In a sense, successful investing is about buying assets for which there will be greater future demand. The theory explains many investors’ preference for equities over fixed income. This doesn’t mean demand for the latter never increases. As the past quarter has shown, bonds’ coupons, rights and lower risks can prove more attractive at moments of market stress, or when interest rates, economic forecasts or inflation fall.
But debt is usually only a promise to pay back a fixed amount at a fixed date. Inflation and the time value of money mean this amount will almost always be worth less in the future. Normally, there won’t be more demand for £100 in a year’s time than there is today.
Shares, by contrast, are perpetual claims on a company’s assets and earnings. By recycling earnings back into its asset base, a business can grow its equity value, creating greater demand for its shares. By growing its earnings, a company can accelerate this process. And by growing earnings faster than the market expects, demand is likely to rise even more.
Key to this is the idea of scarcity. If a company grows its earnings at a faster rate than it issues new shares, investors tend to approve. Conversely, issuing new shares for diminishing per-share returns is a guaranteed way to destroy equity value and reduce demand for a company’s stock.
Companies can also increase scarcity by buying back their shares. Members of the FTSE 100 spent a record £55bn on this trick in 2022, equivalent to two-thirds of the value of their cash dividends, meaning scarcity was a big factor in the index’s 4.7 per cent total return.
Scarcity is central to the value of other assets, too. The relative scarcity of fiat currency in the money supply is critical to the faith investors, businesses and citizens place in it. Scarcity is one reason why London housing costs so much. The allure of owning vintage wine, Beanie Babies or the paintings of Johannes Vermeer is partly because they are scarce.
The impression of scarcity is also a selling point of bitcoin, whose limited supply is by design. Because new bitcoins require ever greater computing power to be mined, and because only 21mn bitcoins can ever be mined, believers argue this will push demand and prices ever higher.
However, this assumes the owners of the 19.3mn bitcoins in circulation today won’t cash out at lower prices – a possibility for a made-up token with limited real-world applications. It also overlooks bitcoin’s widespread fractional trading. In this sense, bitcoin is not scarce like the Ferrari 250 Testa Rossa, of which only 33 were made, because subdividing a classic car tends to devalue it.
Smarter scarcity plays exist. When it listed in 2018, the original idea behind Yellow Cake (YCA) was to offer direct exposure to uranium prices, about which plenty of investors were (and are) bullish. But by buying up 18.8mn pounds of uranium to date, the fund has also increased scarcity in the physical market. Its success is not just reflected in a doubling in its share price – lagging an even higher rise in the uranium price – but in the 2021 debut of a copycat fund, the Sprott Physical Uranium Trust (CA:U.UN).
Another option is SparkChange Physical Carbon (CO2P). This fund (in which I have a small holding) buys permits that EU-based heavy industry must purchase to emit carbon dioxide. Each year fewer of these allowances are issued – itself a form of built-in scarcity – to incentivise switches away from fossil fuels. But by competing with industry for an ever-scarcer resource, the fund aims to accelerate this dynamic, driving permit prices higher in the process.
Like Yellow Cake, CO2P’s investment case paradoxically has something in common with Shell (SHEL), which made up £13.8bn of that £55bn FTSE share repurchase spree. Whether future demand will be greatest for the shares of the UK buyback king, a pound of uranium, or EU carbon credits is hard to say. But the answer will tell us much about the direction of the nascent energy transition.
