moneyweb investment focus, with discovery invest (november 2009)
DESCRIPTION
The new normal - Alec Hogg, Moneyweb / Panning for gold in muddy waters - Kerrin Howard, Discovery Invest / Lessons learned from the collapse of Lehman Brothers - David Shapiro, SasfinTRANSCRIPT
The new ‘normal’
Alec Hogg
6 – 12 November 2009
The new ‘normal’The new ‘normal’
How the world has been changed by the Great Recession and what we should be doing about it
- ALEC HOGG, Moneyweb, November 2009
It’s theIt’s the
new normalnew normalbecause it’s herebecause it’s here
to stayto stay
GlobalisationGlobalisation
Cause one
Person PowerPerson Power
Cause two
TechnologyTechnology
Cause three
ChinaChina
Cause four
Consequence one
We’re time poorWe’re time poor
Consequence two
“Change creates a new paradigm in which enterprising companies can benefit through innovative solutions…”
- Brian Joffe, founder, Bidvest
From the 2008 annual report:
“Bidvest has risen to the challenge of “the new normal”
Business strategyBusiness strategy
Consequence three
Investment strategyInvestment strategy
Consequence four
Disruptors run by entrepreneurs:
Steinhoff (@ 1845c – earnings yield of 13.7%)
Pallinghurst (@ 468c – the Gilbertson factor)
Discovery (@ 3050c – earnings yield of 7.4%)
Altech (@ 7700c – earnings yield of 7.8%)
PSG (@ 2150c – earnings yield of 7.8%)
Some likely winnersSome likely winners
Panning for Gold in Muddy Waters
6 – 12 November 2009
Kerrin Howard
Head of Investment Strategy
Discovery Invest
Newest elements of global economies
Debt
• Nearly USD1 trillion in stimulus bills; USA may need to borrow USD2tn
• Debt to GDP:
› USA: 70% (#1), rising to 108% by 2014 according to IMF
› SA: 31.6% (#43)
Outlook
• GDP growth is not an obvious option for meeting those obligations
• More countries will run larger current account deficits for longer
• Growth is being driven by the funds borrowed to create it
• Is such growth sustainable?
• Governments likely to inflate the debt away Sources: Bloomberg, IMF
Gold’s value as an inflation offset
Source: Bloomberg
Traditionally, gold seen as inflation hedge.
Recently, Gold began moving with stocks.
Gold’s relevance
Warren Buffett is not convinced
‘Gold just sits there, with no yield.’
‘[Gold] gets dug out of the ground in Africa, or someplace.
Then we melt it down, dig another hole, bury it again
and pay people to stand around guarding it. It has no utility.
Anyone watching from Mars would be scratching their heads.’
Warren Buffet, ‘sage of Omaha’
Maybe Buffett has a point
Source: Bloomberg
Why should Gold prices rise or fall?
Driving forces for Gold prices
• Supply
• Demand
• Strength/weakness of the US Dollar
• Inflation
• Interest rates
Views for and against rising gold prices
Shares that may benefit, or not
Supply and demand for Gold
* Net of hedginghttp://www.invest.gold.org/sites/en/why_gold/demand_and_supply/
Mine production*60% (2,209t)
Netcentral
bank sales12% (447t)
Recycledgold (scrap)28% (1,016t)
Jewellery68% (2,436t)
Industry14% (493t)
Investment19% (670t)
Industrial12%
(19,700t)OfficialSector18%
(29,700t)
Unaccounted for 2%
Investment17%
(27,300t)
Jewellery 51%(83,600t)
Supply flows5 year average (2004 – 2008)
Demand flows5 year average (2004 – 2008)
Above-ground stocks, end 2008(total: 163,000t)
Gold: Not enough of it
