We often tend to over-analyze situations and look for hidden meanings. The current macro investment environment causes us to do exactly that. How often do we read the headlines "Gold bugs will be bust", "Commodities are on a tear", "To QE2 or not to QE2"?… The list goes on.
In a week when the news broke that the biggest property bear of them all, John Paulson, has bought a $2.85MM condo in Manhattan, it seems to me that despite the deepest of deep dives undertaken on an investment, one of the biggest determining factors of success is timing.
With this in mind, my simple fundamental outlook for the markets and opportunities to invest are as follows:
- Invest in commodities, namely coal, uranium, copper, gold, platinum and palladium.
- Agriculture is hot.
- Access to clean water is an issue in the developing world and will only get worse.
I have already written about coal and uranium, so now gold is in the spotlight, although I will briefly touch on the other two opportunities. I won’t bore you with the often-quoted facts and figures about gold being cheap comparatively to just about everything, but will rather put forward some plain simple facts:
The Uncle Sam Effect
As a result of the US monetary policy (I am not saying it is right or wrong - that is another discussion), real interest rates in the US are negative. If rates are negative and correlation of asset classes has increased, then I need to find somewhere to put my money, hence gold. Pretty simple.
Of course, the cost of carry is now low, thus providing investment opportunities. What better asset than one that has seen steady increases over the last few years?
With the advent of the ETF it has become far easier for the public to access gold as an investment option. This has been further enhanced with the listing of ETFs that are physically backed by the yellow metal. Admittedly, if investor sentiment turns then the ride down could bumpier and quicker than the ride up; however, investment demand seems to be holding up.
Gold supply tight
There has been a tepid increase in the supply of gold in response to increasing prices. Estimates I have seen are for 1 to 2% increases in supply during 2010 and 2011.
National governments are no longer selling gold on the open markets. I wonder why? As a result, one of the biggest supply points for gold historically has been taken away from the market.
An often-overlooked side effect of negative real interest rates for gold producers is that it can actually discourage increased supply. After all, if volumes and revenue are increased unless there is somewhere to put additional profits to work why increase supply? Negative real interest rates certainly don’t help.
Emerging market government buying
Historically emerging market governments have purchased US Treasuries with any economic surplus. The printing press running at full steam in the US coupled with European governments fiscal woes have put a different complexion on this. I expect to see greater purchases emanating from this source and will support the gold price.
Accepted price floor
It seems the world has grown used to and accepted more expensive gold. When gold dipped to around $1,300, the Indian government response was not to buy US Treasuries but rather buy more gold.
The current string of sovereign bailouts has certainly increased gold attractiveness as an investment class and hedge. Whilst this is beneficial in the short term, if this trend continues over the longer term it may drive up borrowing costs, which would be a drag on the markets.
Of course, there are risks and any reversal in the negative real interest rate policy and consistent signs of strong economic growth would be negative for gold.
So, where to look for golden opportunities? I will deviate from my usual m.o. and name a major player Barrick Gold (ABX) as worth a look, but I still like the smaller players with M&A opportunities, such as Fronteer Gold (FRG).
Turning to agriculture we seem to be having a perfect storm forming in this sector; droughts in major crop producing areas such as Russia have led to countries imposing export bans to protect their home markets. We have the emerging market populations becoming more affluent and increasing expectations of standards of living. Let's hope we do not return to the food riots of 2007 and 2008.
Two smaller players worth looking at are China Blue Chemical (OTC:CBLUF), which has extremely small volume of 2000 to 3000 shares traded daily OTC. It is however, in an enviable position as one of the largest producers of fertilizer in China and its parent is CNOOC (CEO), one of the top three oil state owned enterprises in China. This connection could be useful in acquiring state aid and being at the forefront of any policy changes.
NuFarm Ltd (OTC:NUFMF) is an Australian crop protection firm. They have some interesting major shareholders, including mainstream hedge funds and Sumitomo Chemical, which purchased 20% of issued capital at A$14 in April 2010. Its current share price is around $4.30. As an aside, the company has already been subject to interest from Mainland China companies.
Connected to the agriculture theme is that of clean available water for the developing world to support agriculture and urbanization. This is a major issue for China as estimates put China with 15% of the global population but only 7% of global water resources. This, combined with the growing urbanization of China, presents a volatile situation but one which water companies are falling over themselves to get in on the action.
There are already some large cap European companies with exposure, including Suez and Veolia (VE).
Alternatively, if you are looking for some global exposure to water treatment a little closer to home then Pentair (PNR) and AO Smith (AOS) are opportunities. These are conglomerates and therefore not pure water plays, although they are international players.
Two companies based in Singapore are Memstar Technology or Sembcorp, although these are much smaller companies and as such riskier simply for liquidity issues.
Now, I am sure some will disagree with my simplistic approach to these macro themes, and that is fine with me so long as this article stimulates debate. My basic message is that there seem to be some pretty broad macro themes in the current global investment opportunity set, and we should not overthink the opportunities. Yes, there will be tactical opportunities that come along that allow you to trade in and out, but we are set for the above themes to run for some time.
Disclosure: Author holds long positions in Nufarm and China Blue Chemical