Sahil Alvi

Tag: Gold

Barrick Gold: Gold Medalist among Gold Miners

by sahilalvi on Aug.29, 2011, under Finance

Pascua-LamaBarrick Gold: World’s Largest Gold Miner and Producer

With 140 million ounces of proven and probable gold reserves and 7.8 million ounces of gold production, Barrick Gold (NYSE: ABX) (TSE: ABX) is simply the world’s largest gold exploration and production company.

Much has been said about gold as a prime “haven” asset to protect against the global macro-economic and geo-political vicissitudes of our times. With its size, experience, expertise and resources, Barrick Gold is positioned extraordinarily well to capitalize on this theme of gold reigning supreme on world markets on a secular basis.

As of December 31, 2010, the company also held 6.5 billion pounds of copper reserves and 1.07 billion ounces of silver contained within gold reserves. In July, 2011, “Barrick acquired Equinox Minerals which adds a further 4.5 billion pounds of copper reserves from the Lumwana mine and 1.2 billion pounds of copper reserves from the Jabal Sayid project.”

To cite a few highlights from Barrick’s 2010 annual report:

  • Record adjusted net income from $1.81 billion in 2009 to $3.28 billion in 2010
  • Record adjusted operating cashflow from $2.90 billion in 2009 to $4.78 billion in 2010
  • Increased dividend by 20% from $0.4/share in 2009 to $0.44/share in 2010
  • Record realized price of gold from $985 per ounce in 2009 to $1,228 per ounce in 2010
  • Industry’s only ‘A’ credit rating.

When it comes to profitability, using 2010 figures, Barrick generated operating margins of 42.1% and net margins of 29.4% — numbers that would be the envy of companies in any industry – including the basic materials sector. In 2011, the company’s performance has further improved. Its gold margins on a net cash cost basis have improved by an impressive 32% from a Q1, 2010 figure of $821/oz. to Q1, 2011 figure of $1081/oz. The company’s realized gold price has improved year-over-year by 25% from $1,114/oz in Q1, 2010 to 1,389/oz in Q1, 2011.

Infact, as we speak, Barrick’s Q2 results have shown a further improvement in net margins of another 500 basis points over last year’s results in a markedly slowing global economy.

PierinaWhile, at approximately $1800 an ounce, a section of the investment community may argue that gold is a “crowded trade.” On an inflation-adjusted basis, however, the precious metal needs to climb up to US$ 2300 to 2500 per troy ounce before it even reaches its all-time highs. So, at circa $1800/oz., we are nowhere near gold’s all-time peak yet.

Barrick Gold, at 13 times last year’s earnings per share, is still reasonably priced for being the world’s largest miner and producer of – arguably – the world’s most sought after commodity at the present time. So much so that, despite having better fundamentals than its competitors across a variety of metrics, the stock trades at a healthy discount vis-à-vis its peer group (except Newmont Mining which trades modestly lower than Barrick at 12.9 times trailing earnings; please read my previous post on Newmont Mining: here).

Here are a few valuation data for Barrick vis-à-vis its peer group:

Company

Barrick Gold

Newmont Mining

AngloGold Ashanti

Goldcorp

Kinross Gold

Ticker Symbol

(NYSE: ABX)

(NYSE: NEM)

(NYSE: AU)

(NYSE: GG)

(NYSE: KGC)

Price-Earnings Ratio

13.2

12.9

21.1

24.1

16.6

Price-Book Ratio

2.5

2.2

4.1

1.9

1.4

Price-Sales Ratio

4.4

3.4

3.1

10.5

6.3

 Looking at the above P-E multiples, Barrick is trading at roughly half to one-quarter less than its smaller rivals such as Goldcorp, AngloGold Ashanti and Kinross Gold. On Price-to-Book and Price-to-Sales metrics, Barrick places well in the middle of the rankings versus its peers.

According to Ford Investment Research: “…Barrick Gold Corp.’s earnings have increased from $2.90 to an estimated $4.32 over the past 5 quarters, they have shown strong acceleration in quarterly growth rates when adjusted for the volatility of earnings. This indicates an improvement in future earnings growth may occur.”

What this also means is a positive momentum in the stock price of the company.

Crucially, from a shareholder’s perspective, the company improved its Return-on-Equity from 12% in 2009 to 19% in 2010.

Switching gears to industry challenges: One of the biggest issues facing the precious metals industry is the ability to replenish its reserves. Barrick Gold has done an admirable job in this department. In the company’s President & CEO – Aaron Regent’s words: “The Company has consistently replaced its reserves in each of the last five years, and we did so again in 2010. Gold reserves now stand at about 140 million ounces, the largest in the industry. In addition, measured and indicated gold resources grew 24% to 76 million ounces and inferred gold resources increased by 18% to 37 million ounces. Complementing our gold reserves and resources are 6.5 billion pounds of copper reserves, 13.0 billion pounds of measured and indicated copper resources and 9.1 billion pounds of inferred copper resources, plus 1.1 billion ounces of silver contained within gold reserves.”

