Tavi Costa: Uncovering the Bullish Thesis for Gold, Silver, and The Contrarian Oil & Gas Bet

Key Concepts

• Gold Rush: A period of intense interest and investment in gold.
• Technical Analysis: A method of forecasting future price movements based on historical price and volume data.
• Macroeconomics: The study of the economy as a whole, including inflation, interest rates, and economic growth.
• Cyclicality: The tendency of markets to move in predictable patterns or cycles.
• Emerging Markets: Countries with developing economies that are experiencing rapid growth.
• Commodities: Raw materials or primary agricultural products that can be bought and sold.
• Cup and Handle Pattern: A bullish technical chart pattern that signals a potential continuation of an uptrend.
• Gold to Silver Ratio: The ratio of the price of gold to the price of silver, indicating their relative value.
• Leverage: The use of borrowed money to increase potential returns.
• Exploration Companies: Companies focused on discovering new mineral deposits.
• Venture Capital Approach: Investing in early-stage companies with high growth potential.
• Activist Investing: Taking an active role in a company's management to drive change and improve performance.
• Strategic Petroleum Reserve (SPR): A U.S. government reserve of crude oil.
• Geopolitical Risk: Risks arising from political instability or conflict in different regions.
• Onshoring: The practice of bringing manufacturing or other business operations back to the home country.

Background and Journey into Finance

Taffy Costa, a portfolio manager at Crescat Capital, shares his journey into the finance industry, which began in Brazil. His early exposure to business and finance was shaped by his father's business, which experienced bankruptcy when Taffy was a teenager. This experience, coupled with growing up in Brazil's inflationary environment, instilled in him a deep understanding of money and security. He moved to the U.S. on a tennis scholarship and discovered his passion for finance and investments, particularly through reading newspapers and observing market dynamics. He recognized a gap in macro analysis, especially among his peers, and dedicated himself to studying it. His career led him to Crescat Capital, where he started as an emerging markets analyst.

Key Themes and Investment Strategies

China's Economic Trajectory

Costa's early success at Crescat Capital involved a significant thesis on China. In 2014-2015, he identified that China was heading towards its own "Lehman Brothers moment," a prediction that proved accurate and generated substantial returns for funds and clients. This experience highlighted his ability to identify major turning points in markets from a macro perspective.

The Commodity Cycle and Natural Resources

In 2018-2019, Costa was struck by a chart illustrating the depression of capital spending in the commodity sector. This led him to believe it was an opportune time to invest in natural resources. He recognized the long lead times (12-15 years) for bringing new mining supply to market, which often dictates the industry's cyclicality. This insight led to the launch of a fund focused on exploration companies, which became a core product. Crescat Capital also acquired the fourth-largest silver mine globally in 2022 through a leveraged buyout.

Emerging Markets as the Next Wave

Costa believes that emerging markets, particularly in Latin America, are poised for substantial growth in the next 3-5 years, similar to the valuation trends seen in mining companies a few years prior. While acknowledging the continued opportunity in mining, he sees emerging markets as the next significant wave.

Perspective on Gold and Precious Metals

The Gold Rush and Central Bank Accumulation

Costa describes the current situation in gold as a "gold rush," driven by central banks increasing their gold holdings. He notes that while foreign buyers are still significant purchasers of treasuries through private institutions, they haven't shifted into gold to the same extent as central banks. He anticipates this will change.

Imbalances Driving Gold Demand

Costa argues that the current imbalances forcing central banks to accumulate gold are more severe than in historical periods like the 1970s and early 2000s. He believes this suggests that the gold market has significant room to grow, with "we just haven't seen anything yet."

Technical Analysis vs. Fundamental Drivers

He expresses skepticism about timing gold corrections using technical analysis, stating, "if I would get a dollar for every time somebody tries to time a correction in gold prices using technical analysis, I we would all be filthy rich." He emphasizes that the current gold rally is driven by fundamental imbalances rather than short-term technical patterns.

Gold Miners as a Leveraged Play

Costa views gold miners as the best bet for investors who believe gold prices will continue to rise over the next 5-10 years. He highlights that as long as their cost structures remain manageable, miners offer leveraged exposure to gold price appreciation. He points out that many silver miners produce at costs below $20 per ounce, making them potential "cash flow machines" at current gold prices.

