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    Asset price deflation - making sure it does not happen

    After a relatively slow start monetary authorities have aggressively stepped up activity in trying to slow, stop and reverse the credit crisis. The reversal of credit markets has been so swift and pervasive, that central banks attempts to re-inflate have been likened to blowing air into a balloon that has lots of holes.

    Yes, too much liquidity was the culprit for the technology, property, commodity bubbles, which sparked the recent asset price declines, and the freezing of money markets.

    But what do governments like to do? Well for one they like to manufacture money. Ben Bernanke, current chairman of the Fed, in a speech in November 2002, as a Fed governor said in response to concerns about deflation at the time, “But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

    What is the big issue of the day…. Asset price deflation and the US dollar that is too strong against the euro, yen and emerging market currencies.

    The printing presses are working hard to try and re-inflate. In the short term it’s unlikely to have traction. But in the medium term excessive government action and intervention has a high probability of inflating asset prices.

    Let’s consider some action just this week.


    This week we saw the Federal Reserve bring down their key Fed funds rate to 1%. This left the option to even go lower, should it be necessary. Prior to June 2003, a 1% interest rate would have been unheard of.

    Bloomberg reported that the U.S. Treasury and the Federal Deposit Insurance Corp. are considering a program that may offer about $500 billion in guarantees for troubled mortgages to stem record foreclosures.


    Japan has been hard hit on all fronts. For the first time in 7 years, the Bank of Japan has reduced its interest rate from a level already close to 0% (0,5%) to 0,3%. Many were expecting a drop of 0,25%, but 0,2% it was.

    The drop was the opposite of the next move that Bank of Japan was hoping to do. For years now, they were waiting to increase rates. But global asset price declines overtook their long held ambition.

    The currency is now too strong and the yen carry trade unwound. This leaves exporters unprofitable.

    The decline to almost zero opens up the opportunity again, for almost costless lending and a probability of an even greater carry trade.

    The Japanese government announced another stimulus package of $51 billion to help households and businesses.

    Emerging markets

    The US Federal Reserve set up liquidity swap facilities with the central banks of Brazil, Mexico, South Korea and Singapore. It agreed to provide them each with $30 billion in an attempt to unfreeze money markets.

    The Fed also created a $15 billion swap line with New Zealand. It set up a $10 billion arrangement with Australia’s central bank and then increased this to $30 billion

    IMF Credit Lines
    At the same time the International Monetary Fund decided to almost double borrowing limits for emerging market countries while waiving demands for economic austerity measures.


    Germany had its euro500 billion bank rescue plan approved on Tuesday by the European commission authorities.

    The global consensus from monetary authorities is “Asset prices have declined. The voters are in trouble and we need to help. Let’s do whatever it takes. Soft loans, interest rates as close as possible to zero, swaps lines. Print print print.”

    Are we seeing the start of the next asset bubble in the making?

    Have a wonderful and blessed weekend


    Ian de Lange
    021 9144 966

    Permalink2008-10-31, 18:07:48, by ian Email , Leave a comment

    A reprieve on the inflation front

    We apologise for the lack of Daily Equity Report yesterday, there were some technical problems with uploading the report. Please find the report written after yesterday’s release of September’s inflation data.We have experienced an extremely tumultuous few months, where all investors have been constantly bombarded with news of doom and gloom. Any glint of good news that has come to the market has either been a false dawn or superseded by bad news in another area. Today was another good up day, following Wednesday’s gains with the JSE All Share index back over 20 000, up 5,39%.

    Yesterday can be classed as a day of good news with what is hopefully the start of a declining inflation cycle.

    The latest CPI number was released on Wednesday, and came in at 13.1% for the 12 months ended 30 September 2008. This is the first time since August last year that we have seen inflation coming down and also the first time in a while that CPI has come in under the average economist’s prediction (a positive surprise). One immediately thinks of the clichéd quote “One swallow does not make a summer”, but my thinking is more along the lines of “At least we have seen a swallow!”

    While a decline in inflation is good news, there is the problem that CPI-X, which the SARB is mandated to keep between 3 – 6%, is still at 13.0% (some 7% above the top band).

