COVID-19 Impact on the Australian Capital Markets with Thomas Lambeth & Simon Ondaatje

Thomas Lambeth and Simon Ondaatje of Australia’s VP Capital discuss the current state of the Australian economy as it relates to COVID-19.
Thomas Lambeth and Simon Ondaatje of Australia’s VP Capital discuss the current state of the Australian economy as it relates to COVID-19. China has played a large role in the uncertainty within Australia’s capital markets due to their large interest in Australian commodities. Despite this, Lambeth, as well as many economists, believe that the Australian economy will return to economic stability within the next three years.

Contrary to what the economic impact of COVID-19 may lead you to believe, the country has experienced relatively low infection rates and the health care system has yet to become overwhelmed as we have seen in many countries worldwide. Their neighbor, New Zealand, has successfully flattened the curve, striking hope in Ondaatje for his own nations ability to weather the COVID-19 storm.

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Ryan Morfin:                    Welcome to Non-Beta Alpha. I’m Ryan Morfin. On today’s episode, we’re joined by Thomas Lambeth and Simon Ondaatje from VP Capital based in Melbourne, Australia talking to us today about the impact coronavirus has had on the capital markets in Australia. This is Non-Beta Alpha.

                                           Tom, Simon, welcome to the show. How are you guys?

Simon Ondaatje:             We’re doing fine, thank you, Ryan. And we’re based in Melbourne, Australia and Melbourne, Australia happens to be, I suppose, an island now that is coming out of the deepest lockdown. Not quite clear of it, of course, but coming out of lockdown, and so things are on the improve here. But we’re doing well, thank you, Ryan.

Ryan Morfin:                    Well, gents, we’d love to hear your opinions on how Australia is doing, how the government has been reacting, and what the markets are doing down there, and what your view is from Australia over the horizon to your neighbors in China and the global markets. So Tom, would love to hear some of your opinions.

Tom Lambeth:                 Yeah, sure. Look from a… Thanks for having us on Ryan and Ramon. I think from a coronavirus standpoint, Australia has held up relatively well. Our infection rate is low, our healthcare system hasn’t been swamped yet, and we pray that that remains the case. If there is a second or third wave, as many epidemiologists to predicting, then that may change, but as of early May, 2020, we are okay relative to the rest of the world.

                                           I think from an economic standpoint, it’s a different story. As you would be seeing over there in the United States, the shutdown of our economy has meant a material impact on people’s livelihoods. And you’re starting to see that across many sectors. Certainly travel, leisure, consumer discretionary. Australia, and particularly Melbourne, has a very vibrant restaurant culture, as does much of the East coast of the US, and that’s been smashed, to put it frankly. There are many people who are working in the industry and obviously, many of them are on casual [inaudible 00:02:46] employment contracts, and it’s sad to see that that’s the case, that those people lose their jobs and their livelihoods. So from an economic standpoint, it’s tough. Numbers wise, I’ve seen estimates of a double digit decline in GDP, on an annualized basis as the worst case, and then the best case of a single digit decline. Let’s see where it ends up.

Ryan Morfin:                    Yeah. I mean, Goldman Sachs came out in a comment last week that their head economists thought global GDP was going to be down 17%. But in the sequential quarter, it’s going to start to look like there’s high growth rates, but they’re extrapolating that from the Chinese data that they were able to get out of the Q1 shutdown. And they were down 25% in Q1 and they had much more rigid regime of lockdown than I think the West had. But do you guys feel that the growth of the virus, and the transmission, has been arrested in terms of the policies that were put in place from a social distancing standpoint?

Tom Lambeth:                 Look, I think the government’s done relatively well. I think we weren’t as early as maybe some countries, but the response was not quite Communist Party of China-esque in its policy, but it was, I guess, erring on the side of more authoritarian rather than less. And I think in these times, that appears to have worked. Certainly worked in massaging the numbers down to almost zero new infections on a daily rate. So from that standpoint it’s worked. Now, time will tell to say whether that’s sustainable or not, because at some point citizens have to come out and participate in the economy.

Ryan Morfin:                    And is it right, I thought I heard somewhere on the news in the last week or so that New Zealand’s claimed to have gotten rid of the virus on the island as well?

Tom Lambeth:                 Yeah. Look, so New Zealand’s in a very similar boat to Australia, and both countries have adopted similar policies. New Zealand was earlier than us to be fair, and it seems to have worked in terms of flattening in the curve, so [inaudible 00:05:08] call it. I guess the real question in my mind is the sustainability of that policy. Six months from now, will that prove to be a wise decision? I’m not sold on that yet.

Ryan Morfin:                    And so it seems that Australia is looking to come back on a few weeks earlier than anticipated. Are you seeing a loosening up of the restrictions and people starting to go out and about, open up the economy?

Tom Lambeth:                 Look, we are. There’s some anecdotal evidence to suggests that traffic numbers in the CBD are up materially since the lows. 30, 40%. And that’s a good sign. I think driving around myself to sort of drop supplies to family, you kind of see an up-tick in traffic from where it was, say 30 days ago. But we haven’t seen that in the really beaten up sectors, like travel, leisure, discretionary retail. That hasn’t picked up as I understand it yet. I think consumers are deferring their spend in those sectors for the moment.

Ryan Morfin:                    You know, one thing that I noted this week in the news cycle is that a Prime Minister Morrison has been really taking a lead role from the West’s perspective at really dogging China for their response, I guess, or lack thereof of warning everybody. And I saw that there were some articles out there about state-owned enterprise property companies in Australia, having employees in Australia, gather up PPE early January, February, and shipping it back to China, which really should have stayed in Australia, had they shared the data. What is the public sentiment in Australia about this and kind of how has the politicians in Australia, what’s the rhetoric there on the ground?

