Energy transition, technological advancements, geopolitical risks impacting the global resource sector

Daniel Sullivan, Head of Global Natural Resources and Portfolio Manager at Janus Henderson Investors

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The resource sector encompasses a wide range of commodities and has received increasing attention due to the global shift towards renewable energy sources.

In this episode of the Portfolio Construction podcast, Paul O’Connor, Head of Investment at Netwealth, is joined by Daniel Sullivan, Head of Global Natural Resources and Portfolio Manager at Janus Henderson Investors. They explore the vital role the global resource sector plays in our daily lives, with a focus on mining, energy, gold and agriculture. They examine the impact of various factors, including population growth and its effects on agriculture, energy transition, technological advancements that have reduced exploration risks and improved resource targeting, and geopolitical risks affecting investors.

Paul O'Connor:

Welcome to the Netwealth Portfolio Construction Podcast series. My name's Paul O'Connor and I'm the Head of Strategy and Development for the investment options offered by Netwealth. Joining us on today's podcast is Daniel Sullivan from Janus Henderson Investors, who's the Head of Global Natural Resources and a Portfolio Manager. Thanks for joining us today Daniel, and I look forward to gaining a better understanding of the global resource sector given the important role they play in our lives on a daily basis.

As mentioned, Daniel's Head of Global Natural Resources and has been a Portfolio Manager at Janus Henderson Investors since 2019. Previously, he was a Portfolio Manager and Senior Resource Analyst at 90 West, which Henderson acquired in 2015. Earlier, he worked as an Analyst and a Portfolio Manager at Goldman Sachs, Deutsche Asset Management, Zurich Scudder Investments and AMP Investments.

Daniel received a bachelor of mining engineering degree with honours from the University of Sydney and a graduate diploma of applied finance and investment from the Securities Institute of Australia. He has 34 years of natural resources experience, so is eminently qualified to provide his views and thoughts on the global resources sector.

Janus Henderson is a British-American global asset management group headquartered in London in the United Kingdom. The manager offers a range of financial products to individuals, advisors, and institutional investors globally. The group's holding company, Janus Henderson Group PLC, is incorporated in Jersey and is dual listed on the New York Stock Exchange and the ASX. Janus Henderson was formed by an all-stock merger of the Janus Capital Group and Henderson Group that was completed in May 2017. Janus Henderson Investors Australia Funds Management, who offers the Global Natural Resources Fund, is a fully owned subsidiary of the Janus Henderson Group PLC.

The Janus Capital side of the firm is US-based and was founded in 1969, while the Henderson side is based in the UK and has been managing investments since 1934 with core capabilities across all major asset classes. As of the end of December 2022, Janus Henderson had US 287 billion in assets under management across a range of asset classes including equities, fixed income, multi-asset, and alternative strategies. There are eight Janus Henderson funds on the Netwealth Super and IDPS investment menus covering global equities, Australian and international fixed interest, and alternative strategies. The menu includes the Janus Henderson Global Natural Resources Fund that Daniel runs as the portfolio manager.

Australia is one of the world's leading producers of bauxite, aluminium ore, iron ore, lithium, gold, lead, diamonds, rare earth elements, uranium and zinc, so hard commodities are familiar to many Australians due to our large mining sector that as we all know is dominated by BHP and Rio and the success of these companies plays such a large part in supporting the broader Australian economy.

However, the resource sector is wide and varied covering both hard and soft commodities and has been given an increasing amount of attention due to energy transition as the world moves to renewable sources of energy. I'll certainly be interested in discussing with Daniel today whether Australia can be a winner or loser from the move to renewable energy.

In addition, the sector has been very volatile in recent years, largely due to issues such as Russia's invasion of Ukraine, China's economic slowdown, and technological advancements across the whole sector. The hard commodities sector is such a large part of Australian GDP, but I'll be interested to understand what the future holds for Australia's soft commodities, given our abundance of farmland and quality food produce.

For starters, maybe Daniel, can you share with the audience your story about how you ended up working in portfolio management and what attracted you to the resources sector?

