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Canada gets a majority government-finally!

May 5th, 2011

The results of the federal election in Canada on May 2nd were satisfactory for a number of reasons. Firstly the ruling Conservative party under Prime Minister (PM) Stephen Harper attained its long awaited majority status, raising its total of seats from 143 to 167 in the 308 seat parliament, with 155 being the minimum number needed. This brings to an end the seven year period since June 2004, when the Liberal party under Paul Martin as PM called an unecessary election in the aftermath of the sponsorship scandal in the province of Quebec, and lost the majority it had enjoyed since 1993.The long suffering Canadian electorate has endured 4 elections in the last seven years, producing a Liberal minority government and two Conservative minorities. With each election costing about $300 million, the Conservative majority will ensure not merely continuity and certainty in policy, but also a reduction in government expenditures, especially as the Conservatives intend to scrap the government subsidy of $2 to political parties for every vote they receive.

More importantly from the perspective of foreign investors, the election saw the separatist Bloc Quebecois, which held 47 of Quebec’s 75 seats and has been the largest party representing the province in the Federal parliament since the wipe-out of the Progressive Conservatives in 1993, reduced to a rump of 4 seats. This meant it lost offical party status and the attendant financing, as Quebecers displayed their dissatisfaction with incumbents by replacing them with the left leaning New Democatic Party (NDP) and its charismatic leader Jack Layton. While the NDP shares many of the same big government policies as the Bloc, it is Federalist, not separatist, and assuming that it does a decent job of representing Quebec’s interest at Ottawa, the Bloc may be finished as a force in Federal politics. It was always ridiculous that a party dedicated to breaking up the country should be the Offical Opposition for much of the last two decades, but with the arrival of a new generation of Quebecers who are seemingly more concerned about the economy and other bread and butter issues, rather than leaving a confederation that has been exceedingly generous to the province, it seems probable that the Bloc’s time is over. This does not mean its provincial counterpart, the Parti Quebecois, will not remain and indeed, the PQ may well win the next provincial election due by 2013, but it seems fair to say that the danger of separation from Canada is now at its lowest since the early 1980s.

Finally the once mighty Liberal Party, which had won three successive majorities between 1993 and 2000, and had held power for 54 of the 70 years up until 2004, or over 80% of the time, was reduced to 35 seats from 77 and lost its status as the Offical Opposition for the first time to the NDP, which tripled the number of its seats to 102. In a similar fashion to what happened to the left wing opposition to Margaret Thatcher’s Conservatives in the UK in the 1980s, when it split between the Labour party and the Social Democrats, the rise of the NDP took away sufficient votes from the Liberals to replace them as the largest left wing party. Moreover  the vote splitting between the Liberals and the NDP allowed the Conservative to attain their majority as they won the election in the province of Ontario, which, with 106 seats, has a third of the total. The Conservatives won 24 out of 25 seats in the Greater Toronto Area (GTA) suburbs, where their successful targeting of the “ethnic vote”, primarily new immigrants who had traditionally supported the Liberals, was capped by winning 8 seats in Toronto, formerly a Liberal fortress with them holding 20 out of its 22 seats at the last election in 2008. The NDP also won 8 seats in Toronto, leaving the Liberals with only 7. This is the first time federal Conservatives have been elected in the city of Toronto since Brian Mulroney’s second administration in 1988, and with the Conservative  hold on the western provinces even stronger than before and having become the largest party in the Atlantic provinces, Stephen Harper is not dependent upon Quebec votes, having achieved a majority government with only 6 MPs from that province. He also becomes the third Conservative leader to win three consecutive elections after John D Macdonald and John Diefenbaker, and appears to have achieved his long held ambition of the Conservatives replacing the Liberal party as the natural governing party of Canada. Certainly, the Liberals will need all of the next 4 years in opposition to rebuild their party and vision if they wish to achieve the success they enjoyed for much of the last 75 years.

ECB on wrong track

April 18th, 2011

The decision to raise its short term interest rate by 0.25% to 1.25% a few days ago (April 7th, 2011) by the European Central Bank (ECB) will come to be seen as a major mistake, as some commentators are already suggesting. The official reason given by M. Trichet, the President of the ECB, was their concern over higher than anticipated inflation, with the evidence being the 2.7% headline rate of inflation in the Euro area in the year ending in March,the same as the US, where the March headline Consumer Price Inflation (CPI) also came in at 2.7%.