    Below I have attached a chart of inflation, and food price inflation levels over the past 10 years. Note that we have turned the corner; let’s hope that this trend can continue!

    Over the past few weeks we have spoken to many fund managers. Among the topics we discuss (to assist us with analysing how they will structure their portfolio going forward) is their view on where they see inflation going, and why they have that view. The general response up until a month or so ago was that inflation would be falling very sharply on the back of lower oil prices, but we have since seen the massive weakening of the rand.

    The rand weakness has reminded most investors of the danger to your currency of running a large current account deficit, as South Africa does, when foreigners begin to pull their money out of the country (sell shares and bonds). Rand weakness equates to more expensive imports, which leads to higher inflation in a country that is a net importer (South Africa). One manager mentioned that rand depreciation of 10% equates to an increase of 1% in inflation.

    Most managers now appreciate that a weaker rand could slow the rate of decrease in inflation, which in turn has a knock on effect on when Tito Mboweni can use monetary policy to spur economic growth (decreasing rates).

    With the rand trading around R10 to the US dollar, and the oil price in the $60 – 65 range, its looks like we will see another fuel price decrease next Wednesday, which will help reduce inflation in the future.

    As mentioned earlier the major risk for South Africa’s inflation (and by extension growth) is the currency. Not only is the level important, but also its volatility. Business men and women need to make predictions when it comes to planning future activity, and a more stable currency is more conducive to growth. Our currency’s major enemy at the moment is foreign investors. They currently still own around 25% of the JSE, and any reduction in this stake would weaken the rand further.

    Hopefully next month we’ll be able to report a further decline in the inflation rate.

    Enjoy the rest of your week.

    Kind regards,

    Mike Browne



    Permalink2008-10-30, 18:54:12, by ian Email , Leave a comment

    Anchoring bias

    Study after study has shown, together with observations of actual behaviour reveal that time and time again investors are not as rational as standard finance theory would have us believe. One observed bias is Anchoring. This is a concept that when developing a value, individuals tend to begin by starting with a reference point, i.e. an initial default “anchor”

    They then go through a process of fine tuning, reassessing, into a final estimate.

    This may be a function of how our brains think, i.e. use a shortcut tool to solve complex problems, by first selecting an initial reference point and slowly adjusting to the correct answer as it receives additional information.

    But studies indicate that regardless of how the initial anchors were chosen, people tend to re-adjust final estimates that are essentially then biased to the initial anchor.

    Some examples of anchoring

    Investment anchoring

    o Many investors buy a share at price R25, watch the price move ahead to a high of say R40 on positive news, but then slip back slightly to say R37.

    They now anchor on the high price of R40, believing that prices below this, now represent a discount and a possible buying opportunity.

    o Price indices, such as the Dow at 10 000 become an anchor point.

    o Forecasts or earnings upgrades tend to be anchored around percentage increases or decreases from a particular base.

    Example: An analyst forecasts that a company will post a quarterly earnings of 65c/share, but the company actually posts 75c/share. The analyst tends to then raise his forecast for the next quarter’s earnings, but not by enough.

    Investors tend to hold onto an underperforming investment, waiting for it to get back to its original cost, so that it will “break even”


    1. Property valuations

    Real Estate agents have used anchoring to good effect in their property valuation techniques, which centred on “comparative pricing”. By anchoring on recent area sales values, both buyer and seller, have a cognitive anchor.

    This works well in a “normal” market, but the pricing error mechanism is soon seen when prices fall 25% in one year from a peak, i.e. prices push up steadily but surely, using anchoring to good effect, but they reach an extreme point.

    2. Past history

    Investors can become anchored to the economic state of a company or even a country. An example in South Africa is where investors anchor to the fact that Remgro is a bellwether (i.e. leading) stock. But this may not always be the case. Japan became an economic powerhouse in the 1980’s and investors thought it would last for decades – it did not.

    At all times, investors need to take a step back and adopt a clean slate approach to their investments.