Daniel Sullivan:

Thanks, Paul. It's great to be here and very comprehensive. Yeah, I started out as a youngster. I've always lived in Australia. I liked making things and doing things. They say Lego's quite a determinate factor on becoming an engineer, so I had a lot of Lego. I became an engineer. I went to university in Sydney. Mining attracted me, I'd been out into the bush in the Outback a couple of times, Northwest Australia as a 10 and a 12-year-old.

I'd seen small oil field drilling and flown over iron ore operations and things like that. That was all big and new and very exciting and I thought, "Well, this is a great industry." We've got enormous amounts of minerals, like you were saying, in bauxite and aluminium, alumina, the iron ore. So I picked that as a career and I haven't really wavered from it as the foundational element in my training and my career. In the start of that, I went travelling. I also like travelling in Australia. After four months, ran out of money and thought, "I better get a job."

Paul O'Connor:

As familiar story.

Daniel Sullivan:

Very familiar story. It's a fairly good determinant of when you should go to work. I ended up as a hydroelectric commission tunnel engineer on the West Coast of Tasmania. That was an excellent job and I really enjoyed it. So straight into renewables right at the start of the career. That's been a massive programme there and they're still talking about turning Tasmania into one of Australia's giant batteries and all those sorts of things.

After that, back into Sydney and doing some mining research. So copper mines out at Cobar. People I think know coal mines, the dust can be explosive and can have terrible explosions. That can actually happen in sulphide mineral dust as well in copper mines, both in Australia we've had that and in Canada. So I did some research in that field, again attached to the University of Sydney. I did that for a bit under a year and thought I'm sick of driving back and forth to Cobar. I will look around at what else I can do.

So I hadn't really studied a lot of finance at university, it was all physical material science and engineering science. I walked around town asking people what they did, as you do. I think it was about visit number 20, and I'd learned a fair bit. And I could remember distinctly going to places like UBS, the Union Bank of Switzerland at the time.

And eventually I lobbed into the AMP, had a good chat and they offered me a job. That was fantastic way to get started. They trained me in lots of industries, and I ended up running natural resources there, large cap, and we had a good team there, a number of good foundational bosses and it was a great starting ground for being in this industry.

And then you, unfortunately for you, you had to read out most of my resume. So lots of different things, but always related to equities with a backbone in resources and it's been a fantastic time. It's never dull. There's always something changing. Even this year, we're having massive global takeovers in oil, in gold, and in other things. So there's always something to think about and there's always ways to think about how we can make money for investors.

Paul O'Connor:

Yeah, interesting. But I guess it strikes me that your early days and your background in engineering are sort of the core skillsets required to actually become an investment analyst in this area, given the technological understanding and interactions with the companies there, Daniel. So probably a good background to move into resource equity management.

Daniel Sullivan:

Yes, that was AMP's way. They always thought of it that way, back in the day, to bring specialists from industry and then train them in the financial and market side along the way in-house. So yes, it's been good for me.

Paul O'Connor:

There's been so much going on in the resources sector and you sort of just alluded to it before, but including we've seen the impact of geopolitical risk in recent times. So how do you see the current state of play in resources sectors of mining, energy, and perhaps even agriculture?

Daniel Sullivan:

They're all quite different. They did used to trade together quite closely, mining and energy, but that's changed somewhat. I think there's different elements in the mining space now with lithium doing its own thing at various times. I think it will come to iron ore in Australia. It's been a real backbone for our economy and there needed a lot of equity portfolios overrunning for a long, long time on the strength of China's expansion and continued even at moderate rates, but still growing.

Energy's been kicked around a bit, particularly COVID kicked down hard and then been recovering steadily since then. They move at different times. They're quite unusual. The reason we brought agriculture into the mix here, into this fund, the way we think about the marketplace is predominantly because the mining side can be really volatile and we want people to be able to allocate to this space and be comfortable to stay and not feel as though they've got to do all the thinking about trying to make the timing of various cycles, so that's been a very good thing since inception, although actually in this year that's part of that historic relationship hasn't been working, but we'll come back to that later.

So overall, say looking back to the last really dramatic event, which was the COVID market collapse, they all did fairly poorly. Energy in particular has traded negative in the commodity markets, traded really cheap in the equity markets, which is great entry point for active investors and we did really well around that period. That's been just steadily grinding up as has the oil price to quite a decent price still now.