However, the different decisions of the US Federal Reserve, which left its short term rate at its all time low of 0-0.25%, and even of the UK, where a 4.4% headline figure for March was not enough to persuade the Bank of England to raise its rates from their 0.5% level, to the ECB demonstrates how much different countries’ histories dictate their response to inflation. In the German-dominated ECB, the spiritual heir of the Bundesbank, inflation is always and everywhere the principal enemy. This is understandable, given that Germany experienced not merely the famous Weimar Republic hyper-inflation of 1922-23, but also the post World War II hyper-inflation, when cartons of Lucky Strike cigarettes from the occupying Allied forces were the most valuable currency. The successful currency reform that introduced the Deutschmark in 1949 by Ludwig Erhard, Chancellor Adenauer’s finance minister, set the scene for West Germany’s Wirchtshaftswunder economic revival in the 1950s and 1960s and gave the Germans, and by extension, their EU partners in France and the Benelux countries, a stable currency for the first time in a quarter of a century.

The Anglo-Saxon economies of the US, Canada and the UK, by contrast, had the deflationary experience of the Great Depression as their residual folk memory of the dangers of economic mismanagement. As a result, their central banks ahve always chosen inflation as the lesser of economic evils when faced by challenges, which is why their currencies have generally been weak against the Deutschmark and its successor, the Euro. Sometimes, however, the European suspicion of inflation has led to obviously mistaken decisions on interest rates. The ECB, readers may recall, chose to raise rates in mid 2008, 3 months after Bear Stearns had collapsed, and over 2 years after the US housing market had begun to slide. When Lehman Bros. went bankrupt 3 months later, the ECB was forced into an abrupt reversal, as it became apparent that the commodity-inspired headline inflation which had led them to raise rates was being overwhelmed by the collapse of the global financial system, and the danger, especially to European banks which had large exposures to overextended European property markets such as Ireland, Portugal and Spain, was not inflation but deflation.

It seems likely that the same story is repeating itself now. What helped prevent the collapse of banks in Europe, just as much as in the US and the UK, was central banks dropping short term interest rates to very low levels and committing themselves to leaving them there for a long time. This allowed the banks to ride the yield curve, borrowing virtually unlimited amounts from co-operating central banks and reinvesting with lots of leverage in “risk free” government bonds paying a higher interest rate. This is what enabled the banks to survive , and to generate big enough profits to allow them to write off their losses on sub-prime mortgages, credit default swaps and other defaulted loans. This is what enabled the banks to raise lots of new capital in the stock markets as their share prices rebounded, and to pay their employees generous bonuses once again.

However, once central banks begin raising short term interest rates, or even be suspected of thinking of doing so, the game is over. As the spread between short term and longer term interest rates narrows, profits are reduced, and bond prices fall, turning the wonderful guaranteed profits from riding the yield curve into much more uncertain returns. Banks will not be as willing to buy government debt, which, as economists such as Andrew Hunt (www.andrewhunteconomics.com) have pointed out, is what has been funding the deficits of European countries, especially the peripheral ones such as the members of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). When the ECB stopped providing short term liquidity freely through its emergency funding mechanisms this time last year, the Greek ouzo crisis erupted, as without the access to virtually free short term funding, European banks would not continue to buy Greek government debt. The malaise has now spread to Ireland and Portugal, and the irony of the situation is that the ECB has ended up back-stopping the new emergency funds such as the European Financial Stabilization Fund (EFSF) facilities. The fact that it raised interest rates this year the week after Portugal admitted defeat on cutting its expenditure and applied for a bailout indicates that, like Bourbon kings of France when they returned after 25 years of exile in 1815, the ECB has “learned nothing and forgotten nothing”.

 Incidentally, the Portugese government and the Irish government that tried to apply the austerity measures demanded by the ECB (and IMF)  were thrown out, and Chancellor Merkel’s CDU-CSU coalition has suffered several defeats in provincial elections in the last year, since the EU started trying to bail out its weaker members, including a defeat in Baden Wurttemberg, which the CDU had governed since 1952. The political classes in Europe, such as German finance minister Wolfgang Schauble, are now openly talking about some form of restructuring for holders of Greek government debt, which drove 2 year debt down last week to a price of 79.1 and 10 year debt to 62.6%, representing yields to maturity of 18.44% and 13.6%, assuming, as the Financial Times noted, that the bonds are repaid in full and on time. Portugal’s 10 year notes are yielding 8.737% and Ireland’s, which was downgraded by Moody’s to one notch above junk last week, at 9.288%. European banks’ balance sheets contain major exposures to these and Spanish and Italian government bonds, all still held at book value on the assumption, made during the “stress tests” of large banks last year, that the bonds will be repaid on time and in full. This seems more and more unlikely, and the ECB’s decision to raise interest rates will help to bring the crisis to a head sooner than would have otherwise been the case, as in 2008.

