Moneyweb Investment Focus, with Discovery Invest (November 2009)


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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, Sasfin

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Moneyweb Investment Focus, with Discovery Invest (November 2009)

  1. 1. The new ‘normal’ Alec Hogg 6 – 12 November 2009
  2. 2. 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
  3. 3. It’s the new normal because it’s here to stay
  4. 4. Cause one Globalisation
  5. 5. Cause two Person Power
  6. 6. Cause three Technology
  7. 7. Cause four China
  8. 8. Consequence one We’re time poor
  9. 9. Consequence two <ul><li>“ Change creates a new paradigm in which enterprising companies can benefit through innovative solutions…” </li></ul><ul><li>- Brian Joffe, founder, Bidvest </li></ul><ul><li>From the 2008 annual report: </li></ul><ul><li>“ Bidvest has risen to the challenge of “the new normal” </li></ul>Business strategy
  10. 10. Consequence three Investment strategy
  11. 11. Consequence four <ul><li>Disruptors run by entrepreneurs: </li></ul><ul><li>Steinhoff (@ 1845c – earnings yield of 13.7%) </li></ul><ul><li>Pallinghurst (@ 468c – the Gilbertson factor) </li></ul><ul><li>Discovery (@ 3050c – earnings yield of 7.4%) </li></ul><ul><li>Altech (@ 7700c – earnings yield of 7.8%) </li></ul><ul><li>PSG (@ 2150c – earnings yield of 7.8%) </li></ul>Some likely winners
  12. 12. Panning for Gold in Muddy Waters 6 – 12 November 2009 Kerrin Howard Head of Investment Strategy Discovery Invest
  13. 13. Newest elements of global economies <ul><li>Debt </li></ul><ul><ul><li>Nearly USD1 trillion in stimulus bills; USA may need to borrow USD2tn </li></ul></ul><ul><ul><li>Debt to GDP: </li></ul></ul><ul><ul><ul><li>USA: 70% (#1), rising to 108% by 2014 according to IMF </li></ul></ul></ul><ul><ul><ul><li>SA: 31.6% (#43) </li></ul></ul></ul><ul><li>Outlook </li></ul><ul><ul><li>GDP growth is not an obvious option for meeting those obligations </li></ul></ul><ul><ul><li>More countries will run larger current account deficits for longer </li></ul></ul><ul><ul><li>Growth is being driven by the funds borrowed to create it </li></ul></ul><ul><ul><li>Is such growth sustainable? </li></ul></ul><ul><ul><li>Governments likely to inflate the debt away </li></ul></ul>Sources: Bloomberg, IMF
  14. 14. Gold’s value as an inflation offset Source: Bloomberg Traditionally, gold seen as inflation hedge. Recently, Gold began moving with stocks.
  15. 15. Gold’s relevance <ul><li>Warren Buffett is not convinced </li></ul><ul><li>‘ Gold just sits there, with no yield.’ </li></ul><ul><li>‘ [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.’ </li></ul><ul><ul><li>Warren Buffet, ‘sage of Omaha’ </li></ul></ul>
  16. 16. Maybe Buffett has a point Source: Bloomberg
  17. 17. Why should Gold prices rise or fall? <ul><li>Driving forces for Gold prices </li></ul><ul><ul><li>Supply </li></ul></ul><ul><ul><li>Demand </li></ul></ul><ul><ul><li>Strength/weakness of the US Dollar </li></ul></ul><ul><ul><li>Inflation </li></ul></ul><ul><ul><li>Interest rates </li></ul></ul><ul><li>Views for and against rising gold prices </li></ul><ul><li>Shares that may benefit, or not </li></ul>
  18. 18. Supply and demand for Gold * Net of hedging Mine production* 60% (2,209t) Net central bank sales 12% (447t) Recycled gold (scrap) 28% (1,016t) Jewellery 68% (2,436t) Industry 14% (493t) Investment 19% (670t) Industrial 12% (19,700t) Official Sector 18% (29,700t) Unaccounted for 2% Investment 17% (27,300t) Jewellery 51% (83,600t) <ul><li>Supply flows </li></ul><ul><ul><li>5 year average (2004 – 2008) </li></ul></ul><ul><li>Demand flows </li></ul><ul><ul><li>5 year average (2004 – 2008) </li></ul></ul><ul><li>Above-ground stocks, end 2008 </li></ul><ul><ul><li>(total: 163,000t) </li></ul></ul>
  19. 19. Gold: Not enough of it Sources: The Tudor Group, Bloomberg, IMF, World Gold Council Recycled gold = 28% of production Annual world Gold production Million ounces Annual production as a percentage of available supplies 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 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
  20. 20. Central Bank Gold reserves Central Banks globally seen as net buyers going forward Source: Bloomberg 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%
  21. 21. More investors want to buy Gold Sources: The Tudor Group, Bloomberg 12m-trailing Gold ETF flows as a percentage of 12-m trailing production Gold ETF Holdings as a percentage of above ground stocks 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 25% 20% 15% 10% 5% 0% 30% 35% 1/3/2006 4/3/2006 7/3/2006 10/3/2006 1/3/2007 4/3/2007 7/3/2007 10/3/2007 1/3/2008 4/3/2008 7/3/2008 10/3/2008 1/3/2009 4/3/2009 7/3/2009 10/3/2009 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 11/3/2006 1/3/2007 3/3/2007 5/3/2007 7/3/2007 9/3/2007 11/3/2007 1/3/2008 3/3/2008 5/3/2008 7/3/2008 9/3/2008 11/3/2008 1/3/2009 3/3/2009 5/3/2009 7/3/2009 9/3/2009
  22. 22. USD strength/weakness affects Gold Source: Bloomberg Relative performance Dollar 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
  23. 23. JP Morgan’s economic outlook Global GDP growth: largely funded by government borrowing   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