Mining was probably hit the other way where it had its downside, but came back very quickly. The lithium boom was really pretty active over this last few years. Huge push into electric vehicles and battery storage of electricity. So you mentioned that transitional activity, it's basically created a massive new industry in lithium globally and then agriculture, it's generally the steadier of the three, but this last 12 months has just been more difficult with supply chain. Well, actually distribution really is more the problem that it's just not working out the way the producers are hoping and they keep ramping up to produce more and finding that they've got ahead of themselves. So it's been a bit of a tough year for agriculture.

Paul O'Connor:

So it's a little hard to balance supply and demand in the agricultural game, I guess.

Daniel Sullivan:

It has been, yes.

Paul O'Connor:

So how do you determine whether a commodity is over or undervalued? And it may be my ignorance there, but I guess are most sellers of commodities price takers?

Daniel Sullivan:

Yes. Yeah, I think that's right. I'm fairly simplistic. In the first instance, I basically just look at the history of the last 10 years and where are we sitting against that last 10 years? Are we above or below that level? Are we heading up or down? There's a lot of moving parts here. We're probably monitoring at least 40 commodities, 10 of them are very important and then subsequently stepping down from that. But we can make profit in quite a number of different areas. The backbones are obvious I would think to most people who thought about resources. So oil, coal, iron ore, copper, gold, aluminium, things like that. But then you get sort of smaller things and other sub-markets, which can be useful as well.

The last 10 years has been pretty much trading sideways. There was good action back in 2011, 2012, and then a fairly harsh selloff in '15, '16 and then good years in post-COVID. So COVID was tough, but that's early troughing and then actually a good solid rebound and very strong years in '20, '21, '22. Then this year's more been consolidation but still in a fairly high level. So that's a general pattern, and then within that different things have their own pathway.

But we use that as a framework to sort of establish... One thing you don't want to do as an investor is forget to look for the awkward things or cheaper things, things that people are taking their eye off on. Aren't doing so well, you end up with institutional sellers just sitting in London and selling them for a long, long time. They used to use a nice signal in various places I've worked. If your advisors or your supervisors tell you, "Cease coverage," it's usually a good sign you're pretty close to the bottom and that might be a great time to buy. So when a really determined analyst or portfolio manager's held something for so long and they finally throw the towel in, you're pretty close to the bottom.

So we see that as one of the angles that we're looking at in the fund. So we don't just want the commodity, but if something's been down on the mat for a long time, and uranium as a great example of this type of behaviour, for a long, long time, terrible low price, pretty much everyone knew that was an uneconomic price for the industry and that the price, assuming we were having an industry which everyone thought we were, the price would have to be very significantly higher.

So call it $20 a pound and everyone knew it had to be at least 40 just to survive and probably 60 to have any chance of making some money and incentivizing new players. So that's a very classic cycle that's playing out right now, there's been numerous of those throughout my career and that's part of what we do to try and say, "Let's not forget the unloved things and make sure we keep looking at them even when other people might've given up."

Paul O'Connor:

So it's really a case, I guess, of you looking at the commodities at a high level through the economic cycle.

Daniel Sullivan:

Yes.

Paul O'Connor:

And as you've mentioned, trying to get lower price points of when you'll enter a stock or take exposure in your portfolio there, because I guess on a day-to-day basis, it's impossible to know where a commodity will be going.

Daniel Sullivan:

It is.

Paul O'Connor:

It's a bit like currency management.

Daniel Sullivan:

Absolutely. Correct. Right back from AMP. I've always said don't try to forecast the Australian dollar or the gold price.

Paul O'Connor:

Oh, no.

Daniel Sullivan:

And I think it's a good philosophy that of them are the same. They're all very complicated. Even in recent years, lithium's gone up 10 times and then fallen 70%. We've had some US building, wood products go up 10 times and give it all up. We have the nickel price for years go to ridiculously high levels, and oil go to negative. I mean, who would've thought oil would ever trade negative in the markets? I didn't even know it was possible.

So in terms of our people, price takers, there is a bit of a differentiation here and even now learning things. So we talked about ag sort of shaping up on the downstream. So if an agricultural buyer doesn't want your product, they just tell you they don't want it and you're stuck with it, right? So it's a problem. That's a very normal thing, I guess, in inventory management for those types of companies.