Canadian banks raising dividends-even more attractive now

April 4th, 2011

The first quarter earnings announcements by Canadian banks for the three  months ending January 31st, 2011 saw two of the Big 5, Toronto Dominion (TD-T, TD-N) and Bank of Nova Scotia (BNS-T, BNS-N) raising their dividends by 8.5% and 6.7% respectively, for the first time in almost 3 years. They thus joined the three smaller Canadian banks which had raised their dividends when announcing their earnings for the year ending October 31st, 2010, National Bank (NA-T), Canadian Western Bank (CWB-T) and Laurentian Bank (LB-T), which indicated that the Canadian authorities were comfortable with the levels of tangible equity capital of the banks. This followed the announcement of the Basel III Committee in late 2010 on required levels of capital for banks globally, and it confirmed that the Canadian banks’ had healthy levels of capital compared to US or European financial institutions.

Now that 5 of the 8 Canadian banks have begun raising dividends again, it is only a matter of time before the remaining 3 banks, Royal (RY-T, RY-N), CIBC (CM-T, CM-N) and Bank of Montreal (BMO-T, BMO-N) follow suit. At the moment, all three have payout ratios (dividends as a percentage of net earnings) above their announced range (40-50% for Royal and CIBC, 45-55% for BMO), but the first two should have earned their way into their range by the end of this year for Royal and sometime next year for CIBC. The laggard appears likely to be BMO, which announced the U$4 billion purchase of mid-western bank Marshall and Ilsley at the end of 2010, and will be issuing $400 million worth of new shares to keep its capital ratios up when the deal closes in the middle of this year. BMO aside, however, Canadian banks will be back to their habit of the last decade of raising their dividends 8-9% p.a. by this time next year.

(A somewhat longer version of this comment appeared in The Income Investor March edition)

Time to Buy Japan?

March 23rd, 2011

The horrendous earthquake and tsunami that struck Japan last weekend March 11th) represent a terrible human tragedy. With the death toll still climbing, it already appears that the number of people killed is at least three times as high as the the 6,400 casualties of the last big quake to strike Japan, the January 1995 Kobe earthquake. The largest ever quake to hit Japan (9.0 on the Richter scale) was far greater than the 6.4 quake that hit 16 years ago, but it seems the tsunami that it generated is responsible for most of the 19,000 lives lost.

When assessing the impact of such human tragedies, it is always difficult to avoid sounding heartless when discussing the investmnet implications. The front cover of Barron’s magazine last weekend (March19th) proclaimed “Buy Japan”, which may or may not be correct advice, but risks sounding as if the only aspect of the tragedy that concerns readers is the chance to make money. Nonetheless, while admitting the human toll and admiring the extraordinary resilience and steadfastness of the Japanese population in the face of such enormous devastation, it is worth considering what investors’ response to these events should be.

 Japan is still the third largest economy in the world on a purchasing power basis, only just overtaken by China last year, and consumes between 5% and 25% of such important commodities as iron ore, thermal and metallic coal, copper, many foodstuffs and oil and gas. Japan is China’s largest trading partner, with its trade with China surapssing its trade with the US almost a decade ago, as many Japanese companies outsourced their lower end manufacturing to benefit from China’s lower costs. China’s massive infractructure projects and rising consumption of consumer durabes such as autos and electronics have led to increasing demand for Japanese products, including, ironically, lots of nuclear generating equipment for the many new nuclear plants that China is building.

With the damage to the nuclear facilities at Fukushima and other plants in the Sendai region, it is estimated that 20% of Japan’s electricity will need to be sourced from other forms of power and numerous observers have suggested that demand for Liquified Natural Gas (LNG) will climb sharply, especially as other countries such as Soth Korea and China are also building LNG import facilities to increase their use of this fuel. In the meantime, the disruption to manufacturing at Japanese factories due to either physical destruction or power shortages will interrupt supply chains and lead to shortages of components for autos, electronics and capital equipment makers. Demand for food, with supplies from Japanese farms being reduced both due to the earthquake and fears of radiation, will lead to increased food imports and all of these factors will copntribute to inflationary pressures, already rising in emerging markets and elsewhere (UK March CPI 4.4%).

Lastly, as occurred after the 1995 Kobe earthquake, Japanese investors will need to sell non-Japanese holdings to repatriate their assets to help rebuild their country. It is estimated that costs could range between U$200 billion and U$700 billion, depending upon how serious the damage to nuclear plants is, accounting for 1-3% of GDP this year. While there is a stimulus to GDP growth from the rebuilding, this removes resources from other investments, as what has been destroyed needs to be replaced. If breaking windows really contributed to GDP growth, as some of the commentaries have suggested, then the old Depression=era argument that one group of workers should dig holes, and another set fill them in, so that employment and incomes would increase, would not be the fallacy that it actually is. The only way digging holes creates wealth is if something useful is put in the hole, such as a bridge or gas pipeline.