  24. 24. Low interest rates spur Gold demand Source: JP Morgan   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
  25. 25. Gold can be seen as cheap Source: The Tudor Group Gold inflation-adjusted cash prices – average = $556.2 Inflation-adjusted all time high was $2,422 on 21 Jan 1980
  26. 26. Back to Buffett: better off elsewhere? Source: Bloomberg
  27. 27. Whither South African Gold stocks? <ul><li>Earnings outlook </li></ul><ul><ul><li>Upward potential: </li></ul></ul><ul><ul><ul><li>Higher prices globally </li></ul></ul></ul><ul><ul><ul><li>Higher demand </li></ul></ul></ul><ul><ul><ul><li>More ways to buy Gold </li></ul></ul></ul><ul><ul><ul><li>Central Bank buying: India bought USD6.7bn/200 tonnes from IMF </li></ul></ul></ul><ul><ul><ul><li>Lacklustre production outlook </li></ul></ul></ul><ul><ul><li>Downward pressure: </li></ul></ul><ul><ul><ul><li>Margins under pressure due to lack of upgrade </li></ul></ul></ul><ul><ul><ul><li>ZAR strength </li></ul></ul></ul><ul><ul><ul><li>Higher electricity and wage costs </li></ul></ul></ul>
  28. 28. South African Gold shares: focus on hedging, margins, marketshare Investec Asset Management’s Sam Houlie, manager of Discovery Equity Fund, is invested in Gold-related companies   Deutsche Bank forecasts 2008A 2009E 2010E AngloGold Ashanti Buy EPS (USD) -0.47 -0.41 3.85 P/E (x) - - 11.3 EV/EBITA (x) - 133.6 7.6 Harmony Gold Mining Buy EPS (USD) 0.39 0.43 1.22 P/E (x) 25.4 25.9 9.1 EV/EBITA (x) 28.4 21.2 6.6 Gold Fields Hold EPS (USD) 0.49 1.16 1.8 P/E (x) 20.1 12.3 7.9 EV/EBITA (x) 11.8 7.9 5
  29. 29. 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?
  30. 30. Lessons learned from the collapse of Lehman Brothers David Shapiro 6 – 12 November 2009
  31. 31. Background <ul><li>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 </li></ul><ul><li>Lehman had significant exposure to investment products, designed to facilitate the sale of mortgage finance, associated with the lower end of the property market </li></ul><ul><li>The collapse unhinged the global economy </li></ul><ul><ul><li>Stock markets went into steep decline </li></ul></ul><ul><ul><li>Credit markets froze </li></ul></ul><ul><ul><li>World trade halted </li></ul></ul><ul><ul><li>Liquid markets dried up faster than assumed. </li></ul></ul><ul><li>A year later, equity markets have recovered and credit markets are beginning to show signs of life </li></ul><ul><li>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! </li></ul>
  32. 32. Lesson one <ul><li>Most macro-economics of the past 30 years was spectacularly useless at best and positively harmful at worst </li></ul><ul><li>Paul Krugman </li></ul><ul><li>Princeton professor, economist and Nobel Laureate </li></ul>
  33. 33. Economists misread the economy on the way up, misread it on the way down, and are confused about the way out <ul><li>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 </li></ul><ul><li>Most were sanguine about the collapse of Lehman - no one expected the financial system to break </li></ul><ul><li>Furthermore, they overestimated the power of monetary policy to restore prosperity, but their models failed and conventional weapons have proved insufficient </li></ul><ul><li>Theories worried about the prices of goods and services but neglected the prices of assets – it had too much faith in financial markets </li></ul><ul><li>Even so there is still disagreement about the alternatives and extent of stimulus packages </li></ul><ul><li>They have to adjust their theories from preserving price stability to safeguarding financial stability </li></ul>
  34. 34. Lessons from Keynes <ul><li>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 </li></ul><ul><li>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 </li></ul><ul><li>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 </li></ul><ul><li>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 </li></ul><ul><li>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 </li></ul>
  35. 35. Lesson two <ul><li>The US retains its power to command the global economy and create disorder </li></ul>
  36. 36. US continues to dominate global economy <ul><li>The world has not lessened its dependency on the US </li></ul><ul><li>The US keeps its power to command the global economy and create disorder </li></ul><ul><li>Belief that momentum in emerging economies would fill the void left by the slowdown in developed economies was unfounded </li></ul><ul><li>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 </li></ul><ul><li>Still – some emerging countries positioned for healthy expansion – but without a turnaround in the US the global economy will not recover </li></ul>
  37. 37. Lesson three <ul><li>The dollar remains and will remain the leading reserve currency </li></ul>
  38. 38. The dollar remains and will remain the leading reserve currency <ul><li>When the credit crisis crossed the Atlantic it spread fears about growth in other major economies </li></ul><ul><li>Intensifying turmoil sparked a rush to the safe haven of US government backed treasuries </li></ul><ul><li>Dollar strength triggered a rapid unwinding of commodity hedges </li></ul><ul><li>Falling commodity prices and global slowdown increased doubts about expansion in emerging economies – carry trades unwind </li></ul><ul><li>Debtor 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 </li></ul>