Tom Lambeth:                 Yeah. I mean, you raise a very difficult question for Australia from a GDP legal standpoint. I mean, how do we react here? Because I mean, Scott Morrison, I think rightly has called into question those kinds of practices and you’re absolutely right. That did happen. Now it’s a separate question as to whether sending supplies back to China was an ordinary business activity for [inaudible 00:07:38] companies anyway. And it is, by the way, mainly around the consumer end of the market. [inaudible 00:07:46] for instance, this is a very popular Australian [inaudible 00:07:49] China as consumers. But we’re talking about medical supplies here I understand, so it’s a different category all together.

                                           So I think we’ve got to be careful between making this [inaudible 00:08:03] and maybe responding to China, and China has increasingly become more nationalistic in its, I think, its approach with Australia. We need to be careful about how we manage it. I think public [inaudible 00:08:22] is I guess rising here against the Chinese Communist Party. We’ve kind of handled a crisis and particularly some of the information that has been disseminated globally around who’s to blame for the fires. So I think more broadly it’s on the move against China, and then things like, as you pointed out, these medical supplies example, don’t help at all with Australians view.

Ryan Morfin:                    And is the Australian economy, and I know that they’re a major trading partner for you all. Are the capital inflows, have they stopped over the last several months? Have they kind of grinded to a halt, or are you seeing a lot of buying opportunistically from China? I’ll give you an example of what happened in the US last week. There was a $1.3 billion distress energy company that was bought here in Texas by the Chinese company at a dirt cheap price. Have you seen trading activities slow down from China, and what’s the trading activity like historically between the two countries?

Tom Lambeth:                 It’s very high. So look, China makes up Australia’s biggest export partner, to be clear. And the answer is it depends on which sector you’re looking at. So the first thing is our treasurer, Josh Frydenberg, actually changed the foreign investment rules at the time of this virus I guess limit foreign nationals buying up companies in a similar way to you described in the United States. So that’s been stopped. So there are no opportunistic buys that can really occur of that scale.

                                           Separately, there’s… Australia’s a big commodity producer and exporter as you would know, and that hasn’t stopped. So iron ore has continuing to flow out of the country into China and so is coal and copper and all the things you’d expect. But I guess the more discretionary elements of Chinese capital inflows have completely stopped, and that’s things like property acquisitions, company acquisitions, large scale agricultural landholding acquisitions. These things have basically stopped for now. Now at some point I expect them to return.

Ryan Morfin:                    And are there a lot of capital flows also into the ASX, the Australian Securities Exchange?

Tom Lambeth:                 Not in the same way that there are direct purchases. My experience, the ASX is heavily dominated by the super funds here, which are like our Canadian pension fund equivalents. But Chinese money hasn’t yet reached the point of speculating on the ASX in the same way that it’s speculated on on property and in other direct, I guess, ownership holdings in Australia.

Ryan Morfin:                    Interesting. And were there some policy changes recently about super fund withdrawals, people allowing or being allowed to change the rules so they can pull money out in this period?

Tom Lambeth:                 Yeah. So the rules were changed to try and help ordinary Australians have access to their money so they can spend that money in the economy and obviously create a [inaudible 00:11:55] effect. But to give you an idea, it’s around $20,000 per person that you can withdraw from your super. And that’s expected to be a small impact on the market. I read that it’s around 1% of daily volume if everyone goes up and redeems $20,000 and that’s about it. Sorry, it’s one day’s worth of volume will be the impact on the market. So I don’t expect it to have a big movement, a big impact on where stocks go in the short term, but let’s see.

Ryan Morfin:                    Yeah. And how have FX rates for the Aussie dollar been impacted through this?

Tom Lambeth:                 That’s been a roller coaster. So we’ve gone from 69 cents US all the way down to 55 within a few weeks, and that was in March. And now we’re back with sort of low to mid 60s [inaudible 00:13:06] so 64, 65 again. So, I mean, it’s been some of the most volatile FX trading that I’ve seen. It reminds me of 2009 and 2010 in a way. And I think that’s a very interesting question about where the… It’s more driven by the US dollar, I believe, but it seems to be a relationship of high equity market, low US dollar, and that’s historically been the case. And when the US dollar runs, the equity market seems to tank, which is an interesting relationship, and there’s a number of reasons why I think that is. But the Aussie dollar I think will be governed by that in the short term.

Ryan Morfin:                    Yeah, and it’s interesting. I think the countries that can get the consumer confidence back and short order without a lot of additional ripples or new transmissions I think are going to be the ones that have the out-performance in GDP. But how has this kind of, we’ll call it exogenous shock, changed your investment strategy or the way you’re looking at allocating capital to there?

Tom Lambeth:                 Ryan, it hasn’t changed the way we think about investments, but our portfolio is relatively balanced at the moment, so we have some shorts, we have some cash and we have longs. I think it’s always important to be net long through the cycle, because I think not being at net long just, you won’t make money. But we’ve I guess been a bit more opportunistic recently in some of the things we’ve been doing, and that would include looking for companies that we can buy with the cash balance greater than their market cap for instance. And there are opportunities like that, believe it or not.

                                           And each has a different reason why their cash is larger their market cap, but the key is to pick the ones that have the least worst reason, if that makes sense. There are opportunities as well to buy businesses that [inaudible 00:15:19] times earnings here in Australia, and it depends on what the business is. And again, that’s [inaudible 00:15:26], but that there are tremendous opportunities here in mining services and non-discretionary retail and then some of those sectors have been hit along with the rest of the sectors that I talked about: travel, leisure, discretionary retail. Unfairly so, in our opinion.

Ryan Morfin:                    One question on valuation here that we have is just trying to get a better forecast of earnings. This is second quarter earning season right now, and a lot of CFOs are coming out and really throwing their old forecasts in the garbage, and some companies aren’t even issuing guidance. Are you seeing a similar type of behavior from the reporting companies in Australia, and as an investor in this period, how do you look through the fog for good milestones on where value is?