But for some only selling copper or oil, I mean, there's always a terminal market and you can always get rid of it as with all the metals onto the LME, things like that. So there are some differences. And one of the ways we cope with that is the way we think about things is we do try to get toward low-cost producer status rights so that even at the low points, they can still sell their product and make money. No one obviously wants to be, but we try to set boundaries that show that in downturn so they don't get caught with companies that are going to go broke.

Paul O'Connor:

Well, who would've thought, taken by your comment there, that oil actually got to a negative price? I don't think that was ever reflected at the petrol stations anyway around Australia.

Daniel Sullivan:

No.

Paul O'Connor:

Moving on. The world needs resources given the crucial role they play in our standard of living. So what innovations or process improvements are companies making today?

Daniel Sullivan:

I'd actually like to write a little paper on this because I do think about it, but everything takes time. But historically, I think about STEM, science and technology and women in science and how do you get people interested. And people look at mining in particular and say, "Oh, it's dirty and it's not the thing they want to be in." But actually, because they think it's either dirty or too simple or combination perhaps. So you can see on the TV we get ads from BHP and ads from Glencore and ads from other people trying to explain to us that this stuff's good and we need it.

Now historically, there's been an enormous amount of breakthroughs in all of these industries, but if I take metals and mining, just to be able to actually get the sulphide minerals out of the ground, crush them up, and then to separate them through flotation, that's an Australian invention, how do you smelt metals and get the product into the metallic form? Now of course, that's been done in some ways for thousands of years, but in a modern environment where you want to do a lot of it and do it economically and environmentally responsibly and all these things.

So again, smelting metals, massive breakthroughs in producing aluminium. I'm talking a long way back now, but that dramatically lowered the cost of aluminium. So it went from being a precious metal to a basic material. Here we have it all over the place in our containers and cars and electricity transmission and all these places. There was no way it could have been a hundred years ago at the cost that we made it at. I think there's still the opportunity to see big breakthroughs like that in all these areas. Everything we do relies on people's ingenuity to solve a problem, to apply capital, to build things and make them work efficiently.

And so the other big thing that's been an enormous breakthrough is tech. Like everywhere, the availability of massive processing power and cheap ways to run scenarios and look for danger and all these different things is enormous. So two of the expressions of that is in equipment, operation of heavy and dangerous equipment. People around noisy and heavy equipment is not a good situation. So we've now got driverless trains in the Pilbara, can now have driverless trucks or trucks that are remotely operated. So a number of the Pilbara iron ore trucks are now driven by operators who are sitting in Perth.

We can have underground drilling equipment, which is dangerous both through its tight operating environment, plus noise, plus rockfalls, et cetera, et cetera. That can now be operated remotely away from that production phase, which is the most dangerous part of the mine. Oil and gas production can be operated without any people. So some of the newer, particularly smaller wellheads can just sit there and do their own thing without any intervention.

So all of that stuff's good. Equipment, assets, security. So drones in particular, instead of having to try and put people on the outside of heavy equipment, so things like an oil rig, which could be big, like 10 stories tall in the middle of the ocean, you can now fly drones around that and do your survey with your camera, not put people's lives at risk and probably get a much better result. See a lot more of the facility and spend time where you want to spend time and look at it.

Other side of that is exploration. So always, oil and gas companies have always been big on data. So seismic programme firing off heaps of small explosives to send shock waves through the Earth and get reflective sound wave back, let's get all this data of the interaction of those waves hitting different rock strata and hopefully some oil and gas. That's a lot of information. So as technology got better and better at processing, these pictures became clearer and clearer, so the geologists got a much better understanding of what was going on and where to target the wells. And despite all of this, luck's still got a part in all of this. So things like Olympic Dam discovery. That was done in the last day of the last drill hole at the end of the budget.

Paul O'Connor:

Oh, wow.

Daniel Sullivan:

That thing was nearly not discovered. If it wasn't discovered then and people might've said, "Oh, people have been and done that, we're not going back there." I mean, we might not have gone back there for 50 years. And that thing's going to last a thousand years, right? It's a big thing. And it's the same with a lot of discovery. You can put all your smarts into it and try a lot of things and you might just miss.