Silver's Potential and Technical Patterns

The 45-Year Cup and Handle Pattern

Costa discusses a 45-year cup and handle pattern in silver, explaining it as a representation of human behavior in markets. He likens it to personal life experiences: a significant win (the cup's peak), followed by a period of difficulty and learning (the cup's bottom), and then a recovery and retest of the peak, with a less severe dip (the handle) due to increased experience and awareness.

Supply Constraints and Demand Drivers

He notes that silver supply has not kept pace with its price increases, unlike in previous cycles. This is due to a lack of exploration assets and the inherent resource constraints of silver. Demand is surging from industrial, monetary, and inflationary sources.

Triple-Digit Silver Potential

Given these factors, Costa believes silver is poised for significant upside, potentially reaching "triple digits." He argues that in a world where central banks cannot afford to raise interest rates to combat inflation, silver's intrinsic value is much higher than its current price. The historically high gold-to-silver ratio (around 80) further suggests silver is undervalued relative to gold.

The Role of Independent Analysis and Conviction

Costa emphasizes the importance of having "very independent views" and "conviction" in investing. He believes that while one can borrow a thesis, conviction is personal and develops over time, enabling investors to act during market stress. He stresses that true independence comes from doing one's own research rather than relying on others' reports.

Investment in Mining Companies and Risk Management

Valuations and Future Potential

Costa acknowledges that while traditional valuation methods like discounted free cash flow might not fully capture the value of some companies, especially in the technology sector, a similar shift could occur in the mining industry. As the world prioritizes the security of metals from a sovereign perspective, valuations could "run wild."

Protecting Margins in Mining

For mining companies, Costa advises prioritizing margin protection. He suggests that open-pit projects, where energy costs can represent up to 30% of expenses, should consider hedging their energy exposure. This proactive measure can safeguard margins against potential oil price increases.

The Legacy of Mining and Opportunity

He dismisses the notion that the mining industry is dying, calling it a "legacy industry" that is essential for building infrastructure and supporting modern life. Despite potential mismanagement and challenges, he sees significant opportunities, especially with secular changes in metal prices.

Crescat Capital's Strategy and Exploration Focus

Crescat Capital focuses on investing in early-stage companies with the potential for major discoveries. Their strategy involves redeploying capital into companies that are intrinsically improving, even if their stock prices haven't yet reflected this. They employ a venture capital approach in the mining space, actively participating in exploration project designs and advising management on capital allocation and strategic decisions. This activist approach aims to improve the odds of success in finding new mineral discoveries.

Bullish Stance on Oil and Energy

Contrarian View and Undervaluation

Costa expresses a contrarian bullish view on oil and energy, driven by several factors. He finds these assets attractive due to their current undervaluation, allowing him to acquire more of them.

Energy as a Hedge for Mining Exposure

He sees energy as an excellent hedge for his significant mining exposure, similar to how mining companies should hedge their energy costs.

Declining Rig Counts and Production Lag

Costa argues that the decline in U.S. drilling rigs is not solely due to productivity gains but rather companies' inability to afford exploration and production at current price levels. This reduction in activity will eventually lead to lower production, driving prices higher.

Low Inventories and Geopolitical Risk

He points to historically low oil inventories in the U.S., low Strategic Petroleum Reserve levels, and record oil exports as indicators of a tightening market. Furthermore, he believes that current market prices do not reflect the significant geopolitical risks present globally.

Energy Demand from AI and Onshoring

Costa anticipates increased energy demand from the AI revolution and onshoring initiatives, asserting that oil and gas will remain crucial alongside renewable and nuclear energy sources. He believes the energy sector is currently not priced for this future demand.

Technical Signals in Energy

Technically, he observes breakouts in energy stocks, ETFs, and the energy stocks-to-oil ratio, suggesting growing investor acceptance of risk in this sector. He views this as the beginning of a significant medium-term setup for the industry.

Following Taffy Costa's Work

Taffy Costa can be followed on Twitter/X and LinkedIn at @TaviCosta. His firm's letters and content are available at cresc.net.