Tom Lambeth:                 Yeah, it’s a great question. Look, most companies have been okay at the disclosure. I think where it’s possible, they’ve come out and said, “Look, we’re impacted by COVID, and we’re not sure about the next three to six months, but here’s what we’ve done about it, and here’s how much we’re cutting our OPEX on an annualized basis by. Here’s our balance sheets. Here’s our liquidity runway.” You’re seeing businesses that I’m sure you would have heard of like Quantcast do that. Many of the airports have done that. Afterpay, which is a large Australian tech company expanding in the US currently has done that. Yeah, our biggest car sales company in retail, in Australia is, has done that. So I find actually as a fund manager, the disclosure on this in Australia hasn’t been too bad. It could be a lot worse in my opinion.

Ryan Morfin:                    Yeah. The SEC’s making all the companies give a COVID statement in the coming earnings quarter, so it’s interesting to see just kind of the blanket responses that we’ve been getting, but is the banking sector healthy in your opinion in Australia today?

Tom Lambeth:                 Yeah. I mean, the Morrison government has… The banking system in Australia is made up of four banks, and it’s somewhat of an oligopoly, many would say another arm of the government. And Morrison’s done a good job, I think, at perhaps using them as a sponge to soak up some of this, let’s call it, three to six month volatility in earnings in the real economy.

                                           And the banking system post-2009 has been relatively strong in Australia. We actually had a Royal commission not too long ago, a couple of years back. And that Royal commission tightened up a lot of the banks’ activities, but it also made recommendations to have, for instance, tighter capital rules and more of a buffering in their balance sheet, which we’re seeing now. So, one interesting thing is banks in Australia have allowed the average consumer to defer their loans for up to periods of six months, which is interesting. So no interest, no [inaudible 00:19:02], and it effectually becomes like a payment [inaudible 00:19:07] at the end of six months.

Ryan Morfin:                    And have you seen the retail industry start to pause rent payments to the landlords in the property sector?

Tom Lambeth:                 You’ve seen that, and that’s been a big dispute here. [inaudible 00:19:25] which is Westfield I think has been in the paper talking about it. You’ve had big retailers like Solomon Lu on the other side, and that’s certainly started to happen. So a company we’re invested in has also talked about this and we’re seeing deductions of 50 to a hundred percent. 50% over the medium term and a hundred percent in the short term, and they’re big numbers.

                                           And it’s going to be a tough spot for commercial landlords. I think it’s really tough. But then going back to your early question, that payout, I guess, has been funneled through the banking system, at least partially, because the banks stepping up as well, [inaudible 00:20:10] on the commercial loans or at least deferring. So it’s a matter of if every person along the line differs, where do you actually get to? That’s the big question. The buck’s got to stop somewhere. And my view is, it’s always been, it’s got to stop in the currency. The currency’s the ultimate sponge, because no one directly pays for it. We all share the costs, the inflationary costs, I suppose. And of course the government’s [crosstalk 00:20:41].

Ryan Morfin:                    Yeah. How has unemployment grown through this crisis? I know here we’re looking at, I mean, something as high as 15 to 20% is what people are forecasting for this year. Have people gone on furlough and been terminated, or have employers been able to carry the burden across the last few weeks?

Tom Lambeth:                 So our numbers are not as big as yours, but we’re talking in the order of five to 6%, and obviously growing. But whether we get to a 1991 recession, whether it’s 15, 20% unemployment remains to be seen. And again, I think that’s linked to whether we have a second wave and whether our policy of containment works in that environment. Employees I think have done the best they can. There’ve been government subsidies available to them. We have a job caper subsidy here in Australia which allows the employer to effectively get paid for keeping someone’s job. So there are benefits that the government’s handing out, and we expect to be in an enormous amount of public debt post this crisis. We went from basically having zero public debt to we’re looking at least 15% of GDP if not more over the course of the next one to two years, I think.

Ryan Morfin:                    Wow. Yeah, these debt-to-GDP levels in the West are starting to get very worrisome. Yeah, I’m just wondering if these unemployment levels that are going to be very high relative to historical norms are going to maybe dampen any of the inflation targets from central banks, but it seems like all the central banks have had the same playbook that just throwing the kitchen sink at the problem and saying liquidity will never run out, but at some point someone’s going to blink, I think.

Tom Lambeth:                 Yeah, that’s very much our view. I mean, the deflation that will be experienced in the short term I think is the bigger problem. We can have the money printing and the fiscal spending, but it doesn’t matter if the velocity’s zero, or at least the marginal velocity’s zero. A million times zero is still zero, so [inaudible 00:23:20] on where do we go? I think we get the inflation, but it may not be for the next 18 to 24 months post the crisis at least, and maybe post a return to consumer spending normality.

Ryan Morfin:                    No, it’s going to be a quagmire for the West trying to find the way to grow ourselves out of this, but I’m hoping that it bounces back. I mean, I think some of the early research coming out is saying, “U shaped curve is obtainable,” but yeah, everyone’s got a different shape of the U I guess. What are the economists in Australia saying? What do they expect? How long do they expect kind of this earnings recovery to take?

Tom Lambeth:                 Some are saying it’s L-shaped. Some are saying… You’ve got to a range of views, and also a range of views between sectors, might I add. So I think broadly, the economists expect somewhere between a U and a V. So it’s a nine to 12 month episode with the U, V kind of shape recovery afterwards. And that’s… Maybe it takes a bit longer to get back to a hundred percent of what we were. So that’s the mainstream view. And then within that, there are economists that work within particular sectors that have very bearish views. And I’ve heard the most bearishing in hotels, I think is something like three years and until a hundred percent of consumers bearing returns, which is understandable, but it’s certainly very bearish if you work in that industry.

Ryan Morfin:                    Yeah. In the US, the hotel industry, they’re talking about 15% of hotel keys may not survive. They may go away. So it’s an interesting 18 to 24 month recovery curve is what they’re talking about. Which it’s going to be interesting to see who the winners and losers are, but there’s still new hotel development going on around the world. So it’s going to be interesting to see how that sector plays out. But I think retailers as well, yeah. I don’t see people running back to the mall. Now, I could be wrong. Maybe people are sick of being quarantined in their house, and so looking for any escape or way to spend money, but eCommerce has bounced pretty high in the last six weeks globally, and so I think it’s going to be an interesting question to see what happens if consumer patterns shift during this. Do you think it’s a short term blip on consumption patterns, or do you think there’s maybe some permanent changes as to how the consumer globally responds post COVID?