So, one can safely assert that Barrick is doing a competent (if not a stellar) job in replenishing its reserves in a fiercely competitive, capital-intensive environment where transformational discoveries of new mines is more an exception than a norm.

Pueblo ViejoWhat also, often goes, unnoticed is Barrick’s significant presence in the global copper market. While 4/5th of Barrick’s revenue contribution comes from gold, roughly 20% of its top-line comes emanates from copper sales. In a rapidly urbanizing world – particularly among the growth economies of Asia, Middle East and Latin America – copper will continue to enjoy robust demand across myriad industries from infrastructure to construction to electrical equipment, among others. Game-changing copper reserves, on the other hand, have not come online for a significant period of time. Hence, outlook for copper is bullish beyond the short-to-medium term window while the Eurozone sorts out its sovereign debt issues and the emerging economies take a breather from a decade long spate of high single-digit GDP growth.

In a period fraught with geo-political unrest in many parts of the world, Barrick enjoys a distinct advantage over other miners by having majority of its reserves and production capabilities located in politically stable parts of North America, Latin America and Australia/Pacific. Furthermore, its geographic presence is well-diversified to hedge against concentration risk as well as from a potential fall-out from “nationalization” of mining assets in any one part of the world.

Looking out into the future, the company is aiming for a gold production target of 9 million troy ounces by 2015. Assuming such production growth occurs on a linear basis, this target represents a modest increase of 300,000 ounces a year from its current level of 7.8 million ounces. The company is not resting on its laurels either; in order to continually strengthen its pipeline of reserves, Barrick’s 2011 exploration budget has increased to $320-$340 million.

Ultimately, Barrick trades in commodities that provide tangible sources of stability and security on the one hand (gold) and growth and development on the other (copper). So, whether one is bullish or bearish on the outlook for the global economy, at less than $50 a share, the stock is a “Buy” over the next 6 to 12 months.

Sources: Barrick Gold, Ford Investment Research, Google Finance.

Images Courtesy: Barrick Gold.

Brokerage: TD Ameritrade & Interactive Brokers.

Disclosure: The author plans to initiate a long position in the company’s stock within the next month. All data has been sourced from publicly-available sources.

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Newmont Mining: A Value Stock in a Growth Sector

by sahilalvi on Jul.31, 2011, under Finance

Newmont Mining - North AmericaWhat gold producer sells at 2 times book value?

Which global miner has the lowest beta among its peer group?

Which resources company trades lower than 12 times its earnings?

The answer: Newmont Mining (NEM).

Newmont Mining — a Gold and Copper exploration and production company with mining operations spanning five continents around the world with “proven and probable gold reserves of 93.5 million attributable ounces, copper reserves of 9.4 billion attributable pounds” and an aggregate land position of approximately 27,458 square miles (71,118 square kilometers).

In 2010, the company had attributable gold sales of 5.4 million ounces and equity copper sales of 327 million pounds. Its recent acquisition of the Conga Project in Peru and Tanami Shaft Project in Australia will be adding “400,000 attributable ounces of gold and up to 100 million pounds of copper production per year” by 2015.

According to Newmont’s website, these were but a few highlights from the company’s performance in 2010:

  • Record revenues of $9.5 billion, up 24% from 2009;
  • Record net cash from continuing operations of $3.2 billion, up 109% from 2009;
  • Gold operating margin increased 30% from 2009 on an average realized gold price increase of 25%.

Pick any one of those highlights and one can assume that the company being discussed is a growth company (with a momentum stock).

The stock, however, has been trading in a fairly narrow 52-week range of $50.05 and $65.50 with a P-E multiple that is more reflective of a value stock.

Is there a reason why it should not break out above its upper limit of the trading range?

According to Vickers Stock Research: “NEM pays an annual dividend of $1.20 which, at its current stock price, produces a yield of 2.16%. This is the largest of any company in the Gold & Silver industry, where the average yield is 1.56%…”

According to a company press release: “The third quarter 2011 dividend of $.30 per share (a 50% increase over $.20 per share for Q2, 2011) was declared in consideration of Newmont’s second quarter 2011 average realized gold sales price of $1,501 an ounce .”

In contrast, the company’s 2010 Gold Operating Margin is $737/oz.

At the time of writing this piece in late July, 2011, Gold has crossed the $1600 per ounce mark and is trading comfortably above that level. In a “risk-off” environment, when Gold keeps breaching its all-time highs on a regular basis, Newmont Mining (one of the largest Gold producers) deserves to enjoy a little more buoyancy in its stock than what it has experienced in the recent past. On the one hand, given its exposure to gold production, Newmont is poised to gain in a continued period of “risk-off,” de-leveraging global economy where fiat currencies are being debased across several major jurisdictions. On the other hand, even in a “risk-on” environment when Copper demand begins to soar again thanks to expansionary tailwinds in a rapidly urbanizing global economy, Newmont — being one of the largest copper producers in the world — is positioned to perform exceedingly well as a “long Copper” play.

At an operating margin of over 42% and a net profit margin of approximately 32%, Newmont is one of the most profitable minerals and metals producers — large or small — in the world. The miner enjoys gross margins that are more than 10% higher than its peer group. Furthermore, Newmont is sitting on cash and cash equivalents of more than $4 billion within an asset base of $25.7 billion.