After the Kobe earthqualke, the market initially sold off from 19,500 on the Nikkei, stabilized for a couple of weeks, and then plummeted by 30% to bottom near 12,500 5 months later in June 1995. At the same time, the yen, which had been trading around Y90=U$1, shot up to a then record Y79=U$1, as the Japanese sold foreign holdings and repatriated their cash.This was one of the reasons why the Nikkei sold off so sharply, as the stronger yen was very bad for Japanese exports, already the major contributor to Japan’s growth in that decade. Therefore, although the Nikkei endured a crash in the 3 days after the earthquake, falling 22% from 10,549 to an intraday low of 8,227, it may not necessarily yet be a buying opportunity, as the Nikkei has already rebounded to 9,449.

While the yen has weakened from its all time high of Y76.5=U$1 that it hit on Thursday, March 17th to Y80=U$1 at time of writing, it took the concerted intervention of all G-7 countries to counterbalance the underlying strength of the yen, and there may yet be further trials of strength unless the Bank of Japan (BoJ) continues to print yen at a rapid pace. In the end, the BoJ will achieve its aim of weakening the currency enough to encourage stronger exports as a counterbalance to weaker domestic demand, the Japanese will finish repatriating the funds they need for rebuilding and perhaps the traumatic effect of the crisis will lead to a change of policy by the Japanese government. Until the yen begins to weaken sharply towards Y90=U$1, overseas investors may want to wait to see hwether the Japanese stock market can avoid repeating its dismal performance after the last great earthquake.

The Secret Garden, Billy Elliot and the Miners’ Strike

March 5th, 2011

My wife and I belong to the Mirvish theatre subscription programme in Toronto, which entitles members to see the 6 or 7 new shows that the Mirvish family (one time owners of the Old Vic Theatre in London) brings to Toronto each year. As with any such programme, members take the good with the not-so-good, and to their credit, David Mirvish and his team do try to mix obvious commercial hits from Broadway and London with more experimental and off-beat Canadian works.

One of the advantages of the subscription programme is that seats are reasonably priced at around C$40-45 per seat, as we see shows mid-week from the front balcony of whichever one of Toronto’s 3 0r 4 theatres they appear in. This allows us the wonderful freedom of leaving at the first interval if we don’t like the show, something which would have filled me with horror as a teenager eagerly viewing plays in the 1970s. By now, however, we have learned that first impressions are almost always correct, at least where theatre is concerned. Amongst disasters escaped were several worthy and well-acted transfers from other Canadian theatres such as Tennessee Williams and Greek tragedy, as well as the enormous white elephant of the stage version of  “The Lord of the Rings”.

Probably the high point was seeing Mamma Mia in 2000 in its first North American performance, but both Priscilla, Queen of the Desert and Billy Elliot this season were excellent. Priscilla was once again a North American premiere, as Toronto’s large gay community makes it a sympathetic and enthusiastic venue to launch gay themed or influenced musicals, while Billy Elliot was produced by Elton John’s significant other, Canadian David Furnish, and its opening night this week was favoured by Sir Elton’s presence, taking a curtain call in a tutu with the rest of the wonderful cast. The role of Billy is so demanding that no fewer than 4 different 12 & 14 year old child actors play the part, understandably given that Billy is on stage for almost every scene, and performs several extremely demanding dance routines as well as singing half a dozen songs and maintaining a near perfect Geordie (Newcastle) accent.

The contrast with the musical I had seen the previous week, this time with my 10 year old daughter, the adaptation of Frances Hogson Burnett`s childrens`classic, The Secret Garden, was very noticeable, and not merely because one was seen from the comfortable modern seats in the Canon Theatre and the other in the very tight thinly-padded seats in the balcony of the 100 year old Royal Alexandra. While Billy Elliot is the adaptation of the 1999 film of the same name about the miner`s son who deserts his boxing class during the Miners`Strike of 1984-85 to take up ballet,  The Secret Garden was adapted from a Victorian childrens` story of the orphaned girl from India who discovers a locked garden in uncle`s Yorkshire estate. Perhaps adaptations from movies are inherently more dramatic, with a visual approach and plenty of physical action that allows the easy insertion of song and dance numbers, while novels, especially ones like The Secret Garden that deal with the growth and development of character, are much more internal, and allow the author to reveal the character`s thoughts to the reader, something that is lost or at least much more difficult on stage, unless one relies on the actor addressing the audience directly, which grows tiresome if used too much.

At all events, The Secret Garden was another worthy and well staged, but rather dull evening in the theatre, although my daughter liked the story enough to want to read the book, which counts as a success. Its two and a quarter hours felt a lot longer than the three hours at Billy Elliot, and the latter`s success confimed that live theatre has no equal amongst entertainment when it works.

