In this article we will walk through an example of a contrarian investment thesis using Segra Capital Management’s bet on the price of uranium as an example, but first I thought a riddle would help set the stage.
This riddle comes from celebrity investor Howard Marks. Per Marks, it is one of his favorite interview questions, and he claims no one has answered it correctly. His riddle and the answer he’s looking for, also loosely define what it takes to be a successful contrarian.
Suppose I hire you as a portfolio manager and we agree you will get no compensation next year if your return is in the bottom nine deciles of the investor universe but $10 million if you’re in the top decile. What’s the first thing you have to do – the absolute prerequisite – in order to have a chance at the big money? No one has ever answered it right.
The answer may not be obvious, but it’s imperative: you have to assemble a portfolio that’s different from those held by most other investors. If your portfolio looks like everyone else’s, you may do well, or you may do poorly, but you can’t do different. And being different is absolutely essential if you want a chance at being superior. In order to get into the top of the performance distribution, you have to escape from the crowd. There are many ways to try. They include being active in unusual market niches; buying things others haven’t found, don’t like or consider too risky to touch; avoiding market darlings that the crowd thinks can’t lose; engaging in contrarian cycle timing; and concentrating heavily in a small number of things you think will deliver exceptional performance.
Not all of the examples cited define contrarian investing, but the need to escape the crowd is perhaps the first criteria. Adam Rodman, the Chief Investment Officer at Segra, will tell you that it is a lonely occupation. But to echo the riddle, if you have the temperament for contrarian investing, it can in fact lead to outperformance. The timeline detailed in the narrative for this particular investment thesis should highlight how important this is.
The Price of Uranium: 2007 – 2020
In 2007 the stars had aligned for a nuclear renaissance and uranium hit a high of $136 per pound. Then in 2011, the narrative swung wildly when the disaster at Fukushima discredited nuclear power as a safe and green alternative. Post Fukushima, active reactor count around the globe dropped instantly. Japan, for example, shut down all of its 50+ reactors. By 2013 the price of uranium had dropped into the low $40s, and by 2018 it had dropped to the low $20s.
In 2018, the stock market capitalization of uranium mining companies had dropped from $125 billion to approximately $6 billion. Adam seized the opportunity, and launched the dedicated fund, but the trend dating back to 2011 would not reverse for several more years.
Global production continued to drop, and prices remained low through 2020. Then, in response to the global pandemic, miners started shutting down due to safety concerns and the spread of the coronavirus. This final cut to supply would see fortunes turn for uranium bulls. As the saying goes, the cure to low prices is low prices.
How can you sit on the sidelines and watch markets ignore your investment thesis for years? Adam’s response as it relates to uranium is that it’s a small and overlooked market that can be modeled. Demand is easy to forecast because nuclear reactors don’t just pop out of the ground. Each one takes approximately 7 to 10 years to build.
There is also little sense of urgency to take advantage of fluctuations in price. In the context of building and maintaining a nuclear reactor, the cost of uranium is relatively insignificant. So, buyer’s feel little need to take advantage of what might otherwise be perceived as a buying opportunity. The bulk of the roughly 200 million pounds purchased annually is acquired via long-term contracts, and in a declining market, long-term contracts encourage waiting (why purchase today if you anticipate the price will be lower tomorrow?).
So, long term contracts encourage consistent production, and because the cost of uranium is small relative to the cost of construction and maintenance of a nuclear power plant, low prices do not encourage buyers.
The uranium bear market reversed course in the depths of the pandemic. Through February of 2022, Rodman believes that the average investor in his fund has made approximately 3.5x their money. Adam and his team continue to see opportunity in the space and actively trade the portfolio to take advantage of volatility as the price of uranium climbs.
The benefit to Segra Capital Management extends beyond the gains realized. Adam and his team have created a brand. Much in the same way that the management company for a private equity fund builds goodwill and processes across funds, Segra is now contemplating a new fund to take advantage of the private opportunities available in adjacent spaces.
Per the interview, Adam claims some of the best advice he received was from a highly successful investor that made his career on one big bet and used that success to build an investment business. Please see the video that follows for the full story. (Timestamps available underneath the YouTube video player.)