  39. 39. Dollar’s role as a reserve currency <ul><li>Dollar has been dominant as the world’s reserve currency since World War 1 </li></ul><ul><li>General view is that the world financial system can’t rely solely on the US dollar </li></ul><ul><li>The 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 problem </li></ul><ul><li>Some dollar weakness is welcome – it reverses the inflows into the US that facilitated the over-leveraging and under-pricing of assets </li></ul><ul><li>It is worth noting that a reserve currency requires liquidity that can only be produced through the existence of current account deficits </li></ul>
  40. 40. Lesson four <ul><li>Risk managers at banks, investment companies, regulatory authorities proved entirely inadequate </li></ul>
  41. 41. There are many banks but very few bankers - Warren Buffett, May 2008 <ul><li>The self interest of lending institutions failed to protect the interest of equity and shareholders </li></ul><ul><li>Risk managers at banks, investment companies, regulatory authorities proved entirely inadequate </li></ul><ul><li>Also obvious that senior management were oblivious to the dangers </li></ul><ul><li>Sophisticated, computer-driven systems designed by financial experts failed to pick up the weaknesses embedded in the pooled products </li></ul><ul><li>According 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 priced </li></ul><ul><li>In addition, the degree of exposure to subprime lending and the level of uncovered credit swap derivatives was grossly underestimated </li></ul>
  42. 42. The future of banking under scrutiny <ul><li>Only 3 out 10 bosses in the US kept their jobs after the crisis – in Europe a number of heads also faced the guillotine </li></ul><ul><li>Bankers paid themselves loads of money, made large expense claims and furnished their offices lavishly – more useless than corruptible </li></ul><ul><li>With 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 assets </li></ul><ul><li>It wasn’t a case of how many times management met – banks were simply too big to be manageable </li></ul><ul><li>Banks need to shrink and simplify their businesses and establish a culture of excellence </li></ul>
  43. 43. Lesson five <ul><li>Read Benjamin Graham, read Phil Fisher, read annual reports but don’t do equations with Greek letters in them </li></ul><ul><li>Warren Buffett </li></ul>
  44. 44. It is easier to rob by setting up a bank than by holding up a bank clerk – Bertolt Brecht <ul><li>The origins of the credit crisis are linked to the global spread of mispriced assets </li></ul><ul><li>Questions have been raised over the contribution of academics in the design and evaluation of these mispriced assets </li></ul><ul><li>The 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 </li></ul><ul><li>Belief that financial products should be passed by the equivalent of the FDA before being sold to unsuspecting investors </li></ul><ul><li>Also 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” </li></ul>
  45. 45. The smart guys come to Wall Street <ul><li>According to some cynics the integrity of financial markets began disintegrating when the smart guys started working on Wall Street </li></ul><ul><li>Twenty to thirty years ago the top students aspired to becoming professors, judges or surgeons – the lower third of the class went to Wall Street </li></ul><ul><li>They 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 leverage </li></ul><ul><li>The 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 securitisation </li></ul><ul><li>They wanted to make a fortune first, then become professors </li></ul>
  46. 46. Lesson six <ul><li>Gold failed to perform throughout the crisis and offered little protection against falling asset prices </li></ul>
  47. 47. 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 <ul><li>Gold failed to perform throughout the crisis offering little protection against falling asset prices </li></ul><ul><li>Recent peak reached on dollar weakness </li></ul><ul><li>Performance correlates more closely to movements in commodity prices and oil than a pseudo currency </li></ul><ul><li>In 1940 one ounce of gold bought around 30 barrels of oil – it now buys around 12 </li></ul><ul><li>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 </li></ul>
  48. 48. The future <ul><li>Temperature is normalising but the recovery in the global market will be slow and protracted </li></ul><ul><li>More bank write offs anticipated – $1.7 trillion increasing to $2.8 trillion </li></ul><ul><li>Stimulus programmes beginning to take hold in developed and emerging economies </li></ul><ul><li>High levels of unemployment, surplus industrial capacity and excess householder debt will prove a drag on growth </li></ul><ul><li>Consumption in China and India too small to fill the void </li></ul><ul><li>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 </li></ul><ul><li>Banks will face tighter regulations – could be broken up </li></ul><ul><li>Financial markets will be tamed – includes regulating hedge funds </li></ul><ul><li>Remuneration packages, share options, buy-backs, valuation techniques, scrip lending and short selling will be challenged </li></ul>
  49. 49. Thank you
  50. 50. Q&A