The other point that struck me watching the play was the way the mythology of the 1980s has firmly set in place, regardless of the way it ignores a number of vital facts. The programme notes told the story of how the miners `went on strike to save the coal industry from the threatened closures of Prime Minister Margaret Thatcher, who was politically opposed to state-owned industry and determined to crush the unions.` After noting that the strike went on for one year, the programme notes that ` by employing riot police to intimidate their communities and importing coal from Eastern Europe, the Conservative government broke the unions`and that over the subsequent decade the entire industry was dismantled.

That`s certainly one way to look at the Miners`Strike, and the great thing about the play is that, while using the strike and its incidents as a background to Billy`s story, it never lets the political message intrude too much upon the personal story. In fact, it makes it apparent that the solidarity of the miners and their attachment to their culture is in some ways a bigger obstacle to Billy`s attempts to realize his dream than the assumed snobbery of the Royal Ballet School staff auditioning him.

It was all a long time ago, after all (25 years ago amazingly) and there`s no reason for US audiences to be aware that the Miners`union had twice brought the UK to its knees via power cuts in 1972 and 1974, and the second time brought down Maggie Thatcher`s Conservative predecessor, Edward Heath, who called an election on the question of `Who Rules Britain`, to which the answer was Ànyone But You`. Nor would they know that Arthur Scargill, the leader of the miners, who appears for 10 seconds in a news clip at the beginning of the play, refused to hold a strike ballot when he called out his members, allowing one third of the miners to continue working as they claimed the strike was not official. In fact, the vast majority of the clashes between the miners and the police, some of which form a very effective backdrop to Billy and his ballet class of young girls dancing between the struggling forces, occurred when the police prevented the miners from using their `flying pickets`to stop the Nottingham miners from continuing to work and produce coal, not when they were `intimidatìng local communities`. It would probably have helped the success of the strike if Arthur Scargill hadn`t called it in the spring of 1984,  allowing the goverment to let hunger and deprivation to grind down the miners well before winter arrived.

All of this only goes to show that good plays and great art don`t need to be historically accurate to be effective. It would be nice though, if authors and directors didn`t paint the background in bright primary colours that make difficult issues into simplistic morality plays. The evil Maggie Thatcher and her callous desire to grind the faces of the poor is now too well-established in popular mythology for any amount of evidence to make a difference. The opening number of the second act has the miner`s village putting on a Christmas show, with the children singing `Merry Christmas, Maggie Thatcher`and expressing happiness because each new day means ` Ìt`s one day closer to your death`. So there.

Not So Merry England

February 21st, 2011

Having just returned from a week over in the UK seeing family and friends and meeting with a couple of asset managers, it is evident that the Coalition government’s austerity programme is beginning to bite. Firstly, inflation is up to 4% in January, partially due to the increase in sales tax(VAT)  to 20% from 17.5% at the beginning of the year, twice the 2% upper limit that the Bank of England (BoE) is aiming for. The Governor of the BoE, Mervyn King, was reported to be contemplating at least 2 if not 3 increases in interest rates this year from their present low level of 0.5%, and several members of the BoE’s interest rate panel are reported to be infavour of such a move.

Meanwhile, the first of the Pds 80 billion in government spending cuts that the Coalition has promised over the four years to 2014 are due to take effect this year, with reports indicating that 1 in 7 central government workers and 1 in 5 local government workers would be let go over the next year to eighteen months, primarily through attrition, but if necessary through being sacked. As central and local government, including the National Health Service, the largest employer in Europe now that the Red Army has been reduced in size, account for nearly half of employment in the UK, this will have serious effects on retail sales, average wages and particularly, housing prices, which have begun to fall again over the last few months, despite having risen 2% in 2010 on a national basis.

As much of the private sector employment growth over the previous decade came from the construction and financial sectors, both of which are under pressure despite the substantial 2010 bonuses being paid to those bankers still in employment,  it is difficult to see where any offsetting growth in employment and wages will come from. The one bright spot for the economy is the revival in exports caused by the recovery in global trade and the boost given to British exports due to the 25% devaluation that the authorities engineered in the pound sterling between 2007 and 2009, when it fell from PD1=U$2.15 to Pd1=U$1.60. Company earnings being reported for 2010 show substantial growth in profits for the majority of UK companies, which is partially due to higher export sales and partially to the fact that around half UK companies’ profits come from their overseas operations, as the FTSE100 Index is dominated by energy,and resources, drugs and consumer staples such as tobaco and alcohol and global financial stocks which are not dependent upon the domestic UK economy. In fact, the announced $3.2 bn merger between the London Stock Exchange (LSE-L) and the Toronto stockmarket (X-T) is partially predicated upon their strength in the resource area, as around 30% of the LSE and over 50% of the TSX is comprised of energy and resource stocks, making the merged entity the largest exchange specializing in what ahs become a very desirable sector for investors.