Tom Lambeth:                 Look, I think it’ll accelerate some areas of consumer spending, you’re right. I mean, no doubt online spending has to increase. And we’re invested in companies that have exposure to this, and you’re saying a hundred percent increases during this period in volume, which is just extraordinary. I would have never predicted such a rise in such a short amount of time with some of these online businesses, but part of that, it’s not sustainable. Part of that goes back to bricks and mortar and the ordinary way of doing things. But I suspect some of it is, as it will catalyze some consumer behavior patterns. And we think there’s still good value to be found in some of these companies, not withstanding [inaudible 00:27:11] the online players I’m talking about. So it’s an interesting point.

                                           Just on your earlier comment around when we can expect the consumer to rebound. From an Australian perspective, it’s worth noting that we have a very high private debt-to-GDP here. So much of it’s driven by residential property investment. And I think we’re something like 200% of GDP, which is just extraordinary. So, that will… Yes, interest rates are very low and probably going lower, but that will dictate to some extent how quickly spending and therefore philosophy review presumes and whether that’s habit. Certainly in this country, I think it might be. As Australians receive their payments from the government, I think most will do what they did in 2008, which was just to pay our debt.

Ryan Morfin:                    Yeah, no, that’s interesting. I mean, governments and consumers are in an unusual financing environment where it’s typically really, really cheap right now to borrow debt and keep piling it on. And I think we’re starting to see municipalities and state governments run into problems, even with the cheap interest levels that are obtainable today in the debt financing markets. Have you seen a lot of companies going to the institutional, either bond or credit markets, to borrow money? I mean, the US, there’s been a run on high yield and investment grade debt, and it’s all getting cleared, which is, I mean, it’s interesting. What I envisioned would have been in the credit crisis here in the US, there’s been a huge issue, which I mean, record issuance of debt in the last six weeks. The debt capital markets open in Australia?

Tom Lambeth:                 They are. They are right. In Australia, we don’t have a massive primary and secondary debt capital market in the same way that you do in the United States. We don’t really have the equivalent of a US PP market. We have a very strong banking sector which writes most of the loans. That said, there are bonds and liquidity available that the companies use from time to time. We’ve seen one major deal, which was just a syndication of banks and investors effectively refinance a fleet of aircraft. So you’re seeing things like that. But what you’re getting at I think is happening more in the equity market here. Keep in mind, just to use the global financial crisis in an analogy again, in 2009, we had one of the largest years in equity capital market issuance in Australia and I think we’re on track to sort of equal that or beat that in 2020. And so [inaudible 00:30:25] going instead of debt, they’re going for heavily discounted equity market placements and [inaudible 00:30:31] which is an interesting way to make money in this market as well.

Ryan Morfin:                    And what are some of the silver linings that you see right now going forward for Australia and for the markets in general?

Tom Lambeth:                 Australia, I think with its exposure to commodities and China has the potential to rebound quickly. And I use the word potential cautiously for the reasons that I’ve discussed around the consumer and the dynamics around debt here. But if we can get out of this, it’ll be because we can restart the resources sector and perhaps restart’s the wrong word. We can go into another multi-year bull market, which is certainly possible. And that’s certainly what happened after the last crisis. So that’s what I’m pinning my hopes on. I think you wouldn’t bet the farm on that occurring straight away, and it’s obviously a function of Chinese stimulus. And from what I’m hearing over there, it’s not a good news, so we’re very much tied to China in many respects. We can talk about other sectors, but the reality is the majority of the Australian market’s resources.

Ryan Morfin:                    Yeah, no, the Chinese industrial production has come back online, but only about two thirds of the way of what it was in January. So it’s still not fully corrected, but yeah, I think that’s right. I think if the Chinese market comes back on and they’re buying a lot of commodities, it should electrocute or jolt the Australian economy back, which will be good. Well, one final question for you, Tom. Any books of interest that you’re reading right now? Any research you’re doing that is noteworthy that you mind sharing with our viewers?

Tom Lambeth:                 Look, there’s lots of classics. I think, we’re probably [inaudible 00:32:42] in more of the value investing school, not just value, because we’re kind of broadly opportunistic as well. But rereading some of the old Warren Buffet letters obviously make sense in times like these. The patience that he had through the cycle to hold cash. I think he’s still holding cash now. I think it’s a great lesson to all investors. So, we’ve been doing that. Some of the old sixties, and seventies, and the eighties letters to shareholders is worth reading.

                                           From our point of view, we run a lot of numbers internally. And, I would say to investors who are looking at Australia, look at some of these mining services companies. I mean, some of the research that we’re doing, we’re meeting management and looking at the financials, but you can get these names on one to two times [inaudible 00:00:33:41], which is cheap. Now, whether you believe that that’s sustainable in the near term, but that’s a main [inaudible 00:33:51]. But if you’re patient, I think if you can make money, and that’s where the opportunity is in Australia, having talked about being a big resources economy.

Ryan Morfin:                    Fantastic. Well, Thomas and Simon, thank you guys for joining us. And we’d love to invite you guys back in a few weeks and kind of catch up to see where kind of the markets have taken us and how things are playing out. Thank you so much.

Tom Lambeth:                 Thanks, Ryan.

Simon Ondaatje:             Thank you, Ryan. Thanks everybody.

Ryan Morfin:                    Thanks for watching Non-Beta Alpha. And before we go, please remember to subscribe and leave us a review on Apple podcast or our YouTube channel. This is Non-Beta Alpha. Now you know.

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Pini Althaus: Yeah, so lithium is a separate category to battery material. The rare earths are 17 rare earths. The four, let's call it, key rare earths that we're focused on at our company, the four rare earths that go into the permanent magnets. And these are the magnets that are found, there are a number of them in your back of your cell phone or an iPad. But if you look at an F35 striker jet, you've got about a ton of rare earth magnets in those. And we've got two heavy rare earths and two light rare earths is part of the permanent magnets. You've got dysprosium, ytterbium are the heavies, and then you've got neodymium, praseodymium as the two light rare earths. So those would be key rare earths that are the focus.