    Kind regards

    Ian de Lange
    021 9144966

    Permalink2008-10-28, 17:09:56, by ian Email , Leave a comment

    High volatility in global currencies

    The global credit crisis has morphed into a currency crisis as well. Many emerging market currencies have cracked down versus the US dollar while some like the yen have firmed. Sudden large movements cause disruption. A Standard Bank report cited the root of excessive liquidity can be traced back to the weak dollar in 2002 and the subsequent surge in global reserves.

    The figure below reflects this massive surge in foreign exchange reserves, which had to find a home somewhere. They note that the home of choice has been government bonds, with huge inflows keeping yields artificially low.

    In previous reports I have noted our agreement that the US Treasury bonds yields look exceptionally low and therefore expensive.

    Given the current global dilemma these rates may stay low for some time. But investors should not be fooled into the supposed low risk status.

    The Standard Bank report says that policymakers are now tackling the symptoms and not the cause. I.e. they are seeking to re-capitalise banks, buying sub prime assets, loaning money through the IMF to emerging market nations. Rather they state that the problem may be one of countries fixing their currencies to the dollar, which leads to huge reserve increases when the dollar is weak.

    But what are countries supposed to do in light of the fact that the dollar is the world’s reserve currency.

    I.e. perhaps because currencies are now all floating, one against the other, with no basis to an inherent value, that we are having the larger movements recently experienced.

    I looked back to an essay that Alan Greenspan published in 1967, which was published in Ayn Rand’s “Capitalism, the Unknown Ideal.”. Titled, “Gold and Economic Freedom”, it is a fairly brief essay, expanding upon money, the attractiveness of gold backing, the development of a banking system and credit instruments, and the ability of the tangible backing to keep a reign on bank credit expansion.

    I will touch on aspects of this report over the days because it has some sound logic. For the duration of his tenure as Fed Chairman, Greenspan went against his assertions made in this essay, but his most recent testimony suggests that even he was fooled with banks ability to rein in their own lending.

    A few points to start from his essay.

    “Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.”

    “The existence of such a commodity is a precondition of a division of labour economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.”

    Therefore money is a medium of exchange so as to avoid bartering. It needs to have an objective value, and in order for long range planning, money needs to have some store of value.

    With one currency floating wildly against the other, it’s the objective value that is difficult to ascertain. Just how does one decide which is the best currency in which to deposit savings?

    That’s all for now.

    My partner Vincent Heys is in Jhb this Thursday and Friday and has one or two slots available for meetings. Please mail him if you would like to meet and discuss your investment planning. vincent@seedinvestments.co.za

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2008-10-27, 18:32:32, by ian Email , Leave a comment

    Looking for that next Opportunity

    The previous US Federal Reserve Chairman, Alan Greenspan underestimated the risks as he thought that banks would have been in a better position to protect shareholders. His predecessor, Paul Volcker, Fed chairman from 1979 to 1987, addressing a group at Columbia University, said that the creation of complex financial products, ``instead of spreading the risk and creating transparency,'' wound up concentrating risk and ``opaqueness,''.

    The Morgan Stanley Capital Index, which measures 48 developed and emerging market indices, has lunged 48% in 2008, heading for hits worst year on record. More than $10 trillion has been erased from the market value of equities so far this month alone.

    Today the Japanese index, the Nikkei dropped nearly 10 percent and is at levels last seen in April 1983. Toyota sales fell for the first time in 7 years and Sony slashed its forecast for a second time.
    The South Korean Kospi index tumbled 10 percent and is down 20 percent for the week.
    Markets across the globe continued their negative trend.

    Again as money flowed back to the US from around the globe, it went straight into US cash and into US Treasuries.

    Demand for US Treasuries sends the yield down. The yield on the 30 year bond went to the lowest ever since regular issuance in 1977. It dropped to a low of 3,86%. The 10 year yield is at 3,63%.

    A comment from a 30year veteran of the US bond market, John Jansen today was “Prices of Treasury coupon securities are surging in overnight trading as fears of a global recession spark a meltdown in global equity markets and a massive deleveraging trade. The moves in the various financial markets are stunning and frightening.”