Lastly, the cost of petrol, as gasoline is known in the UK, continues to bring tears to the eyes of any North American visiting England. Petrol was Pd1.29 a litre for regular, with diesel another 7-8p a litre more expensive. As I noted in my first posting back in August, the average Canadian finds it difficult to believe that gasoline could cost C$2.10 a litre, while the average US driver would have apoplexy at the thought of paying $9.30 a gallon. The cost of fuel, whether for driving, transportation of goods or heating is one of the reasons why the UK is such an expensive place to live. Outside of London, where wealthy bankers, Arab sheiks and Russian billionaires are indifferent to the cost of living, the difference with Canada or the US is less marked but everything effectively costs at least 50% more than in North America, except when it costs even more. The domestic UK economy is unlikely to be a happy place to live or work for the next couple of years, but they will not prevent portions of the UK stock market from doing well as long as global growth holds up.

The Golden Rule

January 25th, 2011

Gold has dropped sharply in the last few weeks, falling almost 7% from U$1423 an oz. at the beginning of 2011 to U$1325 today, Tuesday January 25th. Numerous commentators and journalists are speculating that the strong performance over the last year has come to an end and that the “bubble” in gold prices and other precious metals is coming to an end. The samelogic applies to gold stocks as well, and the decline here has been more severe, with the S&P/TSX Global Gold Index, comprised of the largest gold mining stocks worldwide, is down 12% since the beginning of the year.

This is somewhat surprising, given the relatively small size of the decline, and the fact that interest rates in most developed countries remain at extremely low levels, such as 0.25% in the US and Japan and 0.5% in the UK and the Euro area, thus making the opportunity cost of holding a non-income producing asset such as gold negligible. Whether or not one is convinced by the arguments that the very large government liquidity creation programmmes such as Quantitative Easing 2 in the US and the European Financial Stabilization Facility (EFSF) will eventually lead to inflation due to excessive monetary creation, otherwise known as running the printing presses, the continued dislike for gold and other precious metals demonstrates that most investors are very slow and unwilling to change their mind, even in the face of a long period of outperformance.

As a number of gold bugs and gold miners have noted, 2010 marked the tenth year in a row that gold had produced a positive absolute return, making it the best performing asset class over the last decade with a total return of 350% between 2000 and 2010. The next best asset over that period, by the way, was long term government bonds, with a 120% total return (half income, half capital gain from falling rates), and the worst, equities, with a 30% loss, apart from resource-based markets such as Canada and Australia, which did see equities delivering positive returns. Gold rose 30% last year alone, more than double the return from major equity markets, and over the last 5 years is up 150% against zero return from the S&P500 and 20% from the S&PTSX Composite and Nasdaq, the two best performing North American equity indices. There is no reason to believe that gold will not deliver a positive return again this year, given that central banks in the US, Europe and Japan have given no sign that are willing to raise interest rates, and that over 1 trillion dolllars of monetary stimulus is due to be injected into the system this year.

Interestingly, gold mining stocks have been laggards to the actual metal itself over this bull market. Over the last 10 years to January 2011, the S&PTSX  Global Gold Index is up less than 300% (280% at time of writing) against gold`s 400% rise, and over the last 5 years, is up a mere 30% against 150% for the metal itself. Part of the reason for this underperformance is the inclusion of South African miners via ADRs such as AngloGold Ashanti, Goldfields and Randgold listed in New York, comprising 13% of the index, as the South African rand has depreciated against the C$. The other and probably more important reason is that the stocks in the index are naturally the large miners, with Barrick, Goldcorp and Newmont being the 3 largest positions, and with the top 10 holdings comprising almost 80% of the total.

Large miners suffer from several disadvantages compared to both the metal itself and smaller miners, as they are on a constant treadmill to replace the gold that they produce each year. They are the ultimate depleting asset, and whenever times are hard in the mining industry, there is a natural, but dangerous, tendency to high grade the resource by mining those sections which have higher grades, thus maintaining the dollar value of the ore produced, while reducing the life of the mine and the profits that are produced. They also suffer from inflation of mining costs more severely than smaller mines, as the limited supply of mining equipment, trucks, mills and trained staff affects them more severely than smaller outfits. Lastly, to maintain or grow their output, large miners will buy smaller mines, with Goldcorp`s (G-T, GG-N) U$3.5 billion purchase of Andean Resources and Kinross`s (K-T, K-N) U$7.1 billion purchase of Red Back Mining last year only the most recent of the numerous examples of smaller mines being bought out at high prices to enable miners with production of over 1 million oz. p.a. to maintain their output.

