement, the global spread of environmentalist activism and the rise of ESG investing all applied significant pressure on most governments and financial institutions to shun nuclear power as much as fossil fuels (if not more) and to focus on other alternatives and renewables like wind and solar energy.
However, this energy transition, especially in Europe which made the largest leaps away from fossil fuels, proved to be more challenging than many of its proponents expected. On top of numerous nuclear plant shutdowns across the continent over the last decades, the premature legislative and regulatory push against oil and gas that followed in response to green energy demands, created serious vulnerabilities in Europe’s energy sufficiency. As the alternative sources failed to close the gaping supply gap left by their predecessors, Europe was largely rendered dangerously dependent on imports, predominantly Russian ones. The Ukraine war elevated this strategic misstep to a full blown crisis, which directly affected ordinary households last winter, forcing many to make a previously unthinkable “eat or heat” choice.
It is not only geopolitical concerns that are driving the resurgence in nuclear power interest. Compared to both traditional and renewable energy sources, nuclear energy has by far the highest capacity factor (electrical energy produced per producing unit or energy plant). And while the pressure for environmental action is stronger than ever, there is also a growing understanding that realism rather than sheer optimism might be better suited to achieve those crucial goals.
Nuclear power has long been established as a far cleaner energy option, as it emits the least CO2 compared to the other contenders and it generates minimal waste. It is also the most stable option: In 2020, according to the U.S. Energy Information Administration, nuclear plants produced maximum power for over 92% of the time, rendering them almost twice as reliable as natural gas and coal plants, and 3 times or more than wind and solar units (which are notorious for their intermittent nature). This means that nuclear energy can provide 24/7 base load power, which renewables cannot. In fact, options like solar and wind farms must even be supported by base load power if the wind is not blowing or the sun is not shining.
And despite popular belief, it is also one of the safest options available too. While air pollution from fossil fuels causes an estimated 7 million deaths each year, nuclear energy carries a similar risk level as wind power. According to a recent Sprott report, nuclear power has one of the lowest mortality rates per terawatt hour (incl. the deaths from Fukushima and Chernobyl disasters), second only to solar energy. New designs for nuclear reactors, new processes and protocols, stricter and more internationally standardized best practices have all ensured that this trend will most likely persist. As Michael Shellenberger, the founder of the environmental organization Environmental Progress pointed out: “Twelve years after Fukushima, we’re just getting better at operating these plants. They’re more efficient, they’re safer, we have better training.”
Finally, when it comes to public support, as the Sprott report highlights, “Sentiment toward nuclear power has been growing more positive, especially following Russia’s invasion of Ukraine in early 2022. 57% of Americans say they favor more nuclear power plants to generate electricity, up from 43% in 2020, with both political parties showing increasing support. Historically, safety concerns have made investors and the public wary. However, the pressing need for clean energy is now overshadowing these apprehensions.” Indeed, the electrification wave (and the energy demands that come with it) is already underway and it is becoming increasingly clear that nuclear power is best suited to facilitate it. According to the 2022 IEA World Energy Outlook, global electricity demand is expected to rise by 76% surge by 2050.
This all makes nuclear power seem increasingly attractive as a solution, as does the fact that it is a tried, tested and demonstrably reliable energy source. One out of five homes in the US already get their power from it, while US nuclear plants generated 772 billion kilowatt hours of electricity in 2022 - enough to power more than 72 million homes. In fact, nuclear reactors have supplied around 20% of power in the US since the 90s and the country is the largest producer of nuclear energy in world.
Uranium supply side dynamics
Following the 2011 Fukushima disaster, the mass pullback from nuclear energy resulted in a “lost decade” in terms of investment in the industry. However, there is now a tectonic shift underway. Currently, there are 434 nuclear power plants operating globally and 59 under construction, and another 111 more are planned. 2023 has already seen an extraordinary surge in announcements for nuclear power plant restarts, for extensions of the operational lifespans of existing ones and for new ones being commissioned.
Having experienced severe underinvestment for over a decade, uranium mine supply is now massively inadequate to satisfy the globally rising demand, with a cumulative forecasted shortfall of 1.5 billion pounds by 2040, as seen in Figure 2. Even if we factor in secondary sources, like uranium derived as a by-product from the mining/treatment of other metals, recycled materials, the re-enrichment of depleted uranium or decommissioned military equipment, demand will still most likely persistently continue to outstrip supply, which will eventually have to be covered by miners. It is also important to highlight at this point that uranium has no substitutes. Other industries might have more options, for example switching platinum for palladium in the case of the automotive industry, but for nuclear reactors, there are no other choices.
This will prompt utilities to race to lock in supplies and to purchase uranium in record quantities. Due to this demand surge, which has only just begun, prices have already shot up, reaching a 15-year high in November. This is a price level unseen since 2008, three years before the Fukushima nuclear accident.
The majority of global uranium mine supply, over 51%, is controlled by Kazakhstan and Uzbekistan, both former Soviet states and under the Russian sphere of influence, followed by Canada at 15%.
Russia also controls shipping routes though and accounts for almost 45% of the global market for uranium conversion and enrichment. This could add even heavier pressures on supply, should there be further geopolitical escalations with the West.
There are also other practical factors that support the case for uranium. First of all, it is important to note that the impact of the uranium price on the price of the energy generated in a nuclear power plant is very small compared to natural gas and coal (uranium accounts for only 5-10% of the price of electricity generated by nuclear power). This, combined with the fact that there are no substitutes, means that much higher uranium prices can and will be paid by utilities, otherwise billions’ worth of investments in nuclear power plants would go to waste.
Finally, there are fairly recent technological advances that could play a very big role and increase demand even further. Chief among them is the development of small modular reactors (SMRs). These are compact nuclear power plants that typically generate from 10MW (“microreactors”) up to 300 MW, compared to full-scale plants that can produce over 700 MW.
However, thanks to their modular nature, they can be scaled up to generate as much power as needed, even as much as conventional plants. This innovation could represent a whole new chapter for the industry, as SMRs are much cheaper, safer, easier and quicker to build; a sharp contrast to the larger plants that take many years and many billions to complete. Though they are still new, Russia has already built floating SMRs with a 35-MW capacity, while major SMR projects have also been announced in other nations too.
Overall, it is clear that nuclear energy is experiencing a global renaissance and we expect that uranium, the irreplaceable, indispensable fuel of this shift, should have a bright future as an investment.
This report was prepared and published by BFI Infinity Inc., a Swiss wealth management company registered under the U.S. Investment Advisors Act of 1940 with the U.S. Securities and Exchange Commission (SEC) as an investment advisor.
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