    The conundrum is this. Why is the US dollar so strong and why are lenders prepared to accept such a low yield?

    Clearly it’s not because of the intrinsic or inherent value in the US dollar or indeed because of the low risk in US government finances. Rather the mass exodus of funds from around the world back home to their source is driving up the US dollar and the price of the US government bonds.

    There are few to no alternatives that investors, wish to even consider at this stage. I.e. few investors want to risk capital – they want it on tap in the money market.

    Where then is the next possible bubble?

    Over the past 10 year, financial markets have witnessed one bubble after another. Asian markets in the buildup years to 1998, followed by the global technology bubble peak in 1999/2000. As this bubble burst and following the lowering of short term rates in the US, house prices picked up momentum to bubble proportions. As this was bursting, so money started flowing quickly into commodity prices, taking prices up exponentially.

    With the inflation of each asset class, so more and more credit was created. This was especially the case with the US housing market, where asset appreciation supported further money creation, which in turn found its way back into houses, further boosting their asset prices.

    It very easy to be beguiled by a bubble. Normal appetite for an additional payoff for the additional risk slowly turns into greed as opportunity for profit is becomes widespread. Risk is pushed out of mind, as returns are being generated.

    But now as bubble after bubble has burst, global credit has very quickly contracted, with any remaining excess liquidity going straight for the safe haven of US dollars and US Treasuries.

    No one knows when this will end or what damage will be done to asset prices in the meantime. For this reason the trend in the US dollar and developed market bonds may have a way to run, but it’s highly probable that this is itself morphing into a bubble. I.e. lower and lower expected returns for higher and higher risk.

    Today the JSE fell a further 5,8% to just under 18500. Gold shares fell a massive 12,3%.

    Bullion in US dollar terms is under pressure as the dollar is strong, but at some point should investors get nervous of the US dollar and US bonds, there are few opportunities left to turn to. Gold may prove to be a good alternative, which itself has really been depressed since its peak in 1980. Local gold shares have been smashed down in price, along with everything else. There may be an opportunity here and we are looking at this closely.

    Despite the markets have a blessed weekend.


    021 9144 966

    Permalink2008-10-24, 18:26:12, by ian Email , Leave a comment

    Emerging Market Turmoil

    The turmoil in the world’s financial system is defying past levels of volatility. Tuesday saw the Zimbabwe Stock Exchange Industrial index up 257% in one day, following a 241% hike on Monday. Wednesday saw the US equity markets down to new 6 year lows. Argentina’s government made a surprise proposal to nationalise the $30 billion private pension system –yields on their bonds spiked up.

    Risk capital that had slowly started creeping back in search of higher returns post the late 1990 Asian crisis, has now very quickly found its way back to the US and Europe. Shorter dated money market instruments and even longer dated US bonds have found favour from investors keen to ensure protection of capital and limit any further losses.

    As a consequence of money flows and the sudden loss of appetite for risk, emerging market bond yields spiked up as investors pulled money and effectively demanded higher yields for the increased risks.

    And so in a very nervous global system, investors have preferred to lend their money to the US government on 3 month Treasury bonds for a very low 1% annual nominal yield.
    Lending for 12 months will provide just 1,64% in US dollars.

    Still at these exceptionally low yields, money is pouring back from risky emerging markets into US and Europe shorter term money markets.

    It’s having a marked impact on emerging market exchange rates.

    So what do we have.

    In Zimbabwe runaway inflation has been caused by government’s excessive printing of currency. Private individuals know that one of the few available means to hedge against inflation is to buy a real asset. I.e. shares in some of the companies listed on the stock market. The index gains over 500% in 2 days (In Zim Dollars)

    This is an example of a complete breakdown of trust in the medium of exchange – i.e. the Zim dollar. Could it happen elsewhere?

    Across the globe, given Argentina’s proposal to take control of pension assets, trust dissipated, resulting in the yield on their 2033 maturity bonds falling from around 12% just one month back to over 28%. I.e. where one month ago lenders were satisfied in receiving 12%, they are now demanding over 28%.