Over the last 5 years, the company’s Earnings per Share (EPS) has grown a staggering 49.41%.

Newmont Mining - AsiaAt a P-E ratio that is higher only to Freeport-McMoRan (FCX) within its peer group, Newmont is a “value” stock in a growth sector.

Kinross Gold (KGC), for example, trades at a healthy 16.37 its earnings and Goldcorp (GG) trades at almost twice as much as Newmont at a P-E multiple of 22.13. By the time one gets to AngloGold Ashanti (AU), one is looking at an unbelievable P-E multiple of 105.85.

Whether you look at Return-on-equity or Return-on-assets, Newmont ranks among the top 3 of its peer group.

Here’s a tale of relative value analysis that is as stark as it gets for companies that are delivering virtually identical numbers: The company that Newmont resembles most in terms of gross revenues, net profits, net profit margins, and a whole host of other metrics is Barrick Gold (ABX).

Exhibit 1: Profitability

Company

Net profit margin

Gross margin

EBITD margin

Operating margin

Newmont Mining

32.92%

63.48%

53.57%

43.67%

Barrick Gold

29.45%

61.54%

42.56%

42.1%

Here’s a rhetorical question: Which company is more profitable?

Exhibit 2: Debt

Company

Long-term debt to assets

Total debt to assets

Long-term debt to equity

Total debt to equity

Newmont Mining

16.30

17.31

31.34

33.28

Barrick Gold

20.04

20.08

35.03

35.10

Which of these two companies is less indebted?

Exhibit 3: Returns

Company

Return on avg assets

Return on avg equity

Return on investment

Newmont Mining

13.1

19.17

16.27

Barrick Gold

10.65

18.48

11.92

Again, which company provides a higher return?

Exhibit 4: Pricing

Company

P/E ratio

Price-to-

book ratio

Price-to-

sales ratio

Newmont Mining

11.56

2.13

3.33

Barrick Gold

12.4

2.52

4.42

Finally, let us look at the all important metric of reserves:

As of December 31, 2010, Newmont had “proven and probable gold reserves of 93.5 million attributable ounces, copper reserves of 9.4 billion attributable pounds.” Barrick, on the other hand, had “140 million ounces of proven and probable gold reserves. In addition, Barrick has 6.5 billion pounds of copper reserves and 1.07 billion ounces of silver contained within gold reserves.”

Barrick has roughly 50% more gold reserves — which admittedly would allow it to command a premium over Newmont based purely on the metric of gold reserves. Gold, however, is not the complete story. When it comes to copper reserves, Newmont Mining has roughly 1/3rd more than Barrick Gold.

In a certain snapshot in time, if we consider valuations based purely on gold reserves (and silver within it), Barrick should be roughly 50% more valuable as a company. That said, given that Newmont has a third more copper than Barrick, it would recoup approximately 7.5% of the value back (adjusting for the price of copper vis-a-vis gold).

Here’s the clincher: With all these metrics where Newmont beats Barrick Gold consistently (except in the key metric of gold reserves), guess which company is more valuable (as of late July 2011)?

It is Barrick Gold at $47.54 billion.

And, what’s Newmont Mining’s market cap?

$27.45 billion.

So, the market is placing 75% more value on Barrick Gold than it does on Newmont Mining. It is established, however, that even when considering mining reserves as a sole determinant of value, Barrick is a little over 40% more valuable than Newmont.

So, which company would you pick based on the above valuations? What company’s stock would have greater upside potential?

In conclusion, one can’t help but wonder: Is Newmont undervalued…by as much as 35% or more?

Seth Klarman: How’s that for margin of safety?

Michael Burry: Is this enough of a value stock for you?

Need one say (or question) more.

Sources: Reuters, Google Finance, Vickers Stock Research, Cooper Financial Research, Barrick Gold, Newmont Mining.

Disclosure: The author owns a long position in the company. All data has been sourced from publicly-available sources.

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This MINUTE could last you a lifetime: An investment thesis for a period of secular economic instability

by sahilalvi on Sep.25, 2010, under Economics, Finance, Management, Philosophy

We are living in times where a confluence of several secular and cyclical factors are resulting in a profitable rise of capital requirements for, and allocation in, the Materials, Industrials, Non-cyclicals, Utilities, Technology, and Energy (MINUTE) sectors.

“Well we know where we’re goin’ but we don’t know where we’ve been.

And we know what we’re knowing’ but we can’t say what we’ve seen.

And we’re not little children and we know what we want.

And the future is certain give us time to work it out.

We’re on a road to nowhere come on inside.

Takin’ that ride to nowhere we’ll take that ride…”

- Road to Nowhere by Talking Heads

The inexorable quest for “more”…of everything:

It is safe to assume, everyday, almost all of approximately 6.9 billion people wake up wanting more than they already have. Some aspire for more luxuries; others seek more necessities; a vast under-class, just struggles for more dignities.