And so geologists are very creative people who have to really think outside the box to say, "Why hasn't this been looked at this way before? And how can I can convince someone to give me money to get out there and test my hypothesis and get the drill into it?" And they have to give it their best shot, right? They've get a limited amount of money and if they miss it, they've missed it.

So that computer power of how to identify things and figure out where to spend the capital is very important and I think it's going to get massively important. We'll get to copper, but copper's going to go into a big demand push and we're going to need a lot more of it and people are going to have to look and find a lot more of it. So those sorts of things are going to be really important.

Paul O'Connor:

So it sounds to me that the technological advancements have somewhat, to some degree lowered exploration risk.

Daniel Sullivan:

Definitely. It's definitely made things easier to target and the more targeting, your better option of getting it to work. Now, there's still luck involved. So one of the biggest things in the last 20 years, Exxon and Hess have drilled off the case of Guyana in South America. In oil and gas offshore, your success rate is very low. It might be definitely less than 10%, but 3 to 7% maybe. And they've now made about... I'm going to say 23 discoveries and the success rates in the 90% range.

They've found a play type that's working as they study it and look for new targets. Most of those targets are working, so they're up through I think 12 billion barrels of oil discovered now and they've just bought their third floating production facility online. So that's an example of good geology work in an area that's never had oil before, getting some work done, and someone deciding to invest the money and having a massive win. So we're always hoping for that and we've had a lot of times in Australia. This is a great vast country with lots of different options in minerals and energy and we've had a lot of wins, but it's such a big place we can have a lot more wins still.

Paul O'Connor:

There's been some major policy initiatives from governments around the world to support energy transition. Is this having an immediate impact or is this more of a decade-long payoff and what sort of timeframe do you see as a transition to clean energy globally or is that just too difficult to even estimate?

Daniel Sullivan:

Yeah, so lots of things have happened. The real big push I think started when wind power finally became economic against alternatives. The wind industry started being government power tenders in their own right. So there's a lot of technology needed and development to get those turbines bigger and bigger and more efficient. That's been happening over, let's call it, 20 years.

And as that happened, it's like, "Okay, we finally have an at-scale solution that can actually make a difference now." And I think that's when it really took off. And once you see there's a solution that people who are wanting to accelerate climate change and if initiatives get more comfortable and say, "Okay, we can actually now allocate a lot of money here because it's not just going to be a waste of money." I mean, no one's got free money or infinite money and you've got to have some hope that what you're doing makes economic sense and is going to make a return, otherwise it's going to stop. We can subsidise things for a short period, but not for very long.

So wind's been a huge breakthrough in that sense. And I think we saw the European start with massive build-out programmes in Europe and in North Sea and around Britain. America's got on board with the Inflation Reduction Act. I think they have decided, it took a while, but they decided to play ball on climate change activity and targeting net-zero.

They're quite different strategies. So the Europeans tend to be subsidising and carbon taxing and things like that. The Americans have gone a bit the other way of incentivizing through grants and programmes and tax breaks, and so they're actually moving head in leaps and bounds now. They're including carbon capture now, so the US are paying for carbon capture directly as revenue. I think we'll see an enormous take-up in US carbon capture activity in the next one or two years.

So yeah, it's been a huge change. The programmes are enormous. So when I was young, if you wanted to build a mine for half a billion or a billion dollars, you spent a long, long time scratching around the world trying to find the right combination of investors and bankers to give you their money, and that took a long time, at least one year, but maybe a few years to get the financing. Now we're seeing these programmes are hundreds of billions of dollars and sometimes tantalisingly quoting the trillion. Governments want to mobilise and spend upwards to a trillion dollars very quickly on this type of stuff.

So it's incredible amounts of money and we see it as a new long-tail boom, which affects nearly everything we can look at. So China boom, way back in around 2007-2008, was really the end push or well into the push of China moving around 50% of their population into cities and building those cities to do that. So taking urbanisation from 25 to 70+ percent, and that was one of the squeeze periods where they really pushed hard on commodities. And then we've had a long, long consolidation through then till COVID. And then we've had a good step up this last few years where actually things are getting a bit shorthanded and we can see we need more things like copper, lithium, and other things.