Ryan MorfinAnd you use these in, I guess, in military applications as well, but historically, where has the United States sourced the rare earth for supply chain?

Pini AlthausYeah. And that's the shocking part. We've been securing those materials from China. So China controls the rare earth sector and has done so for the past 30 years or so. And it was a significant misstep on the part of the United States, allowing China to have this control. And actually this wasn't a question of China coming in and doing anything nefarious as far as stealing IP or anything. The US government made a conscious decision about 30 years ago to allow China to come to the United States and acquire the processing capabilities for rare earths. So just as part of some background, you've got the rare earth materials containing various mining projects, but once you extract them, you have to then process them and they go through certain phases before they get to the magnet phase. And China, the thought process was let China do the mining, let China do the processing.

Pini AlthausWe don't need to do that here. And we'll buy the materials from China cheaply and the premier of China at the time, Deng Xiaoping made the comment, he said, "The Middle East has oil. China has rare earths." And unfortunately we weren't smart enough to understand what he was saying. And the Chinese understood that the future of manufacturing is going to revolve around control of the rare earth and critical mineral supply chain. So if you think about it today, Ryan, we cannot build... Forget about consumer electronics and medical equipment. We cannot build the equipment that the US Pentagon or the US armed forces require, whether it's F35 fighter jet, Tomahawk cruise missile, communications equipment, without going to China and obtaining those materials. And it's obvious to all that this should be extremely alarming. We've seen China use this as a weapon, if you will, as far as how it interacts with other countries back in 2010, when there was a dispute between China and Japan on the East China Sea.

Pini AlthausSo China cut off rare earth exports from Japan for 40 days. Japan obviously being a significant user of rare earth elements for their high-tech manufacturing sector, that was stopped after 40 days. But in fact, it was President Obama that first made the United States aware of this, formed a division within the Department of Defense to handle this issue, but not much has happened. And we continue to be relying on China for these materials. And what has been made about trade war with China and whether the trade war is really the impetus for China withholding rare earth exports. And that is a huge misnomer. Whilst China had been talking or implying that they would cut off rare earth exports, the truth of the matter is that China, under it's made in China, 2025 mandate, its belt and road initiatives and others. And you seem to control the critical minerals and rare earth supply chain so that it can continue its dominance as a manufacturer or a global supplier of these materials and finished products.

Pini Althaus: It's the backbone of its economy. And in fact, China has become a net importer of rare earths from different countries like Miramar and others. So with that, they are decreasing the exports to countries like the United States, Japan and others.

Ryan Morfin: And was it ever a risk that the Chinese were going to turn off the exports of rare earth to the US during the trade war? How close were we to that? And was that ever some saber rattling that went down during trade negotiations?

Pini AlthausYeah, I think it was saber rattling. I think it would be paramount to an act of war. I can't say with any authority that that would not happen, but it would be probably, aside from war itself, it would be one of the most significant acts of war cutting the United States off from the ability to procure rare earths. But that being said, I mean, if you look at, as an analogy, the oil and gas sector and the reliance of the United States had for many, many years on OPEC countries to supply us with the oil. And we had embargoes and we had price manipulation by OPEC. This is far more significant given the ubiquity of where these rare earths go. And yes, we're always under the threat that China can cut off exports under the guise of a trade war or for any other nefarious reasons.

Pini AlthausBut I think even more importantly, to just as the natural run of the course of things with regards to their business and their desire to maintain themselves as the global leader in manufacturing and exporting of goods, China is in a position now where it actually requires these materials for their own domestic consumption and can legitimately cut off rare earth exports by stating that they need it for manufacturing and that would actually be somewhat correct. So we're in an extremely dangerous position here with this reliance on China. And it wouldn't just be China. If it was another country, it would be similar issues, not to the same extent, but reliance on one country for these materials is dangerous.

Ryan Morfin: And it's been mentioned in the past that in 2010, China flooded the market to really kill all the competitors in the rare earth mining industry. Where was the World Trade Organization during this period? And how did that play out and how does that set the chess board for China to run the tables?

Pini Althaus:

Yeah. So the WTO stepped in when China cut off rare earth exports from Japan, I think it lasted for about 40 days because the US and Japan protested the WTO, and they stepped in and China resumed exports. While I'm not an expert on these trade matters, one thing that I am aware of is that one of the reasons why China had to resume the export of rare earths was it did not legitimately need all the rare earths for domestic consumption. So therefore it was a nefarious act, if you will, to cut off rare earth exports. Now that has changed, which means China have to cut off rare earth exports today, they have a legitimate case to say that they require these materials. There's a shortage of these materials and they require them for their own domestic purposes. It is the backbone of their economy and there's very little we could do about this today, which is why it's becoming an even more urgent issue.

Ryan Morfin:

And the US government started stockpiling some of these after that incident. Can you talk a little bit about what DOD and DOE has done to start making sure that there's not a critical supply shortage going forward, and is it enough?

Pini Althaus:

Yeah, again, there is a national defense stock pile, and there are materials still that the United States needs to procure in order to shore up its stockpile. There are magnets, the finished magnet products as well, the United States government needs to stockpile. Again, there's a limited amount that the United States government has. It requires approval from Congress, whether it's in the NDAA or other approvals from Congress, to allocate monies for the national defense stock pile of these materials. That being said, there's no endless supply of these materials. And unfortunately, the apparatus, the way it's set up right now with the US government, it's going to continue to require having a secure supply chain of those materials for many, many years to come. So it's not a question of stockpiling for 10 or 20 years, and then this complacency and saying, we'll kick the can down the road. But keep in mind as well, Ryan, that US government accounts for low single digits of overall rare earth imports into the United States.