Thuas large miners are more likely to be diluting their existing shareholders and reducing their returns through issuing paper, but unlike central banks, at least they receive some assets which will produce a return when they do so, even if it does not end up being as high as they originally thought. Ironically, the S&PTSX Global Gold Index was outperforming gold itself last year, up almost 40% at its high in early December against 30% for the metal, but mining stocks tend to be a more volatile, higher beta way to play the underlying commodity, going up more in bull markets, such as 2001-05, 2007-8 and last year, and falling more rapidly in bear markets such as 2006-07, 2008-09 and the last couple of months.

One advantage of using gold stocks as a way to play the bull market in gold is that you even receive an income, although fairly small, with Barrick, Goldcorp and Newmont all paying dividends around 1%, and the other 7 stocks in the top 10 holdings, which include  Kinross, Agnico Eagle, Eldorado and Yamana as well as the 3 South African ADRs, all paying a dividend equivalent to at least  a yield of 0.6%, with some (Newmont, Yamana) yielding 1.1%. Furthermore, a number of the stocks have been increasing their dividends meaningfully, with Agnico Eagle raising its dividend 256%, Goldcorp doubling its payout and Newmont raising its dividend by 50%. One other way to play the gold story without being exposed to rising costs or environmental concerns is via Franco-Nevada (FNV-T), the gold and precious metals royalty company, which receives a royalty of between 0.5% and 4% on every oz. produced by mines in which it owns royalties. Even with no increase in the gold price over the next few years, Franco-Nevada will experience rising profits as new mines in which it has interests will come on stream. It also pays a 1% yield.

2010 Auto Sales, and why China will remain the biggest car market

January 6th, 2011

In 2010, China’s auto sales are expected to have hit 17.3 million units, up 33% from 2009, the year it overtook (ho, ho) the USA as the largest auto market in the world, according to J.D.Power and Associates estimates. This compares with a 9% increase to 11.5 million new vehicles in the US last year, which was still the second worst year for auto sales since 1982; only 2009 was worse, with 10.6 million cars and light trucks sold, compared with 13 million in China.  While individual US companies enjoyed a good year, such as Ford (F-N), which experienced a 19% increase in sales in both the US and Canada, where 1.56 million autos were sold, or GM (GM-N) (up 6% in the US) and Chrysler (up 17% in the US), the more important news for the future for GM was their success in China, where they became the first car maker to sell more than 2 million autos from their several joint ventures.

In India, sales are expected to have climbed 31% in 2010 to 2.7 million units, while in Brazil auto sales climbed to another record for a fourth consecutive year, up 10.6% to 3.33 million. Meanwhile France’s auto sales slipped 2.2% to 2.25 million in 2010, as a “cash for clunkers” scheme introduced by the French government wound down. In other words, India’s auto sales were 25% higher than France’s and Brazil’s almost 50% higher, yet the ownership of vehicles in India is only 14 per thousand inhabitants, less than half that of Africa, let alone China, where ownership levels have reached 40 per thousand people, according to the Global Auto Report from Bank of Nova Scotia.

 In the G7 developed nations, ownership levels average 673 per thousand, so reaching even an ownership level equivalent to 10% of the developed markets implies that car ownership in China needs to grow more than 50%, and in India it needs to more than quadruple from present levels. This is doubtless why an additional 1 million units capacity is being added in India this year, but China remains more than 6 times bigger than India and 5 times larger than Brazil, is expected to expand its capacity by more than one third this year and will doubtless continue to be the largest auto market in the world for the foreseeable future. This is why such manufacturers as Volkswagen, GM, Ford, Fiat, Toyota and Honda are concentrating their expansion efforts in Latin America and Asia, and why if one could buy GM’s emerging markets operations, which are No. 1 not only in China but also in Brazil, the stock would be an attractive investment. Unfortunately, investors get the US and European operations as well, with their problems of too  much capacity, aging work forces, and big pension and healthcare liabilities despite the benefits of going through bankruptcy in 2009  to reduce their costs.

2010 Another Positive Year After 2009-the reverse of the normal Presidential cycle pattern

January 4th, 2011

2010 ended up being a year with positive double digit returns for the second year in a row for major North American and European markets, which is the reverse of the normal Presidential cycle, which sees the indexes flat to down for the first two years of a Presidential term and then a strong performance in the two years running up to the election. The Nasdaq was up 16.9%, the TSX Composite was up 14.5%, the S&P500 12.8%, the Dow Jones 11% and the FTSE100 9%. In Asia on the other hand, performances were much more subdued, with the Hang Seng only up 5.3%, the Nikkei225 down 3% and Shanghai down 14%.