And now we're sitting where we're saying, "Well, the whole world has basically said we're going to target net-zero emissions by 2050." And all of that needs a lot of action and the vast amount of action is into clean energy and battery cards to get off oil. Oil will still be here, it'll be half the size if all goes well. Still be an enormous commodity market. But the smaller markets like lithium and other things will be 10 or 20 times bigger than they're now, and wind power and things like that will be the same. So it's a massive change and it'll be long-dated.

Paul O'Connor:

A significant opportunity I would've thought given the capital that will be required to assist with the transition to clean energy.

Daniel Sullivan:

Yes, yeah.

Paul O'Connor:

Commodity prices are so volatile, as we've mentioned. So what bottlenecks are we seeing in this space and how is Australia exposed?

Daniel Sullivan:

Yeah, there have been some really big squeezes and some of them came from the Russia invasion to Ukraine and the European imperative to get themselves off Russian gas reliance. That created havoc in European energy markets and that was one of the places where commodities did go up 10 times, natural gas prices, and very obviously extremely disruptive to industry and seeing numerous industries curtail production shut down for a period and to retail customers, just terrible retail electricity bills going up, what be 10 times, it's not something you want to happen.

So it's been part of the inflationary problem is commodities were disrupted in COVID and that did lead to higher prices at times because of disruption and people needing to scramble to get things done and then getting the timing of trying to have the production at the right time. I think that's where it's seen some of these companies overstock or over expand a bit too early and get caught on the down leg of that. So things like US lumber and US housing are having that type of problem right now where the economic slowness is affecting home building and things like that.

So it's been like that in terms of physical movement of goods. I mean, Australia had pushback from China on a number of goods, lots of goods, not iron ore to any huge degree because they're so reliant on it and there's no real alternative, but lots of other commodities had pushback. Most commodities have moved around that if you curtail somewhere that just gets transshipped and put somewhere else so I think generally commodities have got to people that needed them at times. It takes a while and I guess that European gas lease probably stands out as it's such a massive change to try and take Russian gas supply out of European consumption, but it's led to that enormous spike. Now that's normalised and had smaller versions of it and that will be happening, but it's that major crisis point's probably passed.

Paul O'Connor:

I mentioned soft commodities in my introduction, but agriculture's probably not as well understood as energy and mining. What types of stocks do you invest in? Are they pure play agri farmland companies or do you invest across the whole value chain and what sort of role can that play in a diversified portfolio? And I guess in my mind, you'd made the comments earlier that agri tends to be lower volatility than the harder commodities there, Daniel.

Daniel Sullivan:

Yeah, that's right. We sort of entered the space and thought it was a good idea and thought global population still going to grow by at least 2 billion people, on most projections, most people are still getting richer and their lifestyles are improving and they're able to buy better food and food of high value both to them and to the industry. We looked for a way of, we always want to be able to measure ourselves and say if we're doing okay against something. So then S&P had a global thematic benchmark for natural resources that included agriculture at a one third weight. We sort of set out on the journey with that and that index is interesting. It considers agriculture to be fertiliser in agricultural chemicals, so things like potash and phosphates seeds.

So when we started big companies like Monsanto and Syngenta were in the index. They've both been subsequently taken over by other enterprises. The really sort of slower side or a bit more stable side is paper packaging. So given that it's coming through forestry through the paper packaging, they've considered the natural resource expression in agriculture. So agriculture broadly includes all grown things, and that's timber and paper.

My preference, there's more to the natural resource. So the timber owner and the log or wood product going through into things like housing and construction and I think there's really long-term upside for timber construction in high-rise buildings and uses heaps less energy and it's much more environmentally friendly for people in buildings as well than concrete or energy going to, what do we add onto that? So that's a big issue area, but we also look at agricultural equipment, so things like the tractor, companies like John Deere and we are also very interested in food itself and healthy food.