Pini Althaus:

We're talking about defense contractors, we're talking about the manufacturing sector. The direct impact this has on the economy, jobs, the automotive sector, and others is significant. So it's not just limited to the United States government. If you look at over the past couple of weeks, the sanctions that China have put on Raytheon, Boeing, Lockheed, et cetera. I mean, the question is where are they going to get those materials? And if we go beyond that, you need rare earths for the 5G network. Now that Huawei has been banned from installing the network, not only in the US but other countries, we have to have the ability to get a secure supply of these materials as well. Which currently, again, trying to control the hundred percent. So it runs across the board, both for government, defense and manufacturing in this country.

Ryan Morfin:

Well, and so help me paint a picture for our audience. Does China have all the mines for rare earth, or they're the only ones who started mining it? Or are their mines globally dispersed and nobody's been doing the actual infrastructure to do the mining?

Pini Althaus:

Yeah. So finding rare earth projects or rare earth elements is not the difficult part. It's finding them in significant quantities that makes a project economically viable. And part of that consideration are the environmental rigors that companies in the West have to adhere to. And China, even by their own admission, have had a complete disregard for mining these materials and even for processing these materials. And in fact, just the last week or so, the BBC did an expose on this, 60 Minutes has done an expose on this. But the Chinese have not denied this and have talked about cleaning up their act, but it has an effect on the bottom line for what the costs of mining and processing are if you have no environmental standards to adhere to. So China have exploited those rare earth projects they have, primarily in inner Mongolia, and have brought a number of projects online and quite quickly, and in a significant way, with a complete disregard for the environment.

Pini Althaus:

So it was seen as an environmental no-no in the West for many years. Now, what's happened over the past few years is you're starting to see rare earth projects in different parts of the world sprout up. You've got the Mountain World project in Australia owned by Linus, which is a producer of Nd and Pr, neodymium and praseodymium. So two of the light rare earths. They may have some heavy rare earths coming online at some point in time. And you've got Arafura, which is another company in Australia that we're working with to assist them with their processing so they don't have to send the materials to China for processing. But really these are a drop in the bucket for what the requirements are for the United States. And certainly what the requirements are for allied countries, the EU, et cetera. So there is a race, if you will, worldwide to start bringing projects online. The Chinese are very active in trying to secure assets outside of China.

Pini Althaus:

So in Africa. They have ownership of a project in Greenland. So there is somewhat of a race. The Australian government has stepped in and has started limiting the ability for China to own, or have ownership in, or off takes for the Australian rare earth projects. And that's part of the strategic Alliance between Australia and the US. Canada, similar thing as well. There are a number of projects that are looking to come alive, but these projects are, for the most part, will take many, many years to come online. We have to expedite the process. We have to assist with a [inaudible 00:14:41] supply chain and the domestic rare earth sector, because previously investors have been scared off by things like China flooding the market, which is not a possibility at this point in time, given that China can't actually afford to flood the market. They are already very heavily subsidizing their mine to magnet supply chain there.

Pini Althaus:

This is more now a case of being able to get production from non-Chinese sources so that the United States and allies have a viable, secure supply chain of these materials. And it's a concern worldwide. We speak to governments all over the world, and we're all facing the same issue. Some more than others, especially countries like Japan, that don't have their own rare earth projects there and are reliant on Australia where they've made some investments there. And in the United States, they've made an investment recently in Africa. So there is this race, if you will. And I think we've got a five-year window here to at least stand up a few projects worldwide. Otherwise we've lost this race and we will be dependent on China for many, many years to come. And Ryan, it's a bit of a hypocrisy. If you look at it where you've got materials going through clean, green energy applications, like electric vehicles, wind turbines, et cetera.

Pini Althaus:

That we're sourcing these materials from China, where they've, again by their own admission, has been complete environmental devastation to water bodies around these mines and processing facilities, to the communities. People have been getting sick around these projects yet we're putting these materials into our electric vehicles or wind turbines. It makes no sense at all. And people are starting to wake up to this. And that's why the sector is starting to see a lot of support come out of Congress and bi-partisan support. And in fact, it's one of the only bi-partisan issues right now in Washington. And it's good to see that some things decided to move in the right direction.

Ryan Morfin:

And is there a special process? You talk about the expense, is it really difficult to mine these? You have to go through a special chemical process to extract and clean and purify. Is it a lot harder than, say, gold or silver or some of the other, we'll call, more traditional elements?

Pini Althaus:

Yeah. It's all about the processing to some extent. So if you look at MP Materials in California, which used to be Molycorp before they went through their bankruptcy. They are a miner of Cerium and Lanthanum, which are two of the light rare earths, the lower valued light rare earths. Given that they do not currently have processing technology, they are sending those materials to China for processing where China is tariffing those heavily. Linus is also, they're doing their processing work in Malaysia and elsewhere. So it's really about the processing at this stage. One of the things that we've done, after we put out our PDA last year with our upgraded resource, which now includes a significant amount of lithium. We make a decision that, based on the test work that we had done around our processing methodology, that we were not going to send our materials to China. That it's paramount for us to do this work in the United States and in a collaborative effort as well.

Pini Althaus:

We've been asked by some of our investors, "Well, why would you be looking to help other projects with their processing?" And the answer is simple. There's no one project or one company that's going to put China out of business or make a dent, or somehow be able to take care of the overall demand worldwide for rare earths and critical minerals. And it's very important for us to have processing capability in the West. So that was the impetus for us opening up our own rare earth and critical minerals processing facility earlier this year, which we did in Wheatridge, Colorado. And in fact, we've made some significant progress on the method that we're using for this. And we're starting to collaborate with Australian companies, Canadian companies. We're currently talking to a group over in Europe as well, because this has to be a collaborative effort.

Ryan Morfin:

How does Europe solve for these problems? Do they have this better under control than the US?