Sources: The Tudor Group, Bloomberg, IMF, World Gold Council
Recycled gold = 28% of production
Annual world Gold production
Mill
ion
ounc
es
80
70
60
50
40
30
90
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Annual productionas a percentage of available supplies
6%
5%
4%
3%
2%
1%
7%
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Central Bank Gold reserves
Current (mil troy oz) 1 year ago (mil troy oz) % Change
World total 967.886 09 Jul 955.255 08 Jul 1.32%
Eurozone 347.52 09 Aug 350.92 08 Aug -0.97%
United States 261.50 08 Sep 261.50 07 Sep 0.00%
Germany 109.58 09 Aug 109.74 08 Aug -0.14%
Italy 78.83 09 Aug 78.83 08 Aug 0.00%
France 78.60 09 Aug 81.53 08 Aug -3.60%
China 33.89 09 Jan 19.29 08 Jan 75.69%
Switzerland 33.44 09 Aug 33.84 08 Aug -1.19%
Japan 24.60 09 Aug 24.60 08 Aug 0.00%
Netherlands 19.69 09 Aug 19.98 08 Aug -1.45%
India 11.50 09 Aug 11.50 08 Aug 0.00%
Venezuela 11.46 09 Aug 11.46 08 Aug 0.00%
Spain 9.05 09 Aug 9.05 08 Aug 0.00%
Philippines 5.07 09 Jul 4.28 08 Jul 18.50%
Thailand 2.70 09 Aug 2.70 08 Aug 0.00%
Australia 2.57 09 Jul 2.57 08 Jul 0.01%
Central Banks globally seen as net buyers going forwardSource: Bloomberg
More investors want to buy Gold
Sources: The Tudor Group, Bloomberg
12m-trailing Gold ETF flows as a percentage of 12-m trailing production
25%
20%
15%
10%
5%
0%
30%
35%
1/3/
2006
4/3/
2006
7/3/
2006
10/3
/200
6
1/3/
2007
4/3/
2007
7/3/
2007
10/3
/200
7
1/3/
2008
4/3/
2008
7/3/
2008
10/3
/200
8
1/3/
2009
4/3/
2009
7/3/
2009
10/3
/200
9
Gold ETF Holdings as apercentage of above ground stocks
2.5%
2.0%
1.5%
1.0%
0.5%
0%
3.0%
1/3/
2006
3/3/
2006
5/3/
2006
7/3/
2006
9/3/
2006
11/3
/200
61/
3/20
073/
3/20
075/
3/20
077/
3/20
079/
3/20
0711
/3/2
007
1/3/
2008
3/3/
2008
5/3/
2008
7/3/
2008
9/3/
2008
11/3
/200
81/
3/20
093/
3/20
095/
3/20
097/
3/20
099/
3/20
09
At the end of 2006, the World Gold Council estimated that all the gold ever mined totaled 158,000 tonnes.This can be represented by a cube with an edge length of just 20.2 meters
USD strength/weakness affects Gold
Source: Bloomberg
Relative performanceDollar value of total international reserve assets
10,000
8,000
6,000
4,000
2,000
0,000
$USbn
Apr
70
Apr
73
Apr
76
Apr
79
Apr
82
Apr
85
Apr
88
Apr
91
Apr
94
Apr
97
Apr
00
Apr
03
Apr
06
Apr
09
JP Morgan’s economic outlook
Consumer prices % year-on-year
2Q09 4Q09 2Q10 4Q10
USA -0.9 1.2 2.1 1.0
Eurozone 0.2 0.3 0.9 1.2
China -1.5 0.9 3.2 2.7
South Africa 7.7 6.3 4.5 4.1
Real GDP growth % (quarterly, over previous period)
1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10
USA -6.4 -0.7 3.5 3.5 3.0 4.0 4.0
Eurozone -9.6 -0.07 3.0 2.5 3.0 3.0 3.0
China 8.4 14.8 10.0 9.1 9.0 9.5 9.3
South Africa -6.4 -3.0 0.6 3.4 4.5 3.7 3.6
Global GDP growth: largely funded by government borrowing
Low interest rates spur Gold demand
Official interest rates forecast
12/2009 03/2010 06/2010 09/2010 12/2010
USA 0.125 0.125 0.125 0.125 0.125
Eurozone 1.0 1.0 1.0 1.0 1.0
China 5.31 5.31 5.31 5.58 5.85
South Africa 7.0 7.0 7.0 7.0 7.5
Source: JP Morgan
Gold can be seen as cheap
Source: The Tudor Group
Gold inflation-adjusted cash prices – average = $556.2Inflation-adjusted all time high was $2,422 on 21 Jan 1980
Back to Buffett: better off elsewhere?
Source: Bloomberg
Whither South African Gold stocks?
