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In 2019, InvestorPlace’s Eric Fry recommended his readers buy $10 Freeport McMoRan (NYSE:FCX) call options.
At the time, it could’ve been the punch line to a Wall Street comedy routine. The copper miner was still reeling from the 2015 commodities crash and the next “commodities supercycle” sounded more like a joke.
How the world has changed…
Today, FCX shares are worth over $50. And governments worldwide are stumbling over each other to secure the raw materials that Freeport and other miners create.
Meanwhile, energy firms are similarly doing well. Shares of Indonesia Energy Corp (NYSEAMERICAN:INDO) are up 660% this year and Moonshot-recommended natural gas play Enservco (NYSEAMERICAN:ENSV) has tripled in price. Mr. Fry’s bullishness has proved correct.
And I have some more good news. Though it might feel as if the “commodities cycle” has already passed, it’s not too late to hop in for one last laugh.
Oil & Mining & Agriculture! Oh My!
Commodity-based firms have long been a treasure trove of Moonshot bets. High capital costs and a cyclical market mean firms can go from worthless to Wall Street stars in a matter of months. Case in point, Freeport-McMoRan traded as low as $3.52 before rising to its current prices.
But not every company is so lucky.
Rare earths miner Molycorp was once worth nearly $20 billion back in 2011, before a series of failed projects sent the company into bankruptcy. And today’s high energy prices wouldn’t have saved the dozens of now-defunct coal companies that folded after the 2015 cycle ended.
It’s essential to be able to differentiate between the survivors and losers.
In short, that’s because most metals and mining firms look a lot like Olympic Steel (NASDAQ:ZEUS) — low-margin companies that rise and fall with the markets.
When commodity prices are high — as they were in 2021 — these firms can mint small fortunes. Olympic Steel’s Return on Equity (ROE) exceeded that of Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) and Proctor & Gamble (NYSE:PG) in 2021.
But in most years, these companies fail to cover their cost of capital. Since 1998, ZEUS has averaged a less than 5% annual ROE, a fact highlighted prominently by its lagging share prices. As a general rule, no company can succeed if long-term returns lag its cost of capital.
Separating the Lunar-Bound from the Lunacy
What about higher-quality plays?
Sometimes these bets pay off…
Take Moonshot-recommended Cameco (NYSE:CCJ), which operates some of the most productive uranium mines in the world. Shares have doubled over the past year.
…But other times, they don’t.
Companies like Minerals Technologies (NYSE:MTX) often diversify into so many industries that their financial results no longer benefit from supercycles. MTX supplies limestone, talc, alloy casting, water treatment, well testing and cat litter — among hundreds of other products. Shares have been flat since 2017.
That leaves moonshot investors with two viable choices.
Option 1: Pursue low-quality companies and hope for a commodity supercycle
In November, I recommended shares of Enservco, a struggling gas services company:
“Not all 2x companies need to be high-tech — or even particularly high-quality, for that matter. That brings me to Enservco, a struggling oil and gas services company that has failed to generate profits since 2014.
“The reason to consider ENSV is straightforward: rising natural gas prices. The U.S. Energy Information Administration (EIA) now expects Henry Hub gas prices to average $5.80 in the fourth quarter, up $1.80 from its September estimate, and $3.70 more than in 2020.”
— The Moonshot Investor, November 2021
Shares of the penny stock would eventually peak at $8.76.
Other firms such as Indonesia Energy have done even better. If your business generates zero profits in normal times, any gain will be infinitely large in percentage terms.
Option 2: Higher-quality, lower potential
On the other hand, Moonshot bets can also come in higher-quality packages like Cameco. These wider-moat firms either have a low cost of production or a technological edge — a “special sauce” that lets them churn out profits even during lean years.
Some of these firms are already well known. Oil services company Schlumberger (NYSE:SLB) invented the first commercially viable fracking systems. And seed company Monsanto has created an entire ecosystem where farmers using their pesticides are locked into buying matching pesticide-resistant seeds.