Pini Althaus:

No, they're in a far worse position than we are. The EU commission recently put out a report, I think, a couple of months ago that the requirement for rare earths is going to increase tenfold within a short period of time. Lithium 18 times. They don't really have rare earth projects. Again, there are the Greenland projects, which people have heard in the news recently. Those need to further development work so they don't have rare earth projects ready to come online there. There are a couple of lithium projects that are spread around Europe, but for the most part, Europe is in an even more precarious position. If you look at Germany with the auto manufacturers, you look at the big companies like ThyssenKrupp and others, all these countries and companies are looking for alternatives to China, because we've already seen in the news about China withholding or reducing exports of some of these rare earths that are required for these industries.

Ryan Morfin:

And you mentioned earlier the regulatory posture of the US makes it difficult to mine. Is it becoming a more bi-partisan issue that we need to maybe relax some regulation around the mining exercise, to incentivize private sector to come in and start producing this? Or is the Republican party versus the Democratic party on two separate pages of music?

Pini Althaus:

Yeah. Good question, Ryan. I mean traditionally the Republican party is obviously being more pro-mining and in favor of less regulation when it comes to these things. With regards to our project, we're on Texas state land. So we don't trigger federal environmental permitting at this point in time. And obviously Texas being Texas, a mining state and oil and gas state, things are a lot easier in Texas than they are on projects on federal land where the Bureau of Land Management controls the environmental process around that. But the thing is here, and I don't want to step into what other companies are doing, et cetera, but we do need to be reasonable about allowing projects to come online if they're adhering to environmental standards that are acceptable worldwide. And what we do know, is that China is destroying the environment and cities and water bodies around their mines and processing facilities.

Pini Althaus:

We have standards here in the United States, and I think what we need to do is make it easier for companies to mine, while at the same time protecting the environment. And there are ways to do that. And we're definitely seeing buy-in from Congress, from both sides, with regards to looking how we can stand up a secure supply chain. And, obviously under the Obama administration, they had very strict regulations when it comes to mining. And that's changed under the Trump administration. Hopefully what we start to see is some normal middle ground that'll allow other projects to come online.

Ryan Morfin:

And typically in these rare earth mines, is it amalgamation of different minerals that are all consolidated together and you have to separate them out? Or do you ever find pure play, Europium, I can't even pronounce some of these. Gadolinium, Cerium. I mean, are they all mixed together and you've got to filter and sift them through, or are they pure play mines?

Pini Althaus:

No, they're generally they have a mix. So they're polymetallic projects. They have a number of different materials. Some projects, you more to what we call the light rare earths like MP in California or Linus in Australia. Our project is actually on the opposite end of the spectrum. We have a very high concentration of heavy rare earths. That being said, we do have to go through a process of separating these materials. But the case of our project where we've got 30 materials. We're not going to produce 30 materials. We're not going to market 30 materials. So what we're doing is we're focusing on the key materials that are marketable, that we need for permanent magnets, lithium as well, and working on the separation and the optimization of those materials in particular. But we're all faced with the same processing challenges and that is something that can't be set.

Pini Althaus:

There's no easy way to do this. There are different technologies that have been used in different parts of the world. So predominantly there's a process called solvent extraction, but it's big, it's bulky, it's not benign. It's a bespoke solution for one particular project. So it doesn't work for feedstock from other projects. What we've done is we're using a processing technology that's actually been around since the 1940s. It was part of the Manhattan Project. It's called continuous ion exchange. In fact, the Chinese use it to increase the purities from 99.99 to four nines, five nines, and even six nines. So for some applications you require higher purity levels. It's a far easier processing method to scale up and to take feedstock from other projects. In fact, we've demonstrated for the Department of Energy that we can take coal waste from Pennsylvania and do high purity separation of rare earths using our processing methods. So it's not a step that can be skipped unless one needs to send it to China for processing, which is not going to help us with our objectives here.

Ryan Morfin:

How many other, we'll call it, going concerns on any other businesses that are doing this, that are trying to, I guess, start the development of these mines. Are you guys one of a few or are you one of many? And is it an international or just a US game? Who's leading the charge at going after this?

Pini Althaus:

Yeah, well, I'd say the Australians are leading it outside of China right now. You've got some really good projects in Australia. Again, more skewed toward the light rare earths. There's one more heavy rare earth project in Australia, which is not yet producing. The United States, you've got MP Materials, you've got Ucore in Alaska, you've got the Bear Lodge project in Wyoming, which is also another light rare earth project. So as far as a heavy rare earth project that looks like it will come online in the near term, that would be our project. In Canada there are a couple of projects there as well, and again, more skewed toward the light rare earths. But we really need to get as many of these projects online as possible. Because again, I don't see it as competition. We all have a problem doing supply agreements or offtake agreements for our materials.

Pini Althaus:

In fact, one of the things that we're going to have to consider is looking at potentially scaling up our production, based on the demand that we're already starting to see. And I think other companies would find that as well. So it's all about the economics of the project. You have projects that were economically viable back in 2012 or rare earth prices with 35% or so higher than they are today, and are not necessarily viable today. So that's the challenge as well, economically viable projects. And we've got to get as many of them online as possible. It takes many, many years. I mean, our project has had over $70 million put into it to get to where we are today, and we're close to getting to the production scenario. It all revolves around processing at this point in time.

Pini Althaus:

We'd be very happy to see another couple of projects come online, because this is extremely important for national security and for the economy as well. I mean, if you think about it, Ryan, if you've got a billion dollars of rare earth materials, that translates into a trillion dollars or I should say trillions of dollars of finished product. So you've got a magnet in your phone there that's worth a couple of dollars and the cell phone's a thousand dollars. And electric vehicles and defense applications even more.

Ryan Morfin:

Yeah, everyone has one of these iPhones now, and there's tremendous amounts of rare earth on the circuit boards here. And I think people take it for granted that that supply chain is not secure right now. So one question for you, there's talk of this maybe medium term to longterm, but there's talk about mining in space. Do you think that's a feasible option in the longterm, medium term? What are your thoughts on that?