Global commerce is an agile, pragmatic force transforming more and more lives than ever before. Thanks to the forces of globalization, we are witnessing a free-er flow of goods, services, capital, and people around the world. Also, largely thanks to globalization, every year tens of millions of people from a wide variety of emerging and frontier markets are joining the growing global mainstream of what broadly constitutes as “middle-class consumers.” This somewhat loose grouping of “middle income” consumers already constitutes roughly half of the world’s population.

More food is needed, produced and eaten. More clothes are bought, sold and worn. More property is being built and inhabited. More cars and trucks are being manufactured and driven. More oil, gas, coal and other conventional energy sources are being harnessed, distributed and consumed. More alternative energy sources are being discovered, produced and commercialized. Trillions of dollars of roads, railways, power plants, transmission networks, dams and bridges are being built and utilized. More paper is being used…and forests felled. More minerals are being mined, processed and used in a wider variety of industrial and consumer applications. More manufacturing is being done and absorbed – on a net global production basis.

It is an insatiable, inexorable quest for more…and more…and more from a planet that has its very real physical limits.

Resources are limited.

Demand is rising. Supply is not. In fact, supply is diminishing for a wide variety of natural resources.

It is that simple.

The real, the tangible, the substantial: The World is Pyramidal

Imagine Maslow’s hierarchy of needs represented in a world that isn’t round, ovular, or even flat.

The world is a four-dimensional pyramid of time, population, demand, and supply.

Due to the enormous pressure on resources owing to a rising global population and various other sub-plots, our times are characterized by exceptional change or instability underpinned by the triumvirate of: uncertainty, ambiguity, and complexity.

What is also undeniable is: because of – or in spite of – globalization, the individual or family is much more disconnected from a social support structure. During earlier times in more settled communities, this support structure was taken for granted. With professional certitude and financial stability petering out, the individual or family is much more vulnerable to the financial consequences of the high-velocity change we experience today and can anticipate to experience for the foreseeable future.

By mixing in the notion of rising demand and declining supply of natural resources, the concoction we have is a period that harkens back to our pre-historic ancestors’ times of operating in a hostile, uncertain, ambiguous, high-risk, constantly-evolving environment.

It is only natural that a Darwinian “survivalist” instinct kicks in among us to seek safe havens.

Investors are us: You and I.

Quite obviously, our investment decisions are not disconnected from the complex interaction of our personal, social, economic, and financial imperatives and choices.

Therefore, what we find is a seamless connective tissue between our psychological makeup which may be in “survivalist” mode and our investment bias to seek a real, tangible protection from the real, intangible economic storm. It is this quest for the real, the substantial that has Gold breaching record highs on a regular basis. Silver is at a 30-year high precisely for the same reason. In a period of secular uncertainty and instability, Gold can be expected to continue to hold its status as the ultimate haven of safety and trust. A haven that has stood the test of time for its ability to act as a reliable medium of exchange and as a store of value (or wealth).  Gold has also, unsurprisingly, held its purchasing power over several thousand years of human commercial history. It has, and continues to be: rare, valuable, and tangible.

Due to demand-supply constraints, prices for most commodities are on a secular upwards trajectory anyway. What, however, we are witnessing is something much deeper and more primordial. We have begun to witness a global, long-term, broad, social, “survivalist” quest (beyond just the investment world) for the physical security of the real, the tangible and the substantial.

This survivalist quest is a pragmatic quest.

Manifestation of individual and societal “tail” risks; particularly of the “fat” variety:

The quest for financial security and a steady income at the expense of higher-risk, dividend income (or capital appreciation) is the underlying driver for fixed income security markets booming in most parts of the world.

Baby-boomers in many ageing, developed economies of the West have had multiple setbacks in regards to their retirement savings and entitlements over the last decade. At the start of the millennium came the dot-com bust, shortly followed by the 9/11 attacks and the collapse of financial markets with a deep, ensuing recession. Barely recovering from that shock, the Credit Crisis came bringing along with it the worst recession since the Great Depression.

As a result, a significant number of boomers have seen their nest eggs shrink just at the time when they have been made redundant or have had to accept lower paying positions with fewer benefits.

Hence, the need of (and pursuit for) income security, reliability, and predictability is only going to strengthen in the coming years.

Leading up to the Global Financial Crisis, trillions of dollars worth of “intangible” securities had disastrously evaporated into thin air. During the ensuing global “Credit Crunch,” we were all rudely awakened to the notion of “tail risks,” i.e. Risks that lie outside the confidence interval of the expected range of outcomes on a normal distribution curve. Nicholas Taleb’s “black swans” do exist. In its aftermath, The Great Recession has also illustrated how our inappropriate or inadequate intervention (e.g. not intervening to save Lehman) of regular tail risks can allow them to morph into “fat tail” risks – unleashing a set of devastating, systemic, and inter-connected outcomes in what has come to be called The Great Recession.

Even if “fat tail” risks do not actualize (or not as severely or frequently as in the recent past), our time is still to be characterized by an acute awareness of the possibility of tail risks in general, and “fat tail” risks in particular. Whether at the micro-economic (individual and family) level or at the macro-economic level, the notion of tail risks can be expected to play a significant role in the economic lives of nations, going forward.