So the problem with a lot of the areas in this space, a lot of them are still privately held. So if you think about all the best farming land in the world, a lot of it's probably been owned by the same people for a hundred years and it probably will be for another hundred years. So if you own prime agricultural land, you make good money most of the time and there's no need to come to the equity market to list your company to raise more capital because you can make enough money to make it work and a lot of bank equipment can be leased now for harvesting and things like that, so you don't necessarily need to own everything yourself either. You can use contract harvesting and things like that. We would like to see the sector much, much bigger. In some ways, the really good stuff's already taken by someone else.

There are large moves into forestry by fund managers who are seeking to get that diversification away from equities by owning that physical asset and having that long duration asset in the timber property. So that's good to see. And in pure food, it's so exposed to the weather, how much rainfall, how hot storms, droughts. It is complicated. Some companies have tried to mitigate for a lot of that and done a reasonable job of it, but it is quite difficult to mitigate all of that. So I guess future farming, we'll see more and more intervention I think to actually remove the farm from a lot of those difficult elements. So we'll see more direct control of water, fertiliser and chemical use, protection of crops under cover and things like that.

Paul O'Connor:

What are the opportunities for developing the Australian agri sector?

Daniel Sullivan:

I mean, I think it's a massive opportunity. We've got such a vast amount of land, you don't have to drive very far in Australia to be pretty much by yourself wondering, "What's going on here? Why is there so much space and no people?" I think obviously water's an issue here, generally pretty dry country, but we are surrounded by ocean. So water is desalinated in a lot of places around the world. Middle East and southern part of Chile now for copper mining, they're now going to do desalination in large scale to provide water to cities like Arizona from the Gulf of Mexico seawater. There's ways of doing things, so everything's economics. I think again, if we have such a vast amount of space, we can do an enormous amount of renewable energy in solar and wind, and that means we will have a very long-dated cheap supply of power.

If that power is needed to make more fresh water to boost agriculture, then that's probably something that will happen in the long run. I think we're one of the big food producers in the world, and that's not going to go away. Most agricultural lands being degraded around the world through all sorts of things like encroachment from development, climate change in some cases, soil degradation gets through erosion and things like that.

We'll have a bigger role to play. I think the Ukraine's a big food producer as well. So that's been greatly disrupted. As I say, as the world heads up to another 2 billion people, we're going to need more food and we're going to need to do it more efficiently. And some of that's waste control as well. Again, technology is a massive thing at controlling all your inputs to minimise your cost and maximise timing of when you harvest and storage, transport, all of those things can benefit from the application of technology.

Food wastage is still massive. We also divet a lot of edible products into non-food uses, either feeding animals or making fuel and things like that. So those things may change through economics as well. The food demand, those things will drop away. We're not advocates that we're all going to start or run out of copper or any of those things, but we do see pressure there that there will be long-term needs to increase food production. I think Australia's in a prime position to do it, and water's probably the problematic element. And we know now, hey, we can make water. If you've got the ocean and cheap enough power you can make it. And then conservation of water through smart agriculture means we could probably get things done.

Paul O'Connor:

Yes. Well, we have a rather underutilised desal plant down here in Victoria, so if anyone would like us to provide some water there, I'm sure we're capable of so.

Daniel Sullivan:

Yep, yep, that's true.

Paul O'Connor:

Well, you've often have an overweight to gold stocks, so what makes them attractive investment case in your opinion?

Daniel Sullivan:

Yeah, it's almost always overweight gold. So I guess at the outset to say some people think feel as though it's an insurance policy which will protect them if everything else goes wrong, and that's not true. There's no sort of leverage in it. So gold's more like your ultimate store of value that won't go down. In a macro sense, that's super, super important to lots and lots of people.

So we just haven't been one of those groups of people yet. So to explain a little more, currency evaluation, the US dollar has been relatively strong say in the last 10 years. Really the only thing that's beat it actually is gold. So gold's doing a good job at beating a US dollar, which itself is devaluing but a lower rate than everyone else. And lots of other currencies are out down 30%, which is probably where we are, 50%, which is where a lot of countries, like I'm going to say Brazil and others are, and there's plenty of countries that are down 90 plus percent, they're horrible outcomes.

