Weekend Reading #26


This is the twenty-sixth weekly edition of our newsletter, Weekend Reading, sent out on Saturday 20th July 2019. To receive a copy each week directly into your inbox, sign up here.


Radosław Załoziński on Poland's transformation.

We’re delighted to share a recent conversation with Radosław Załoziński, a close friend of Three Body Capital and a senior executive at JSW, a leading producer of coking coal and one of the largest employers in Poland, with more than 26,000 employees.

In the conversation we touch on so many interesting and timely themes – including the (ongoing) transformation of Poland's economy, the rise of the climate change narrative and the challenge it poses to commodity producers, the dreaded "B" word (Brexit) and China's role in the global commodities market.

We hope you enjoy the interview and please do let us know what you think.  


The Polish government fiscal stimulus has not gone unnoticed by international investors. On a recent visit to Warsaw we noticed that the shops were full and people were spending freely. But rural areas represent 93% of Poland’s total landmass and the rural population share has been rising since the early 2000s. What impact have the government's bold fiscal measures had on Polish consumers outside of the major cities?
You wouldn’t judge the state of the US economy on the basis of packed NY restaurants and its clubs. You need to go to the Rust Belt. Even in 2008/09 the best places in London were fully booked. Warsaw, as far as I know, is one of the few capital cities of ex-Eastern Block with a rising population. In many larger Polish cities, real estate has performed well, plus folks tend to prefer living in detached houses, so they move to rural areas with access to the big cities. So some rural areas have benefited.
The zloty strengthened to a 14-month high against the euro in July. As Poland's biggest coal exporter, how does JSW plan for currency movements such as this?
As a commodity producer, our exposure is mainly on the USD/PLN side. We act as the typical exporter, which means we are monitoring the market and using derivatives to hedge ourselves at historically attractive levels. In broader perspective this is very interesting. The Polish economy has been growing rapidly in recent quarters (at around 5% of GDP). For many years now, the Polish zloty has been quoted in a narrow corridor of 4.00-4.30 to the Euro. Even though the economy is thriving, the market is pricing our currency in the upper band, around 4.25 - 4.30 in recent months. There are a few ways to interpret this. Either the market does not believe in the long-term sustainability of this growth, or the future is too blurred in front of a potential global slow down. Our economy is growing thanks to the contribution of private consumption, but investment levels are stubbornly low. PMI is below 50 and the German economy is also showing signs of weakness, especially in the automotive sector, where Poland is the main outsourcing base. Risk on/risk off mode does not seem to change this paradigm.
There has been a lot of press about the influx of workers into Poland from Ukraine, with some commentators arguing that this has offset labor shortages and kept salaries (and inflation) in check. Earlier this month a central bank study argued that looser regulations in Germany could lure away a quarter of the country’s Ukrainian workforce in the next four years. How do you think Poland's labour market will be affected by this?
That is the question that every Chief Economist in the financial sector is analysing. Some of them perceive it as a big risk for a second round of price index increases, whilst some argue that Poland is much closer on a cultural level to other nations than Germany is. Polish cities are closer to Ukraine and in many cases men are working here and repatriating income to their families. It’s important for them to be able to return to their families with relative ease. They are able to get a bit better jobs in Poland, but the main issue though is salary level. Of course, in Germany they are able to earn up to three times more. 
Inflation is picking up in Poland. It’s expected to hit 3% this year and some economists are calling for 4.0% in early 2020. And yet, rates remain at record-low levels they’ve been at since 2015. How are commodity prices feeding into this picture?

This is politically driven, since current MPC members will not change rates before the elections in mid-October. It’s important to remember that Poland has no impact on the broader commodities sectors. Of course, the reverse is true, and commodities prices can have a big impact on the Polish economy. Higher fuel prices would drive further CPI/PPI increases.
Energy prices for medium-sized and large companies will be deregulated in 2020, implying there will be some price volatility going forward. Furthermore, costs for consumers were frozen by the government for 2019. What happens when these are relaxed?
This would directly impact costs at these institutions, implying a further psh towards a slowdown of the Polish economy. Apart from oil, this is the biggest threat for the CPI control.
Transformation is our key investment theme at Three Body Capital, and there is no better example of a market that has undergone profound transformation over recent decades than Poland. Can you pick out some of the key ways that the Polish capital markets have changed over the past decade?

“De-form” (the opposite of reform) of the Polish Pension fund system in 2013/14 has been a significant headwind for the Warsaw Stock Exchange. One of the most painful things is still the new regulations (MAR for example). Many companies were withdrawn from the WSE. The number of IPOs or SPOs in recent years has been embarrassingly low. It’s not easy to see how this changes. The new mutual/pension funds created in 2018/19 might perhaps change the whole outlook of the Polish capital market. 
The GetBack scandal severely dented confidence in Polish markets. Investors seem to be sitting on the sidelines and banks have circled the wagons. What do you think needs to happen to fully restore confidence in Polish assets? Is structural reform needed, or just the most precious commodity of all – time?