A future flush with capital: Sovereign Indebtedness & Fiat Currency Debasement

Post-Global Financial Crisis, whether due to genuine commitment towards the welfare of their constituents or due to political expediency or some combination thereof, governments (particularly developed economies) have demonstrated a renewed sense of purpose to generate employment by investing in “energy security” and “infrastructure upgrade” projects for their respective economies. These investments are expected to be made through various fiscal measures such as:

a)     shifting budgetary priorities away from defense, space and entitlements to sectors like energy and infrastructure projects,

b)    launching deficit spending measures to invest in new infrastructure projects, and

c)     raising taxes as well as growing the tax base, among other measures.

The ironic upshot of the Global Financial Crisis is to add more fuel to the fire that created all the havoc and instability in the first place. Further loosening of monetary policy and expansion of sovereign credit have been used as levers to stimulate economies out of the “credit crunch” that resulted from a crisis of confidence in the financial markets — which to begin with — was induced due to lax and expansionary monetary conditions sustained over an extended period of time. Since the Great Recession began, central banks across most of the developed, and several of the consequential emerging markets, have progressively eased interest rates to near zero. In fact, the prospect (and reality) of additional rounds of quantitative easing by central banks has been another favored recipe to further increase money supply in the global financial system.

Quantitative easing (or sovereign debt and other fixed income asset purchases by central banks through new fiat currency issuance) can continue for some time before inflationary pressures start to seep in to the real economy. As these sovereign credit purchases by central banks expands their balance sheets, ever larger proportions of their respective treasuries’ revenues have to go towards servicing this debt. As the costs of servicing this debt grows, the central bank has to print more money. It becomes a vicious circle.

In essence, all that such quantitative easing measures are doing is to leave sovereign treasuries more indebted, fiat currencies more debased, and asset prices inflated (primarily in nominal terms).

Asset price inflation is, however, very real for the ordinary citizen on Main Street. The component of asset price inflation that is over and above nominal levels owes its increases to rising demand for these assets by a growing number of consumers around the world. Further, one can argue that the “real rate” of inflation, based on fundamental demand-supply dynamics, is also magnified by market speculators betting on directional moves on asset prices thanks to the cheap money available within the financial system. As cheap money floods in from the financial economy to the real economy, the increasingly “financialized” world has begun to show ominous signs of expansive, unintended consequences being unleashed upon the broader society. The Global Financial Crisis, that began to show its first material consequences on the world economy in 2007 (and most will argue is still underway), can be expected to be only the first of many global “events” that will send shock-waves across the global economy for years to come before some sort of global “reset” will have to occur when the collective pain of the debtor nations and corporations gets too unbearable to prolong any further.

Private sector credit creation: A growth imperative for banks in a de-leveraging environment

Meanwhile, proprietary trading is on the way out for the money center banks and investment banks. Therefore, fee-based investment and corporate banking will become ever more consequential for generating profits for these institutions. This reduction and eventual evaporation of trading revenues will entail an aggressive pursuit for increasing lending and underwriting activities among the banks. We are entering a period where, on the one hand, there is a concentration of capital in the financial economy among the hands of relatively few banks. On the other hand, there is diffusion in the real economy where innovation happens and jobs are created. Hence, despite the enormous monetary stimulus programs rolled out by governments, bank lending has tended to remain tight and expensive to a majority of businesses. At some point in the imminent future, however, all the build-up of excess liquidity on bank balance sheets will have to be put to work in the real economy. At that point, despite Basel III compliance obligations, there is a likelihood of banks and other lending institutions expanding their loan books and loosening their lending requirements to win business.

In addition, non-bank, private sector players such as private equity firms, asset management firms and hedge funds are also expected to pursue their profit motive in this new phase of monetary expansion.

Inorganically created trillions of dollars of capital (fiat currency) is about to chase limited real resources and organically growing investment opportunities. The result: value of “hard stuff,” i.e. real, tangible assets (metals, commodities, natural resources, plants and machinery, infrastructure and real estate) is to grow over a secular trend line for the foreseeable future – albeit with a higher degree of volatility. The “hard stuff” also can be expected to out-perform the “soft stuff” (Software & Technology, Media, Entertainment, many parts of Financial Services, Hospitality, and other Services sectors, among others).

Hence, most of the world’s reserve currencies (US Dollar, Euro, UK Pound Sterling) are to come under pressure in this monetary expansionary environment.

Most currencies, in this period, can be expected to  face a downward pressure but a few are also likely to stay resilient or appreciate due to the “flight to safety” phenomenon or because they belong to countries that are net exporters of raw or finished goods and services. Currencies that can be expected to strengthen are:

  • currencies that have sound macro-economic fundamentals and fewer, more insulated fiscal and monetary variables to contend with (Swiss Franc, Swedish Krona); or
  • currencies that are issued by large net exporters of natural resources or finished goods (Canadian Dollar, Australian Dollar, Brazil Real, Russian Ruble, Norwegian Krone, Chinese Renmimbi, Korean Won).

