I Am Down $12,000

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Investors,

Holy crap. The All In Portfolio is getting absolutely slaughtered right now. In the past week the All In Portfolio is down 15% or $7,316. From the high of $52,500 to a current level of $40,491. Since rebuying into coal equities the All In portfolio is down 18.28% or $9,057.

I was first buying coal equities back in early summer. They were all trading at basement level valuations. Sure, the equity prices were up 200-500% from COVID-19 lows, but still cheap. My timing was almost perfect. After I bought two of the three coal equities they both ran up over 100%.

My thesis was pretty simple at that time. Met coal prices were surging, yet the equities had languished. If the price of met coal held out through the summer, every producer would have the chance to lock in contracts for 2022 at significantly higher prices. Given the fixed cost business model, most of the price increase would drop straight to the bottom line.

The thesis worked out even better than I had expected. In the first writeup I ever did I had one of the coal equities locking in pricing at $120/ton for 2022 as my best case scenario. My bear-case scenario was $100/ton. That company recently announced that they locked in 56% of 2022 production at a whopping $196/ton.

I won’t go into great detail what this means for free cash flow as I have detailed it extensively to Alpha Letter Pro subscribers. If any of the members have missed these notes please find them below:

Contracts for 2022 were starting to get leaked a month or so ago. When I saw the pricing on 2022 contracts I decided to start rebuying into coal equities. The contracted pricing was extremely high and met coal prices were at all time highs.

Since I have rebought into coal equities, almost every single coal equity has fallen off a cliff? The selling has been relentless.

I’d much rather buy a stock and have it re-rate immediately. That is the dream. A quick reversion to the mean based on improving fundamentals. But that’s not how the market works. If the market worked like that we’d all be rich and there wouldn’t be a market. Price discovery would be gone. The fun of finding an undervalued business wouldn’t exist.

The real success in the stock market comes from having the conviction in an idea and holding for the long-term. If you panic sell anytime there is blood on the streets your results will be subpar. Building the conviction, holding and even doubling down is what turns boys into men.

Despite the dramatic fall in my coal portfolio, I continue to hold. I have not sold one share or bought anything since my last note. I believe that 2022 will be a record year for most met coal producers given the locked-in contracts and higher pricing.

Right now I think investors are focused on Seaborne pricing into China, which is spooking markets. There has been a large drop in pricing from $625 per ton to around $400 today. Met producers are still netting over $300 per ton in margin at current pricing, but the wild swings are scaring people off.

In addition China is slowing down their steel production. China wants steel production to be flat from 2020, which will make the back half of the year weaker as the first half of 2021 was operating at a ramped up basis. This cut in steel production is due solely to environmental issues, not a demand slowdown:

“It’s very difficult to do,” Larry Hu, chief China economist at Macquarie Group, said of Beijing’s balancing task. “The cut on steel production is due to environmental issues and high iron-ore prices, but not a calibration on [the extent of] a demand slowdown.” - WSJ

This new steel policy of flat production from last year requires China to cut production by 11% (59 million metric tons) in the second half of 2021. I’m guessing when 2022 comes knocking, which is only 45 days away, steel production will ramp back up again.

What is most interesting is the entire world is producing steel at a record level. Demand for met coal remains high and steel producer need coal. I mean why else would you lock in met coal prices close to $200 per ton in 2022 if you thought prices were going to come down?

In addition, the supply and demand dynamics are getting pretty interesting. Met prices are at record highs, but there is very little incremental tons coming online over the next few years. Usually high prices are cured by more supply, but in this case it doesn’t appear to be happening, given the dirty nature of coal, ESG concerns and lack of project specific financing in the space.

Peak capex for coal has happened years ago. If you are a miner you typically mine the best stuff first, a process called high grading. As the mines age it becomes harder to get coal. Eventually mines will close down due to economic inefficiencies.

Met coal capex is estimated to have fallen over 75% below peak 2012 levels in 2020. Both a high cost of capital and lack of access to funding for many producers. ESG pressure continues and is getting stronger.

With the largest coal miners in the world focused on decarbonizing and generating cash flow, there is a very real chance that coal stocks are headed into a multi-year commodity cycle. Combine that with contracts for 2022 at record highs, I am holding onto my coal equities.

If I am wrong, maybe they go down another 20%. A decent loss, but not life changing depression type loss. I don’t think any of the assets I am holding will go to zero given the contracted book for 2022 and improving balance sheets. If I am right on the other hand, we could be looking at major cash flows for a few years. I’m staying patient and thinking long-term. Nothing in the short-term really matters at this point.