We need time. Although greed is good is no longer the mantra in Poland. Our SEC is still very anxious about further scandals, but this will change over time.
On a recent trip to Warsaw we met with some interesting VCs who were particularly active on the hardware side of the technology market. What is Poland’s venture scene doing right now? Have you seen the flowering in technology startups that we’ve experienced in London and other major European capital?

This is a promising market, but still very niche right now, in my view. As a country we won’t be able to compete in the automotive market with the Germans, but as an entrepreneurial nation I think we have found a possible way to beat the system. Our gaming industry is very promising. As a country we are missing access to capital. This has been the case for several centuries and cannot be reversed in 30 years. VCs here are still small in comparison to their western peers. We don’t have an equivalent of Shoreditch, with funky hotels and folks chilling in flip flops whilst making millions with their low profile beards and hipster sensibilities. But at the same time, it’s still a huge opportunity and will be a source of growth going forward.
Traditionally, Poland has had a strong relationship with the US, politically, economically and militarily. Now, according to Reuters, Huawei is prepared to invest $793 million in Poland as long as it's allowed to sell equipment to the Polish telcos. How do you derive the growing influence of China in Poland and the broader European region impacting Poland's relationship with the US?

It’s not as complicated as the dilemmas of the UK’s major political parties! But I do see this as a very complex decision path for the Polish Prime Minister. It looks like our politicians are trying to find a balance by dancing on two legs. On the one side, his lack of capital seems immense and imminent. From a strategic point of view, the US is (and will be) perceived as the only shelter from the Russian threat. Morawiecki (PM) is trying to attract FDI flows but has to carefully manoeuvre within the Trump method of global governance. Ultimately Poland will always seek a pattern that allows us to keep the US government satisfied.
When we met earlier this year you flagged the Łódźkie region's cooperation with Chengdu and Sichuan province as a prime example of Poland's willingness to entertain the advances of China whilst maintaining the trans-Atlantic alliance. How do you think these developments will affect Polish mining, logistics and infrastructure sectors? What has been the effect of China's “Belt and Road” initiative on Poland's position in the commodities supply chain?

Incredible changes are occurring in the city of Łódź, which has been recast as a key logistics hub for the whole of central Europe, as a prime example. I perceive this as a chance for growth but again it has to be played with care, bearing in mind the Trump administration.
Poland has an election coming in the Autumn. We noticed that Poland's biggest opposition group, the European Coalition, promised to eliminate coal from power production by 2040. What's your take on the politicisation of coal in Poland – and other countries?

There is a big push from financial markets towards the sector. The current situation is driven by political incentives, not economics. JSW should retain sound financials thanks to the fact that we produce coking coal. LW Bogdankashould survive thanks to good management of its cost side and very good approach towards systematic care and effectiveness.
JSW is the EU's largest producer of high-quality coking coal. You were also the first sponsor of the UN Climate Talks in Katowice, held in late 2018. Climate Change has become a dominant narrative in the popular press, and investors are starting to take notice. How do you intend to position your business in order to manage this transition in sentiment? What work has already been done and what is left to do?

That is our strategic goal – to change perceptions and explain how we differ from the thermal coal business. There would be no Tesla cars and windmills without steel that is produced from coking coal. The job that remains to be done is huge. We are just at the starting point, no matter what we might have done already in this area. It’s something that keeps our executive team up at night.

Poland is investing heavily in renewables especially, especially wind power. How do you see this affecting JSW going forward?

Wind power comes from windmills, which consume huge amounts of steel. So this supports our business.

How do you see renewables affecting fossil fuel producers over the short, medium and long term?

I’m very bullish for coking coal over the long term. In the short and medium term, the climate change narrative causes the banking sector to pull back from financing producers in the form of credit facilities and other forms of banking financing. That puts pressure on every coal miner, with severe consequences. The big rating houses are going to be cruel too in their rating assessments.
What effect does China have on commodities markets? What are people missing here?

Commodities markets are volatile. They are capital intensive and many assets are acquired via M&A – in most cases when markets are at max hype. That means transactions are often overpriced and in many circumstances, producers access experienced labor and production in a high inflationary pressure environment. I am very bullish on coking coal, copper, molybdenum, nickel and lithium for these reasons. Each year on average in China 1% of the population is moving into the middle class. That’s 13 million people. It’s like building a new London in Europe every year. Imagine the number of electric cars, fridges, TVs and air conditioning units needed to satisfy this new demand. China is also a big exporter of home appliances, so it is importing vast amounts of commodities needed to create these products.
We recently read that Poland's ruling national conservative Law and Justice Party (PiS) has "restructured" Polish politics by using “its absolute parliamentary majority to undermine the rule of law and attack press freedom.” Is this media hyperbole, or do you believe that Poland has regressed as a liberal democracy?