Pursuit of yield and the resulting fixed income bubble:

It may not seem like there is a profusion of liquidity in the general economy, yet the waves of capital are building up around the world and liquidity has already begun to creep into certain parts of the global economy such as a wide array of fixed income securities and emerging markets equities.

There are already signs of a bond bubble building up on the horizon.

Furthermore, central banks around the world are likely to continue to sustain a posture of extremely low interest rates to promote an increase in money supply thereby making a tight lending environment an unattractive proposition for banks and non-banking financial institutions. Government and corporate borrowings, on the other hand, will become ever more attractive to lending institutions’, corporations’ as well as institutional investors’, burgeoning balance sheets. The “promise” of a long-term steady yield would aggressively chase down returns in an otherwise uncertain environment. Therefore, fixed income instruments – whether sovereign debt, municipal bonds, or investment-grade (even high-yield) corporate debt – will increasingly become popular in this environment. Popularity, however, is not going to ensure high returns. Risk of a strengthening investor bias towards bonds is very real. Spreads – between high-grade and the enlarging pool of high-yield (aka junk) bonds – is expected to grow. Spreads – between fiscally austere and responsible governments vis-a-vis spendthrift economies, states and municipalities – is also expected to widen.

In pursuit of yields, investor appetite for high-yield fixed income securities has reached enormous proportions. This ravenous demand for high-risk fixed income securities, so recently after the Great Credit Squeeze, does not seem to abate even when it comes to high-risk sovereign debt such that of countries like Greece, Spain, Ireland or Portugal.

It is for the same reason why even the convertible bonds asset class can be expected to perform better than pure equities across many industries – particularly, the services-oriented industries. It follows that various forms of capital structure arbitrage opportunities are expected to present themselves in abundance during this period of dislocation and change.

It is in this setting that large, old-world behemoth corporations with steady cash flows and dividend payouts are expected to gain investor favor in the equity markets.

It is also noteworthy that, in early autumn of 2010, various Central Banks are still trying to fend off deflationary pressures both in word and in action – across many parts of the developed world.

The Fed, for example, is indeed in a fix. On the one hand, the US economy remains sluggish despite interest rates near record lows inching closer to zero. On the other hand, unemployment rates continue to trend upwards over – what can now be considered – a secular trajectory rather than a cyclical one.

Safety is the theme du jour: Defensible (not necessarily just defensive) industries that get “hands dirty”

So, how can we confidently utilize the above analysis to:

a)     preserve capital;

b)    grow capital.

It is quite straight-forward, really.

One way is to listen to what legendary investor Jim Rogers professes in terms of the merits of investing in “hot commodities.”

What companies would benefit from the “hot commodities” theme?

Metals & Basic Materials Producers:  BHP Biliton (NYSE: BHP), Rio Tinto (NYSE: RIO), Vale (NYSE: VALE), Newmont Mining (NYSE: NEM), Barrick Gold (NYSE: ABX), Freeport-McMoRan (NYSE: FCX), Vedanta (LON: VED), Xstrata (LON: XTA), and so forth.

Energy Producers: Chevron (NYSE: CVX), ConocoPhilips (NYSE: COP), Exxon Mobil (NYSE: XOM), LUKOIL (PINK: LUKOY), Petroleo Brasileiro (NYSE: PBR), Royal Dutch Shell (NYSE: RDS.A), ENI (NYSE: E), among others.

What is noticeable is that a commodities boom will entail alternating cyclical demand for “risk on” assets such as oil, coal, gas, copper, etc.  on the one hand and for “risk off” assets such as gold on the other. From a secular growth perspective, however, we are already in the midst of a bull run for both “risk on” and “risk off” commodities.

Capital flows, and consequent capital appreciation, can be expected to occur in miners, producers, harvesters, distributors and traders of commodities. We can fully expect for producers and manufacturers of consumer staples (particularly those with a global reach), basic and intermediate materials, and various energy sources — to see a significant increase in capital allocation as well.

In a multi-year period of de-leveraging across some of the highest consumption-driven (developed) markets, consumer staples can be expected to remain one of the few relatively stable sectors of the economy. Within the food and consumer staples space, companies like Kraft (NYSE: KFT), Nestle (VTX: NESN), General Mills (NYSE: GIS), ConAgra (NYSE: CAG), H.J. Heinz (NYSE: HNZ), Syngenta (NYSE: SYT), Monsanto (NYSE: MON), Bunge (NYSE: BG), and Archer Daniels Midland (NYSE: ADM) are likely to do well during this period. If agricultural commodities traders such as: Glencore, Cargill, and Louis Dreyfuss go public, they would be an attractive companies in which to buy equity as well. Their debt would also be an attractive way to gain exposure to the “food security” theme. Companies like Proctor & Gamble (NYSE: PG), Unilever (NYSE: UL), Johnson & Johnson (NYSE: JNJ), among others are expected to show resilience in the consumer non-durables space.

Our times, however, are not just characterized by rising values of “hard assets” such as: physical commodities, basic materials, and energy sources. Our times are not just about molecules found in nature. Our times will also re-discover the value of hard-to-replicate, “get your hands dirty,” industries like: infrastructure, industrials, utilities, telecoms, distribution and transportation.