Earnings outlook
• Upward potential:
› Higher prices globally
› Higher demand
› More ways to buy Gold
› Central Bank buying: India bought USD6.7bn/200 tonnes from IMF
› Lacklustre production outlook
• Downward pressure:
› Margins under pressure due to lack of upgrade
› ZAR strength
› Higher electricity and wage costs
South African Gold shares: focus onhedging, margins, marketshare
Deutsche Bank forecasts 2008A 2009E 2010EAngloGold Ashanti Buy EPS (USD) -0.47 -0.41 3.85P/E (x) - - 11.3EV/EBITA (x) - 133.6 7.6Harmony Gold Mining Buy EPS (USD) 0.39 0.43 1.22P/E (x) 25.4 25.9 9.1EV/EBITA (x) 28.4 21.2 6.6Gold Fields HoldEPS (USD) 0.49 1.16 1.8P/E (x) 20.1 12.3 7.9EV/EBITA (x) 11.8 7.9 5
Investec Asset Management’s Sam Houlie, manager of Discovery Equity Fund,
is invested in Gold-related companies
Takeaway for South Africa
Rising Central Bank purchases create market momentum
‘Weak dollar’ policy is likely to stay in place
China = largest export destination; rise in jewelry demand?
Lessons learned from the collapse of Lehman Brothers
David Shapiro
6 – 12 November 2009
Background
Influential investment banker, Lehman Brothers filed for bankruptcy in September 2008, a consequence of problems that were fuelled by the collapse of the US housing market
Lehman had significant exposure to investment products, designed to facilitate the sale of mortgage finance, associated with the lower end of the property market
The collapse unhinged the global economy
• Stock markets went into steep decline
• Credit markets froze
• World trade halted
• Liquid markets dried up faster than assumed.
A year later, equity markets have recovered and credit markets are beginning to show signs of life
However, it will take a long time before the global economy returns to levels seen before the recent crisis – financial markets will never be the same – new regulations will see to that!
Lesson one
Most macro-economics of the past 30 years was spectacularly useless at best and positively harmful at worst
Paul Krugman
Princeton professor, economist and Nobel Laureate
Economists misread the economy on the way up, misread it on the way down, and are confused about the way out
Most economists thought that the housing bubble in the US would pop and that the dollar would fall – they believed even if house prices fell by 20% in 2 years, the slump would knock only 0.25% off GDP and add only 0.1% to the unemployment rate
Most were sanguine about the collapse of Lehman - no one expected the financial system to break
Furthermore, they overestimated the power of monetary policy to restore prosperity, but their models failed and conventional weapons have proved insufficient
Theories worried about the prices of goods and services but neglected the prices of assets – it had too much faith in financial markets
Even so there is still disagreement about the alternatives and extent of stimulus packages
They have to adjust their theories from preserving price stability to safeguarding financial stability
Lessons from Keynes
Economic theory dictated that markets clear continually – if wages and prices are completely flexible, resources will remain fully employed and any shock will result in instantaneous adjustment
Keynes taught that when shocks to the system occur, no one knows what will happen next – in the face of the uncertainty spending is not adjusted, people refrain from spending until the mist clears sending the economy into a tailspin – the economy does not maintain its buoyancy and it becomes a leaky balloon
Keynes believed in those instances the authorities need to inflate the economy to minimise the shock – his theories were thrown out as economists reverted to old doctrines that markets were self-correcting
But it was financial deregulation that led to the credit crisis – Keynes opposed financial innovation beyond the bounds of human understanding – complexity for its own sake had no appeal to him
Where he was misunderstood is that he believed in a balanced budget and was not a tax and spend fanatic – nor was he an inflationist, believing in price stability – but he believed that unless the government took steps to stabilise the economy at full employment the benefits would be lost and the political space would be opened up for extremists
Lesson two
The US retains its power to command the global economy and create disorder
US continues to dominate global economy
The world has not lessened its dependency on the US
The US keeps its power to command the global economy and create disorder
Belief that momentum in emerging economies would fill the void left by the slowdown in developed economies was unfounded
Emerging economies currently add more to global growth than the developed countries but with the US, Europe and Japan accounting for over 60% of world economy, their prosperity and expansion is still relevant
Still – some emerging countries positioned for healthy expansion – but without a turnaround in the US the global economy will not recover
Lesson three
The dollar remains and will remain the leading reserve currency
The dollar remains and will remain the leading reserve currency
When the credit crisis crossed the Atlantic it spread fears about growth in other major economiesIntensifying turmoil sparked a rush to the safe haven of US government backed treasuriesDollar strength triggered a rapid unwinding of commodity hedgesFalling commodity prices and global slowdown increased doubts about expansion in emerging economies – carry trades unwindDebtor countries calling for alternative to dollar, but this is unlikely to materialise in short term – needs history of political and financial stability and liquid bond markets to comfort investors
