Picks and Shovels

Updated: Feb 12

In 1896, the discovery of gold in the Klondike region of the Yukon territory created a rush of an estimated 100,000 prospectors looking to strike it rich in the search for the yellow metal. Speculative fervor drew everyday citizens to the snowy, treacherous paths of the Yukon. Unfortunately for the prospectors, many lives were lost on the journey. Then, if you were lucky enough to survive the harsh elements, food shortages and other gun toting prospectors, it was unlikely you were to find enough gold to cover the costs of your trip. Of course, there were stories of life changing riches, but in general it was a deeply unprofitable venture for the majority of prospectors. Many went broke and returned to normal life worse off than before they had left. There was, however, an interestingly profitable venture in the midst of the speculative prospecting — that was the business of selling picks and shovels. Shovel retailers didn’t have to strike gold to make profits, they just had to be in the right place at the right time with a well stocked supply. By providing a service to the prospectors, the hardware salesmen were able to take part in the gains made by the prospectors, but without the risk of not finding any nuggets!

I think we can extrapolate this thinking to events occurring today. It’s clear we are in a speculative bubble when it comes to a few specific technologies. If you haven’t been living under a rock for the past year, you will undoubtedly have heard of the explosion in Tesla stock, which is now valued at more than 2x the largest car maker in the world despite Tesla selling less than 1% of global vehicles. Whether you are a Tesla bull or not, you can’t ignore the surge in valuations of any EV manufacturer — take Nikola, Nio, Tesla et al. Novel battery and energy systems, such as Ballard Power, have also exploded higher and plug power and the like are registering triple digit percentage gains for the year.

What is equally a sign of speculation, further to the price surges themselves, are the types of investor increasingly placing wagers on Tesla and others. Commission free trading platforms, fractional shares and media coverage of the stock market has driven retail investor participation in markets to heady heights. This in itself is no bad thing — I for one am in favour of everyone taking a share in the prosperity of financial markets. However, the swarm of ‘retail’ investors flooding to unprofitable, bubble-esque names is worrying. Twitter financial advisors, ‘Teslinaires’ (Tesla shareholders becoming millionaires) and massive short term order volume on these names bears similarities to the gold prospectors of the Yukon.

These are clearly two very different situations, however, by using the same principles from the Klondike story, we can identify the following:

  1. New technologies (especially electrified/autonomous vehicles) are entering bubble territory in their valuations.

  2. These bubble stocks are too risky to invest in should you be looking to be prudent with your wealth.

  3. However, massive amounts of capital are flowing into these industries — can we find a way to benefit with less risk?

The third point above explains our mission as prudent investors. Although we might determine particular EV companies to be too risky to invest in, we are still interested in profiting from the overall boom and disruption of the legacy industry. So how do we go about finding our modern day picks and shovels? Firstly, we need to take our particular industry and break it down into two parts — those who supply the industry and those the industry supplies.

Take our EVs for example: the actual vehicle itself will require a different set of materials to a combustion engined car, which could include increased usage of cobalt or copper; its need for electricity will require changes to local infrastructure and high capacity computing chips (to handle software for autonomous features) will also be required. However, unlike the days of the Yukon, easy money flows; access to information and heavy participation from investors have made following the trend of buying up the obvious benefactors a path already trodden. Looking further afield, the table below suggests some opportunities for companies that will benefit from the investment cycle into EVs, but who won't be heavily affected by the possible downside in the case of a bursting bubble in the EV sector.

Between the companies above, there is a varied extent to which capital flows as a result of an industrial revolution in the EV/autonomous vehicle sector would affect business. Let's take Seeing Machines (who literally sell machines that ‘see’ whether drivers are focused on the road by using driver facing cameras and AI): whilst contracts are somewhat limited to a few production vehicles at the minute, if autonomous driving takes off, this technology will likely be required by regulators. In essence, the onset of autonomous technology will feed the existence of a company like Seeing Machines.

Alphabet, for instance, is a more balanced bet on the take-off of this new technology. Currently, the vast majority of revenues and profits are provided by its advertising business through Google search and other platforms like Youtube. However, it has an autonomous vehicle subsidiary ‘Waymo’ — which in the opinions of many experts sits at the forefront of AV enterprise. This segment is currently valued at £30Bn — roughly 4% of the value of its parent Alphabet. Add this to Alphabet's burgeoning capabilities in AI and big data and it's not hard to see that Alphabet would be a beneficiary should this movement gain momentum.

Lastly, you have stocks like Spotify, where, in all likelihood, more modernised EVs and autonomous vehicles would lead to more time for people to consume media in their vehicles and provide a likely tailwind for Spotify. I understand this link is too casual for this to be a real factor in deciding whether to buy this sort of stock for this type of proposition. You would have to like the business for other reasons to justify its purchase, but it is an important factor to consider.

I couldn’t write this article without mentioning a strikingly obvious thought to those planning to capitalise on the EV/autonomous vehicle revolution. If you do firmly believe in these technologies (as I do), severe disruption is going to be had on a specific set of industries: car insurance immediately comes to mind! There is also the need to consider that we all are travelling far less due to Covid-19, and for the lucky few, commutes to the office five days a week are to never return. In the world of safer autonomous driving, less collisions mean fewer accidents and lower premiums. This is all in addition to the question of who is to blame if your car crashes itself? Insurance policies may eventually fall to the responsibility of the manufacturer or software programmers. With this being said, it is important to keep an eye out for those industries likely to see their current business models evaporate — as it will likely be bad for your portfolio!

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