Pini Althaus:

No, that's just ridiculous. I mean, we're trying to find ways to make mining on earth economically viable. I think the cost of going up to space would be more than what our capex will be bringing our entire project into production. I mean, we've got about a 350 to $400 million capex to bring 130 year mine life into production. I'm not an aerospace expert, but I think sending a rocket, building a rocket ship and sending it up, I think maybe on the fuel alone, you could bring a couple of projects into production. So unless we have a fortunate situation or an asteroid lands on earth, and fortunate if it lands somewhere where we don't care, I don't see how that happens. And if it's big enough, it's a problem as well. It's nonsense. And even, options aside of the deep sea mining for rare earths, I mean, you've got all sorts of environmental issues around that as well. I think we need to look at projects that we can bring online, that can be done so in an economic way, that can be done so in an environmentally responsible way.

Pini Althaus:

I mean, one of the things that we've done at our project is we've got in excess of 60% of the materials that have come out around top, will have a clean green energy applicability to them. So we're using the benign processing method. We're going to be using renewable energy on site. In fact, we will likely be putting a solar farm on site as well. We've talked to a couple of companies that have approached us about that, and we'll be a net producer of power for the surrounding area. So there are ways to do it which don't affect the environment. Obviously if there's a project that's situated on a sensitive area, that's a unique situation for that specific project. We've seen it with the Pebble project, which is not a rare earth project. The Pebble project in Alaska where their environmental concerns is we've been recognized by both Republicans and Democrats, but we have to be reasonable about the projects that don't have environmental concerns.

Ryan Morfin:

So Pini, in season two, we ask all of our guests a series of six questions. They're usually, yes, no questions, but trying to take a survey of our conversations. And if you want to add a little context to the yes or no, feel free, but here goes the first question. If there was a COVID vaccine available today, would you take it?

Pini Althaus:

Yes.

Ryan Morfin:

Who do you think is going to win the election?

Pini Althaus:

Which election?

Ryan Morfin:

The US election.

Pini Althaus:

Well, I think it looks like Joe Biden's going to win it, but I think what happens, if we go past January six from my understanding is that the house will vote on it and it's one vote per state. But I don't know if I see it getting there at this point in time. I really don't have a crystal ball.

Ryan Morfin:

Third question. What type of economic recovery are we in? What type of shape is it taking? A V-shape, W, U, L?

Pini Althaus:

Yeah, I think 2021 is going to be challenging. I think we've been, and rightly so. I mean, we've had no choice as of almost every other country. We've been printing money for the past year because of COVID. And I think we've got to brace ourselves that, at some point in time, the chickens come home to roost. It was a necessary step. People needed it on an individual level. Businesses needed it as well, but I think we've got to do whatever we can to stimulate the economy, give people confidence to go out and work again, employ people. So I think we've got to watch ourselves, especially in 2021. And I have some concerns, but long-term, I think the approach in the United States is a healthy one.

Ryan Morfin:

During lockdown this summer and quarantine, was there anything in particular that you accomplished that you're particularly proud of?

Pini Althaus:

Yeah. A great amount of family time, which, if you would've asked me a few years ago if I could sit at home and be at home for six months, I would have told you absolutely not. I wouldn't be able to do it for six days, but it has... I'm sure it's done this with a lot of families as well. It's brought families together. We had a baby actually last year on Thanksgiving. So I was doing a lot of travel at the time and thought I wouldn't get to see my daughter in her first year or couple of years too often. And being home with her every day is actually been just the most amazing experience. So thankful at least for some silver lining in COVID.

Ryan Morfin:

Are there any silver linings that you see in the economy going into 2021?

Pini Althaus:

Yeah, I think we've gone through an absolute beating and it looks like we've got the ability to come out of it. And I think that's a testament to how strong the economy was built up in the years preceding COVID. So overall I remain an optimist. I mean, we are a country built on opportunity and going out and making it happen. And we're not a socialist country sitting and waiting for people to send us paychecks or wealth distribution or anything like that. I think the American dream still lives on. I think if you go out and you're willing to work and put your head to it and heart in it, I think we do have the ability to climb out of it. So if we look at what the economy is doing over the past few weeks, it looks like it's starting to rebound. And to me, that's assuring because it could go completely one way as well.

Ryan Morfin:

And the last question is, is there anything that you're watching, or listening to, or reading today that has been impactful on your thinking that you'd like to share with our audience?

Pini Althaus:

Yeah, that's a good question. I think it's been more personal stories. The news, I sort of take that in context or with more than a grain of salt. In some cases stay off the news channels for a number of days at a time, it became quite repetitive. But I think on the personal side, talking to friends, my family's all back home in Australia, they've just come out of 110 day lockdown, which we can't relate to that. It's been very trying on them and seeing the fortitude that they've had to come out of that and stay intact. I think the mental health issues that will come out of COVID are going to have a far longer effect than the economic issues. I think we're going to have to focus on mental health issues in this country for a long time to come.

Pini Althaus:

The impact on kids has been significant with regards to lockdown or remote schooling, et cetera. But to see people come through it. I think it's a testament to people in general and to the country and other countries as well, to see got that fortitude and survival instinct to try to get through whatever adversity we can. So hearing the personal stories, the challenges that people have gone through, I think it's made me a lot more aware of things that I have to be thankful for and where we can help out other people as well. I think we have to be united going forward because there are things...

Pini Althaus:

I think one of the things that COVID has shown us is we can get into this complacency and life goes on and we go one day to the next. And all of a sudden we get hit by something that affects everybody equally. I mean, COVID, whilst there were groups of people, whether it was the elderly or people with underlying health conditions, that got hit the worst. I mean, we all got hit in some form or another. So really, this should be something that unites us, not divides us.

Ryan Morfin:

Well, Pini, I appreciate you coming on today to talk to us a little bit about the supply chain crimp on rare earth and we'll definitely keep an eye on it and would love to have you back in the future.

Pini Althaus:

Thank you, Ryan. Thanks for having me.

Ryan Morfin:

Absolutely. Thank you. Bye-bye. Thanks for watching Non-Beta Alpha. And before we go, please remember to like, and subscribe on Apple podcasts and our YouTube channel. This is Non-Beta Alpha, and now you know.

 

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