The Industrials (Building Materials Suppliers, Construction and Heavy Equipment Manufacturers, etc.) would be attractive investment destinations. Leaders in this space will continue to demonstrate their dominance: Alcoa (AA), Lafarge (LFRGY), ArcelorMittal (MT), POSCO (PKX) are all positioned well to benefit from global growth in infrastructure and real estate development — particularly within emerging and frontier markets for years to come.

Utilities and Distribution industries would benefit from a “flight-to-safety” phenomenon. They would also be viewed as defensible businesses that are hard-to-replicate overnight. Utilities like Pacific Gas & Electric (PCG), E.ON (EONGY), RWE (ETR: RWE), GDF SUEZ (GDFZY), Gas Authority of India (532155) are bound to perform well in an environment of rising energy consumption and high barriers-to-entry for a new energy producer/distributor to replicate the extensive production, distribution and transmission network that these enormous utility companies have laid out over decades.

The Tech (and Telecoms) sector can be expected to retain resilient levels of demand and investment.

In a world of rising telecommunications usage coupled with dramatic adoption rates of first-time users in vast expanses of the developing world, those companies which have a head-start in their respective telecoms (particularly mobile telephony) markets are poised for significant upside. Examples that come to mind: Bharti Airtel (532454), Reliance Communications (532712), Brasil Telecoms Participacoes (BRP), VimpelCom (VIP), Turkcell (TKC), Vodafone (VOD), among others.

In each of the above mentioned sectors, the companies (and their securities) of the following types are expected to do well:

  • clear and diversified market leaders, or
  • the ones which have significant exposure to emerging or frontier markets, or
  • the ones with dominant or monopolistic  rights over raw materials, or
  • those which are well-managed, low-debt, low-cost structures.

Fundamentals of companies in the ‘MINUTE’ space will point toward the best-performing equities and corporate debt — as long as — their securities are not over-priced vis-a-vis classic valuation metrics.

Fundamentals, at the end of the day, will differentiate the winners from losers even in the highest-performing sectors.

It is against this backdrop, that investors can generate superior risk-adjusted returns by investing in industries encapsulated within the ‘MINUTE’ theme.

“Welcome to your life
There’s no turning back
Even while we sleep
We will find you

Acting on your best behavior
Turn your back on Mother Nature
Everybody wants to rule the world

It’s my own design
It’s my own remorse
Help me to decide
Help me make the

Most of freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world…”

- Everybody Wants to Rule the World by Tears for Fears

Power Shift from West to East: Potential for Trade Disputes, Currency Wars and Protectionism

These are times characterized by structural changes in the global economy as the clichéd economic weight of the world shifts back from the West to the East (for fifteen of the past eighteen centuries, such has been the status quo).

These structural changes have only accelerated since the Global Financial Crisis.

Since the ensuing Great Recession, United States – the wealthiest country in the world – has now approximately one in five of its citizens living in poverty. Unofficially, 16% of the workforce is unemployed or under-employed. United States continues to run enormous trade deficits vis-a-vis China. China is buying American treasuries and United States is buying Chinese consumer products. As of now, it is in both countries’ interests to continue this policy of “mutual engagement.” The situation, however, is untenable.

Hence, the question is: Who will blink first?

Meanwhile, the UK is squeezed from many sides: rising unemployment, surging entitlement requirements, declining tax revenues, increasing need for economic stimulus, falling industrial competitiveness, and a general economic malaise. The country has elected its first right-of-center government (with a leftist coalition partner) in over a decade that is pushing through sweeping austerity measures to curb its out-of-control budget deficit.

Portugal, Ireland, Italy, Greece, and Spain are all dealing with enormous fiscal problems threatening the very existence of the European Monetary Union. There is a good possibility that we have not heard the last or the worst of the Greek fiscal woes or the Irish banking crisis. Default from either one of them cannot be ruled out.

Even hitherto fiscally robust economies like Austria and Belgium, are showing signs of economic strain.

The historically liberal, left-leaning post-World War II Western Europe seems to be building up a rising appetite for anti-immigration, right-leaning, populist tendencies. Nationalistic, anti-immigrant sentiments are beginning to manifest in electoral politics as well as in government policy across liberal and/or socialist heartlands such as France, Germany, Sweden, Denmark, and The Netherlands.

All of these are developed economies. All of these are some of the wealthiest societies in the world.

In this environment, overt or covert forms of protectionism are only a matter of time. Such protectionism, however, tends to help those industries more which are resource and labor-intensive — where jobs cannot be exported over a broadband connection. On this go around, however, there are fewer manufacturing jobs to protect in the West. As it is, the global manufacturing supply chain is extraordinarily intertwined where the component suppliers may be head-quartered in China, Taiwan, Malaysia, Indonesia or India. The final, branded consumer product, however, is – more often than not – designed in the US or Western Europe. Import tariffs, therefore, are not likely to trigger significant changes in global trade flows until and unless, the West brings about structural changes in its economies to support indigenous manufacturing to compete with cheap imports from Asia and elsewhere — particularly, those imports that are more competitive due to lower cost structures as well due to artificial currency depreciation. Any such structural change itself would take at least a generation to show marked effects in global trade flows.