Other picks are less well-known. And that’s why they’re popping up on Moonshot’s radar.
Blue Chip Pick: Compass Minerals (CMP)
At the top end of Moonshot’s quality picks is Compass Minerals, a Canadian-based producer of premium-quality potash and rock salt.
The company has a cost advantage in both products. Its Goderich rock salt mine measures 100-ft thick (3 to 5 times the size of rivals) and maintains access to deep-water ports. Meanwhile, Compass owns one of just three naturally occurring potash salt brines in the world (and the only one in North America). The firm estimates they save 40% to 50% from bypassing the chemical process that potash would otherwise need.
Russia’s war in Ukraine has added a new dimension to Compass:
Growing fears of commodity export bans sent governments scrambling to secure supplies of potash and other fertilizers. Compass’s U.S. and Canadian mines fit that bill perfectly. Even if you likely won’t see a 10x return from CMP, it’s still a worthwhile bet for 50% to 80% gains.
High-Risk Pick: Benson Hill (BHIL)
On the other hand, the commodities supercycle will also benefit riskier stocks.
And that’s where agriculture Moonshot Benson Hill (NYSE:BHIL) comes in.
Benson Hill is a self-proclaimed “agri-food innovator” that commercializes high-protein soy products. In other words, it turns plant protein into human food and animal feed (The firm also has a smaller segment that grows and packs fresh produce).
In ordinary times, I would group Benson Hill among the hundreds of other zero-profit startups that may or may not survive. BHIL has yet to turn a consistent profit.
But the commodity supercycle has propelled the startup’s prospects into overdrive.
“Two crops dominate U.S. farming: corn and soybeans,” explain analysts at Bloomberg News. “The former requires massive amounts of fertilizer. The latter requires very little.”
Russia’s invasion of Ukraine has turned soy into agricultural gold. According to the same researchers, U.S. farmers plan to “dedicate about 2 million more acres this year to soy… and about 2 million fewer to corn.”
Benson Hill will benefit. The company now expects a 190% growth rate in its soy-based business in 2022 to compound its 206% growth last year. And though the firm won’t achieve profitability until at least 2024, its 2022 windfall will have lasting effects on its long-term viability.
3 More Picks from InvestorPlace.com
Eric Fry has also kept busy with his commodities playbook. In December, he recommended call options on the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP) in The Speculator, his trading service. Shares of the ETF are up 36% since then, giving his $105 options a 3x return.
Now he’s published three new bullish recommendations. To learn how to access Eric’s trades — as well as all of his Speculator research — click here.
How High Will Oil Go?
Last December, the U.S. Energy Information Administration (EIA) predicted that WTI Crude Oil would average $66 per barrel in 2022, about 2% lower than in 2021. A combination of OPEC+ production growth and slowing consumption would keep a lid on prices.
Fast forward four months, and the EIA has thrown those estimates out the window. Prices are now expected to average above $100 for the year.
With such uncertainty, how can any investor hope to make money?
That’s precisely why oil firms are approaching higher prices with such caution. Oil services firm Baker Hughes counts 673 rigs in operation in the U.S. — two-thirds fewer than in 2015.
And energy mega-projects are largely still on hold. A $500 billion project announced by the Saudi Crown Prince on Monday would fund a futuristic city to diversify the oil-rich country away from crude.
That means oil prices will stay higher for longer. Analysts at energy consultancy firm Rystad predict oil prices of up to $240 if Western countries agree on a blanket Russian sanction.
But oil demand is also self-regulating. Researchers at the Dallas Federal Reserve estimate that every 10% rise in gas prices cuts demand by 3%. Rystad analysts themselves predict a massive drop-off in energy consumption above $130 per barrel.
Personally, I don’t see oil remaining above $150 for long. And neither should you if you’re buying oil companies. Unless a stock is benefiting from a years-long supercycle, it’s best to jump in and out with call options rather than staying in for the long haul.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.