Dollar’s role as a reserve currency
Dollar has been dominant as the world’s reserve currency since World War 1General view is that the world financial system can’t rely solely on the US dollarThe servicing charge of the huge overhang of dollars is undermining confidence and stoking inflation fears – still the US government can borrow 30 year money at around 4.2% and 10 year money at 3.4% suggesting that deflation is more of a problemSome dollar weakness is welcome – it reverses the inflows into the US that facilitated the over-leveraging and under-pricing of assetsIt is worth noting that a reserve currency requires liquidity that can only be produced through the existence of current account deficits
Lesson four
Risk managers at banks, investment companies, regulatory authorities proved entirely inadequate
There are many banks but very few bankers - Warren Buffett, May 2008
The self interest of lending institutions failed to protect the interest of equity and shareholdersRisk managers at banks, investment companies, regulatory authorities proved entirely inadequate Also obvious that senior management were oblivious to the dangersSophisticated, computer-driven systems designed by financial experts failed to pick up the weaknesses embedded in the pooled productsAccording to Alan Greenspan, the data fed into the risk models covered only two decades of data during which time conditions were euphoric – hence the assets were not properly pricedIn addition, the degree of exposure to subprime lending and the level of uncovered credit swap derivatives was grossly underestimated
The future of banking under scrutiny
Only 3 out 10 bosses in the US kept their jobs after the crisis – in Europe a number of heads also faced the guillotineBankers paid themselves loads of money, made large expense claims and furnished their offices lavishly – more useless than corruptibleWith banks considerably larger than even oil companies there’s little wonder that management didn’t understand the books – the extent of their exposure to toxic assets or any assessment of how much to write down these assetsIt wasn’t a case of how many times management met – banks were simply too big to be manageableBanks need to shrink and simplify their businesses and establish a culture of excellence
Lesson five
Read Benjamin Graham, read Phil Fisher, read annual reports but don’t do equations with Greek letters in them
Warren Buffett
It is easier to rob by setting up a bank than by holding up a bank clerk – Bertolt Brecht
The origins of the credit crisis are linked to the global spread of mispriced assetsQuestions have been raised over the contribution of academics in the design and evaluation of these mispriced assetsThe intellectual view – with Greenspan as cheerleader – was that complex derivative products in tandem with electronic communication systems reallocated risk over a broader global base – the models were fine, one had to examine the input and how they were used Belief that financial products should be passed by the equivalent of the FDA before being sold to unsuspecting investorsAlso growing concerns about the role of colleges and universities over-emphasizing the use and complexity of derivatives in their courses – “I haven’t shorted before, but I do have my CFA”
The smart guys come to Wall Street
According to some cynics the integrity of financial markets began disintegrating when the smart guys started working on Wall StreetTwenty to thirty years ago the top students aspired to becoming professors, judges or surgeons – the lower third of the class went to Wall StreetThey were decent people who were not greedy and wanted nothing more than to earn a modest living – they also came from well-to-do families and didn’t need to leverageThe spread of computers and the internet attracted the smart guys to Wall Street. Where, instead of doing their PhD in physics they invented complicated derivative products like CDOs, credit swap defaults and securitisationThey wanted to make a fortune first, then become professors
Lesson six
Gold failed to perform throughout the crisis and offered little protection against falling asset prices
You dig a hole in the ground to extract gold, then dig another one to store it, and then pay someone to watch it – Warren Buffett
Gold failed to perform throughout the crisis offering little protection against falling asset prices
Recent peak reached on dollar weakness
Performance correlates more closely to movements in commodity prices and oil than a pseudo currency
In 1940 one ounce of gold bought around 30 barrels of oil – it now buys around 12
In 1940 it took 40 ounces of gold to buy the average house in the US – it now takes 187 ounces – gold underperformed US housing market
The future
Temperature is normalising but the recovery in the global market will be slow and protracted
More bank write offs anticipated – $1.7 trillion increasing to $2.8 trillion
Stimulus programmes beginning to take hold in developed and emerging economies
High levels of unemployment, surplus industrial capacity and excess householder debt will prove a drag on growth
Consumption in China and India too small to fill the void
Inflation not a short-term or medium-term problem – not reflected in capital markets, banks retaining large sums of capital, demand remains restrained, unemployment and excess capacity puts pressure on wages and price levels
Banks will face tighter regulations – could be broken up
Financial markets will be tamed – includes regulating hedge funds
Remuneration packages, share options, buy-backs, valuation techniques, scrip lending and short selling will be challenged
Thank you
Q&A