The Eastern governments, for their part, would have to stop (or at least reduce) meddling with their currencies in order keep their exports artificially attractive in global markets.

Meanwhile, the currency row between the US and China is not just indicative of a growing tension between the Western (consumer) economy of the US and the Eastern (producer) economy of China. This currency row is a thinly veiled manifestation of the power struggle and transition we are witnessing from the West to East.

Ultimately, societies that “create” stuff (largely the West) should have more leverage than the societies that “make” stuff (largely the East). Intellectual property rights, however, cannot be as directly and completely measured, enforced and monetized as manufactured value addition. Hence, the West is being viewed as more profligate and less productive than the East and vice versa.

In fact, in very real terms, global trade and savings imbalances are partly due to this very phenomenon where the West is not being compensated in full — for its innovations in hi-technology, bio-therapeutics and conventional medicine, automotive, aviation, distribution and logistics, financial services, media, telecommunications, among other industries.  The West is doing the innovation “heavy-lifting” only to see the East create a cheaper, faster, more mass-market version of the product or service that is sold across the globe without much (if any) financial compensation or intellectual acknowledgement offered to the original Western innovators of that product or service.

Meanwhile, the East is now beginning to move up the innovation value chain where it may, increasingly not only produce the products and services of the future, but may also originate the innovations of tomorrow.

As this shift occurs, power will be transitioned — from the West to the East – much like before in the history of civilizations in spasmodic, discontinuous bursts of instability and discord (if not all out combative military interventions or wars).

Global scarcity of resources, birth of new nations and a period of secular economic instability:

Historically, the world has dealt with scarcity for most of its existence. Make no mistake, despite armed conflicts in the past several decades not being as devastating or multi-lateral as World War II, the quest for resources continues to intensify among nations. In fact, one can argue that beneath all the cultural, religious, and linguistic differences that are offered up as the key bases for the independence struggles of various minorities, the central (although not always overtly stated) raison d’etre for new countries being carved out of existing ones is the notion of safeguarding ancestral, “sovereign” economic interests of a minority residing in a resource-rich territory within an existing nation.

Right from the mid-twentieth century – when former South Asian British colonies became independent as India, Pakistan, East Pakistan (later Bangladesh) – the pursuit of economic self-determination has been as much a factor as the desire for political autonomy or social equity and liberty in all independence struggles. Obviously, such a dynamic is not uniquely pertinent to the British empire either, the French relinquished their control over Indochina to give birth to three new nations for a similar set of reasons – Vietnam, Laos, and Cambodia.

Self-determination of political, social – and crucially – economic interests was the common thread across the founding fathers and the indigenous populations that catalyzed the break-down of the Soviet Union. Since the Communist union’s dissolution, a slew of new nations (many of which resource-rich) have come into being: Russia, Ukraine, Moldova, Armenia, Azerbaijan, Belarus, Estonia, Latvia, Lithuania, Georgia, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.

East Timor became independent a few years ago fuelled by its quest for religious, cultural and economic freedom.

As a matter of fact, there have been rumblings for independence in resource-rich Kurdish Autonomous Region of Northern Iraq (popularly known as Kurdistan) for quite some time. Yet another example of economic drivers playing a significant part in seeking autonomy and independence, many in the Flemish region of Belgium want to separate from Wallonia – in large part, due to the economic disparity and dispensation structure of state-provided welfare benefits.

North and South Sudan may go their separate ways as early as January 2011. In addition to all the ethnic violence that has culminated in the proposed referendum for independence, South Sudan sits on over five billion barrels of proven oil reserves. Economics, again, becomes a critical consideration.

If we peel all the layers of the onion, as it were: Through the centuries and across geographies, the ongoing march of societies staking claim to resources they consider are rightfully theirs, has led (and continues to lead) to conflicts.

We are entering an era where, again, the quest for basic resources is expected to form the basis for many a major and minor future conflict — not just among nations but even within them.

As the sense of scarcity rises and the gap between ‘haves’ and ‘have-nots’ widens: anger, resentment and strife can be expected to follow. Recent strikes by workers in Greece and France over raising the retirement age and reducing entitlements, collective unrest in Pakistan and Haiti over the slow and inadequate response by their governments in the wake of natural disasters, as well as food riots in Mozambique are but a few manifestations of public anger boiling over. Despite those episodes not yielding the desired results for the ‘masses,’ we haven’t seen the last of them. Au contraire, if anything, we can expect to see more such collective manifestations of economic tensions brewing at the international, domestic, community, family unit and individual levels.

The writing is on the wall is: We are entering an era of secular economic and geo-political instability.

Hence, these times are about valuing the basics that sit at the bottom of Maslow’s hierarchy of needs: Food, clothing, and shelter.

“I close both locks below the window
I close both blinds and turn away
Sometimes solutions aren’t so simple
Sometimes goodbye’s the only way

And the sun will set for you
The sun will set for you
And the shadow of the day
Will embrace the world in grey
And the sun will set for you…”

- Shadow of the Day by Linkin Park

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