After a very strong 2009, with the S&P500 up 23.5% for the year and 67% from the 666 low on March 9th, it was surprising to many observers that the index was able go up more than 10% the following year. In fact, at the end of August 2010,  the S&P was down 5.9% and the Nasdaq down 6.8% and it took the best September since 1938 to turn the year positive. Of course this was after the Fed’s Jackson Hole meeting, when Bernanke first announced that QE2 would be happening, so in essence the last four months of the year saw the S&P up 18.7% and the Nasdaq 23.7%. The power of liquidity injections proved once again to be the most important effect in the short term, overpowering concerns about a slowdown in China, the Bush tax cuts not being renewed and the continued collapse of smaller Euro area countries such as Ireland and Portugal.

Appearing on BNN, and why live TV is always interesting

December 18th, 2010

Yesterday, Friday December 17th, 2010,  I appeared on BNN’s Marketcall programme in their new studios at 299 Queen St W in downtown Toronto, where they had moved two weeks ago. BNN started as Report on Business TV (ROB-TV) in late 1999, backed by CTV and (after the takeover by BCE during their convergence phase) Bell Canada. Its first studio was in a converted warehouse on Church St, just around the corner from the old Maple Leaf Gardens, and had been thrown together in a few weeks when they won (somewhat to their surprise) the licence for a Canadian business TV channel, only 15 years after CNBC had started in the US. It was incredibly cramped and gloomy, the cameras were hand operated and pigeons nested in the roof, from where they would occasionally make life interesting for the presenters.

I was invited to appear on the first week of Marketcall, the phone-in programme which has the biggest audience of any of its shows, as one of the producers knew a colleague at Guardian Group of Funds, in February 2000, and Jim O’Connell, the knowledgeable and professional host, gently walked me through the details of which camera to look at and when the commercial breaks would occur. Having managed to look at the camera and finish with a Hitchhiker’s Guide to the Galaxy reference when Nortel’s share price was falling (“Don’t panic”), I was invited back to become a regular guest, and had the pleasure of being the opening night guest on Marketcall Tonight with Ali Velshi (now starring at CNN) later in 2000. BNN moved to its new purpose-built studios on the top floor of a new building at King  & Bathurst, with automatic cameras, I would appear regularly on Marketcall, usually with Jim and Howard Green, and sometimes do an interview from the TSX broadcast centre to a remote camera with an earpiece hopefully plugged in, and anniversaries such as the 5 year birthday for Marketcall would  come and go. Jim O’Connell sadly passed away far too young, and we attended his funeral service, the make-up ladies would change, guest parking was removed as a cost cutting measure, and old friends from the business desks at other stations would appear as producers.

Through it all, the interest of the viewers in my commenst and those of other guests on individual stocks never flagged, and I have been approached on numerous occasions by people asking me what my 3 Top Picks were, or commenting on some of my recommendations, usually the ones that didn’t work out in the short term! The remarkable fact is that once you appear on TV, you are an “expert” and therefore presumed to know what you are talking about, until such time as you comprehensively destroy your credibility. I always chose the 3 top picks from the funds that were run by Guardian and latterly BMO, as I knew the managers, and regularly reviewed their selections with them, and the reasons why they were buying and selling, but that did not, of course, guarantee that the 3 stocks I’d chosen for that month’s appearance would go up over the next few months. In fact, I used to remark on air on a regular basis to Jim, Howard and MIchael Hainesworth that, much though I enjoyed their company and being on TV, if I could successfully pick stocks that went up in the short term, then I wouldn’t be on BNN, I would be enjoying my gains on my yacht in the south of France or Caribbean.

On Friday this week, I was making my second appearance at the new studios, BNN having moved to the building that houses CP24 , MuchMusic and other CTV specialty channels. Howard Green and I had settled in and were answering viewers’ questions, which the producers clear with you before putting them on air, as they don’t want managers admitting they don’t know anything about the stock the viewer is interested in; it’s boring TV and doesn’t help the credibility of the guests, who, after all, can’t be expected to know details on every stock in Canada, let alone the US. Suddenly the overhead lights went out, fortunately just as we were going to commercial break. Howard alerted the producers and technicians hurriedly ran up with smaller lights on stands, which they wired up rapidly. The overhead lights came back, Howard remarked “Well, that looks okay” and they promptly went out again. We spent the rest of the half hour having the producers put stock price charts up on screen when the lights went out, which left Howard and myself sitting in virtual darkness, until the techies finally got the smaller lights working consistently.

Howard is a complete professional and handled the situation admirably, while letting the viewers know that there were technical issues. We finished the show, and the senior management from BNN appeared to thank Howard and I for carrying off the show; Howard said it was lucky I was on, as an experienced guest, as someone new would have found it pretty distracting. It felt like disco TV, as one producer remarked, as the lights kept flashing away! That’s why it’s always interesting doing live TV; you never know what might happen and sometimes, everything does. Incidentally, my 3 top picks were Cameco (CCO-T), the uranium producer, Genworth MIC (MIC-T), the mortgage insurer and ICICI Bank of India (IBN-N), the second largest Indian bank.