When I was working in the copper business in South America, I was asked by many friends why Poland was moving so much to the right after 30 years of unstoppable GDP growth. Since then we’ve had Brexit and PDT, as well as Marine Le Pen in France and the ADF in Germany. These worrying trends exist in a broader neoliberal narrative.
For decades, Poland and the UK have been great friends and trading partners. Now the UK is due to leave the EU at the end of October. In a fraught political environment, new focus has been thrown upon the pros and cons of economic integration and the single market. How do Poles perceive Brexit as a political and economic phenomenon? How might it affect Poland's economic relationship the UK going forward?

Polish people don’t care. On a personal level, I think Brexit is a disgrace. David Cameron and Boris Johnson are the prime examples of why not to send your kids to Eton! I am pessimistic with regards to the economic consequences. The collateral damage after Brexit is going to be massive in my view. Although it is worth noting that Poland traded with UK before we entered the EU in 2004.
If we had 3 days to spend in Poland what should we do, where should we go and what should we eat/drink? We recently did Warsaw and it was great, but are there any places you could recommend that are off the beaten track?

You should try visiting the seaside in Gdańsk for a day trip. It’s a thriving city. Also, Wrocław.


Quickfire questions.

Best investment ever?

I sold puts on oil in the recent autumn, with expiry in Dec call19 and closed my position on the May highs.
Worst investment ever?

LCCOPR, a Polish developer run by the Lech Czarnecki (Getin). 
Current favourite stock?

Beyond Meat. Although as an avid reader of your newsletter I know you are going to dislike this one!
What would you buy for your children right now?

Land in Poland, plus fintech.
What would you buy for your children’s children right now?

My children’s education. Although not Eton!
What’s your view on crypto?

Currently hyped but could be interesting once it matures.
The one piece of technology that most excites you?

The one book that shaped your outlook on the world?

I do not have one. Recently I liked very much Sapiens and Homo Deus.

The one quote or piece of wisdom that you think about every day?

Be a good and considerate person. Or at least, try to be!


 What we're doing.

When you live and work in a place, it’s easy to take it for granted. So when friends visit from another country (or continent), it helps to cast fresh light on your surroundings. Which is precisely what happened this week, when we caught up with friends from Indonesia for lunch in Camden. 

We had a great time swapping stories and exploring ideas over a pub lunch, before the conversation turned to the subject of whiskey. Before we knew it, we were sitting in the Members’ Room at The Scotch Malt Whisky Society as guests of our visitors, sampling some incredible malts and wondering why we had never come across this place before. Located near London’s Hatton Garden diamond quarter, 19 Greville Street is a classic Victorian building with a beautiful bar, close enough to the City for convenience, but far enough removed to feel different and exciting. It also happens to contain the world’s largest collection of single cask whiskies, so if you do visit, tread lightly and drink plenty of H20! 

Our sincere thanks to our friends from far afield, who managed to show us a new side to our beloved town.

What we're watching.

This week, whilst visiting Germany, we watched an extraordinary film – an old film, and not one you’re likely to catch at your local Odeon any time soon (although, to be fair, it is available on Youtube). 

Kirmes (“The Fair”) is a 1960 West German drama directed by Wolfgang Staudte, who championed the revival of the German film industry in the post war period. 

The film explores a group of villagers’ collective decision to literally bury their recent dark history and deny it when it resurfaces. It’s a gripping wartime story, one that explores the power of narrative to delude and compel, and the terrible human consequences of lacking the courage to question prevailing narratives – and of people failing to recognise and face the meaning and morality of their own actions.

Throughout his life, Staudte directed films which reflected on National Socialism, war crimes and suppressed memories. Kirmes is perhaps the finest expression of that mission, and one well worth checking out. 

What we're reading.

The FT recently published an op-ed entitled, “Does investing in emerging markets still make sense?” The LONG article argues that recent high-profile departures of Turkey's central bank governor and Mexico's finance minister are nothing new for EM investors accustomed to dealing with political risk. But "the basic calculations are changing for emerging markets as that growth potential dims – and with it, part of the core rationale for investing in the asset class." It argues that convergence is losing steam as growth in EM is stalling and globalisation retreats.

Whilst well written and diligently constructed, this article is not one we’ll be pinning to wall here at Three Body Capital. The concept of “emerging markets investing” is a simplification that lumps together countries who similarities disappeared many years ago. Of course you can’t pump money into “emerging markets” as a group and expect ironclad success and yet, that’s what the majority of EM investors do, comparing their returns to that of a broad index. Thought and expertise (not to mention a sprinkling of imagination) are required to navigate markets characterised by volatility, political risk and nascent market infrastructure. Growth in traditionally classified emerging markets has become scarce and we at Three Body Capital are searching for it differently, in a way that makes sense to us. As one astute FT reader commented, “If there ever was a case for active versus passive management, it's this asset class.” 

Perhaps the real question we should ask is “Does investing in DEVELOPED MARKETS still make sense?” Especially in this era of “new new normal” conditions characterised by sluggish growth, bloated balance sheets, ageing populations and domestic political uncertainty and international brinkmanship. Our answer to this question is yes. Investing always makes sense, provided it is done right. And sometimes, doing things right demands doing this differently.


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