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OUR FAVORED INVESTMENT THEMES

OUR FAVORED INVESTMENT THEMES

Spring is about a month away in the northern hemisphere, and we are ready for it after a cold and wet winter in much of Asia, Europe, and North America. Global warming may be with us, but you could have fooled me about that these last few months.

As soon as the forecasters predict another dry winter here in Los Angeles we get a good soaking.  Fortunately, forecasting economic events is easier than forecasting weather…and our forecasts have been good or lucky as the case may be.

COMMODITIES AND INFLATION IN THE NEWS

We read a lot of newspapers and news magazines from many parts of the world.
An underlying theme in all of them is the high price/cost of commodities and the rising inflation taking place in various countries.  This pattern is common to Asia, Europe, North and South America, Australia, and parts of Africa.  Of course this type of news is beneficial for the companies and economies which produce commodities and for the investors like us who are holding mostly commodity-related investments.

However, it is very bad news for the commodity importing countries especially for the poor countries that have to import food, which is more high priced with each passing month.  Huge hardships are being felt already by the poor in many countries and there is little relief in sight.  Rising global food costs eventually will lead to economic and political turmoil in poor countries and food riots are already beginning in countries like Mexico.  For people who live hand to mouth, a small rise in the price of food can be devastating.

GRAINS-WHY ARE PRICES UP SO MUCH?

Well, many disbelieved the call we made a couple of months ago saying that food prices would rise, and rise rapidly on a global basis.  Since that time, food prices have really taken off.  Soybeans are at an all time high.  Most grains and sugar are rocketing along, and the outlook is for more of the same.

Some have asked how we knew this would happen.  The analysis was simple.  It was based upon macroeconomic analysis combined with basic research and an awareness of the political situation in several grain producing countries. We knew the following before making the prediction.

1. Rising standards of living in China, India, and many other countries will mean more consumption of meat.  Increased meat consumption requires a lot of grain to feed animals.  As most everyone knows it takes several pounds of grain to produce one pound of meat.
2. If more corn is used as animal feed, other grains will need to be substituted for other purposes. When other grains are substituted for corn, demand for those grains grows and their prices also rise.  It is a simple case of rising demand and almost static supply.
3. Supply of grains is hard to increase as it can take a very long time to build the infrastructure to store and deliver any new grains produced in previously unfarmed areas.  To add production in already farmed areas is very difficult.  More fertilizer and special seeds are two methods available to increase crop yields.

On top of these, many politicians have created unintended consequences when they sought to pander to farm voters.  For example, corn availability is being further diminished by the politically popular, but highly economically and environmentally flawed system of using corn for ethanol production.  In the U.S., it has become politically popular to suggest that ethanol will reduce our dependence on foreign oil.  Ethanol production from corn is incentivized with tariffs on imported ethanol and economic subsidies of various types in the U.S. and in several other grain producing countries.

Ethanol will prove to be a poor alternative fuel and very costly environmentally and financially.  However, it is almost comical to see U.S. lawmakers falling over themselves to attract farm voters by passing ethanol legislation.  Of course, ethanol production from corn has the effect of diminishing the amount of corn available for animal feed, therefore further driving up prices.

COMMODITES INDICES ARE HITTING NEW HIGHS

Grains, gold, platinum, and even sugar are booming along, and let’s not forget base metals.  The banking crisis afflicting the developed world is not impacting China, India, and the other fast growing segments of the world.  These economies continue to grow rapidly; maybe a little slower than in 2006 and 2007, but still rapidly by historical norms.

STOCKS ARE TAKING IT ON THE CHIN

It is true that stock markets all over the world are taking it on the chin. This may be a case of investors selling their winners because  no one will buy the losers (for example mortgage bonds), or it may be a case of fear dictating that many investors are just holding cash until the serious banking system problems are quantified and contained.

Probably, it is just a case of valuations shrinking as investors feeling insecure are paying a lower price for a unit of assets or earnings than they were willing to pay during the heady days of 2007. This is known in the money management profession as “Price to Earnings” shrinkage.

Whatever the case, some stocks are getting cheap. We are not buying in a big way yet. Currently we are just nibbling, but we have a big list to buy and price targets at which we think stocks are attractive. Our plan is simple, as stocks reach our targets we will buy in India, Hong Kong, China, other parts of Asia, Brazil, Russia, and other markets that fit in our themes.

SUMMARY OF SOME OF THE PREDICTIONS WE HAVE BEEN MAKING…
FIRST, SOME OF OUR LONGER TERM PREDICTIONS:

1. For more than six years, we have been bullish on oil and oil shares.
2. For more than six years, we have been bullish on precious metals, especially gold.
3. For most of the last 6 years we have been bullish on base metals, with the caveat a few months ago that base metals shares could be taking a time out for a few months.
4. We have been bullish on India, China, Brazil, and other emerging nations for about 6 years. A few months ago, we stated that a correction in these markets could lead to a period of underperformance and we had sold, more recently we have stated that we are beginning to nibble on them once again and will buy more aggressively when our price targets are reached. Even after the recent price declines these developing markets have substantially outperformed the developed markets over the past 6 years.

The above themes will be further accelerated by oncoming inflation. You may ask how does this happen?  As inflation rises, users of raw materials will start to hoard and overstock them to make sure that they do not have to pay higher prices in the future this further exacerbates the inflation problem. We look for more trends like these to continue to develop in the upcoming months.

…AND THREE OF OUR MORE RECENT PREDICTIONS

1. We stand by our prediction of rising inflation and will go so far as to say that the current inflation increases are just beginning a trend that may last for a while. 
2. We still believe food and agriculture prices have not completed their rise and will continue to rise for years.
3. Our final prediction that the dollar would rally for a few months seems to be coming true.  We do not believe in the U.S. dollar long term, but see it continuing to rally for a few months longer.

OUR INVESTMENT THEMES

Our favored investment themes remain agriculture/food, gold, energy, and fast growing countries.  We favor Russia, China, India, and Brazil.  Our last theme is base metals, and we plan to buy base metal stocks on corrections like the current one.  In many of the areas we like, corrections are taking place and we are beginning to nibble on investments in these sectors and countries.

Thanks for listening.


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