But if a gold holder in those countries would've had complete preservation of the money they invested in the gold, plus the growth of gold actually is going up as well. So I guess we don't feel it because our currencies, I'm going to say relatively stable, it feels a bit weak, it should be stronger I feel with where commodities are, but it's not been something investors have really needed to clutch to here to manage their wealth position. But in a lot of countries around the world, it has been playing that role. Why do we actually like the individual companies? Gold has one of these great cycle benefits. So we talked about exploration. So you've got to have an idea about what's out there to find. You've got to have enough smarts to find it and fund and then enough capability to raise money to build it and operate it.

So in gold, the amount of capital you need to go and look for gold is one of the lowest across all of the mineral industries' and oil industries and everything else. So with a relatively small amount of money, you can become a gold explorer. If you're lucky and your exploration thesis plays out, the returns are extremely high. So that's the first phase of why gold's interesting. I find a junior might only raise 10 to $50 million, and that's enough money to actually go and have a look and start building your investment case. And if you actually get onto a winner, you could easily find a deposit. I'm not saying easily, but if you find a deposit, it may well be worth one to 3 million. So the payoff's exceedingly large for a successful exploration campaign on a modest amount of capital.

The other end of the spectrum is oil, where to drill a single oil well offshore these days probably costing you around a hundred billion dollars US. So a junior probably can't raise a hundred million to say we're going to have a single shot at something and then it'll be worth nothing if it doesn't work and the probability of it not working, it's probably 95%.

So it's a terrible bet, right? And they're not going to be able to raise 500 billion, they're going to try that trip five times. So it's just really difficult for juniors to get involved in things like oil, which is a big company game, but gold can. So we're always on the lookout for the new small gold company that's getting out there to start. And that's why things like Dickson Dealers has such a massive following because most of the gold action in Australia is driven from Perth Fremantle, and most of that action's uncovered out in the goldfields area.

Paul O'Connor:

So we've seen such a rapid rise in inflation and bond yields over the last 18 months. And I guess I'd be interested in your thoughts on the increased impact of the cost of capital and how this is playing out across the resource sector given certain areas of the resource sector that you've highlighted has a real need for capital and a large amount of capital.

Daniel Sullivan:

So in some ways, in general, it's been okay because the down cycle in 2015, '16 was so bad that most of our companies have been... Most resource companies have been cleaning up their operations and getting rid of their debt and getting rid of their high cost production and really tidying themselves up greatly. So they went into COVID in pretty good shape and traded through it fine, and we didn't have too many disasters and shutdowns come through in COVID, which is great. There's very robust outcome with the bond yields really going up now, it's difficult.

Again, a lot of them don't have a lot of debt, so it's not a massive impact. But as you say, the people who are building new things, that's a problem. It's a problem for two reasons. One is if you're about to build a copper mine and you take on five to 10 billion of debt, that's a lot of new debt at a higher rate. And the other is, it's not really a circular argument, but inflation is higher. So if you try to build something, what you think is going to cost you is often blowing out now by 20 or 30%.

So you might do your maths, your economics on a certain size project, and a lot of these could have had their financing set up in the last few years before interest rates really took off. And suddenly you find, "Oh, it's costing me 30% more and my cost of money's doubled or more." It's quite awkward. So we have shied away a bit from people who are actively building large projects right now, particularly if the margin on those is not great, given where interest rates are commodity.

Paul O'Connor:

Well, I think in the interest of time, we will probably draw to a conclusion the podcast this morning, but it's certainly been a fascinating, and from my perspective, very educative discussion with you, Daniel. So thank you very much for joining us on the Portfolio Construction Podcast today.

Daniel Sullivan:

Yeah, thanks very much, Paul. I've enjoyed being here. It's been good.

Paul O'Connor:

Well, and I've got the feeling there that we've only just scratched the surface on a whole variety of topics such as clean energy and agri opportunities, and the lower bowl of the sector and battery power and the demand for lithium and the lower cost of capital required by gold mining, so I think you've certainly highlighted your extensive knowledge on the sector. So I thank you again for joining us, and hopefully you get to relax a bit over Christmas and maybe pull out that old box of Lego and go back to your engineering days there.

Daniel Sullivan:

That's right. Yep. Thanks very much.

Paul O'Connor:

Thank you to the listener for joining us on today's Portfolio Construction Podcast, and I look forward to you joining us on the next instalment. Have a great, great day everyone.

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