    Emerging market and high yield spreads have widened dramatically as capital flees. Bloomberg reports that Emerging market bonds have lost 22% so far this month.
    For now US bonds are seen as a safe haven. It is unlikely to persist over any reasonable period of time.

    Kind regards

    Ian de Lange
    021 9144 966

    If you would like to discuss your asset allocation of your portfolio, please don’t hesitate to contact Vincent Heys at Vincent@seedinvestments.co.za. He is in JHB next week Thursday for one on one meetings.

    Permalink2008-10-23, 18:04:30, by ian Email , Leave a comment

    Medium Term Budget Policy Statement

    Yesterday saw the release, by Trevor Manuel, of the Medium Term Budget Policy Statement, which has been dubbed the ‘Mini Budget”. A fairly recent innovation, the mini budget allows the finance minister the opportunity to address the public in a formal manner, giving an update on events since the past budget speech, and looking forward over the following three years. In essence the minister reduces the importance and impact of the annual budget speech by guiding the market mid way through the government’s financial year.

    Unsurprisingly, given the nature of the global economy, the statement began with an overview of global events, and how these dynamics have altered the world going forward. Minister Manuel mentioned that despite the ‘storm’ being fierce, South Africa was well prepared, and has been able to weather the storm to a certain extent so far, and that the storm would eventually pass.

    Following on from this overview it was logical that he should mention that economic growth expectations have been cut for 2008 from 4% to 3.7%, and that 2009 growth should come in at 3%, significantly below the 5% that we’ve been accustomed to, and arguably not high enough to create jobs.

    On the inflation front, in the future, CPI (rather than CPI-X) of between 3 – 6% will be targeted, as South Africa makes the adjustment to using ‘owners' equivalent rent’ as a proxy for the measure of the cost of housing, as opposed to the previously used interest on loan measure (that was impacted by monetary policy, and hence excluded from the current inflation target). There is the expectation that inflation will come into this range in the third quarter of 2009.

    Key priorities of the government going forward are: Providing of quality education to all (and an expansion of no fee schooling to 60% of learners), improving the provision of healthcare, and particularly reducing infant mortality and tackling TB and HIV/AIDS. Other priority areas are improving the criminal justice sector and public infrastructure (public transport, water, sanitation, housing, etc).

    Some of the adjustments in expenditures include an increase of R 2.5bn to the Road Accident Fund, R 344m to the school nutrition programme, R 1.4bn to cover FIFA World Cup cost overruns, and provision for a R 300m to assist Zimbabwe with short term food requirements should various conditions be fulfilled.

    Essentially the government has been in the fortunate position over the past few years in terms of the revenues that they have received; they are now able to increase spending to support those sections of the population that will come under pressure as the economy slows.

    Reports earlier today reported that Trevor Manuel has said that he’s been finance minister for too long now, and that he is in discussion with the ANC leadership as to his future in the party’s leadership. It will be a sad day when he leaves, but like any functioning democracy there comes a time when every leader needs to be replaced, and Mr Manuel has had an extended run in the hot seat.

    Kind regards,

    Mike Browne

    Permalink2008-10-22, 18:00:44, by Mike Email , Leave a comment

    BAT listing

    Remgro’s and Richemont’s unbundling of their indirect interest in British American Tobacco plc (BAT) will now see the shares listed on the JSE as a secondary listing. The listing will commence on 28 October under the abbreviation BATS. Remgro and Richemont held just over 30% of the issued share equity of BAT, which is a substantial company with pre tax profit of GBP3 billion in 2007.

    BAT product has many detractors and quite rightly so. We don’t agree with its tobacco products, but the fact is that it’s grown into a substantial industry. Rupert identified the addictive qualities of tobacco and held it as his core business interest. In 1999 the Rupert’s merged their Rothmans interests with BAT, which resulted in Remgro and Richemont obtaining a major 35% stake in the ordinary and convertible redeemable preference shares of BAT through R&R Holdings

    BAT was originally created in 1902 when Imperial Tobacco Company and the American Tobacco Company agreed to a joint venture company. It is now one of the major tobacco companies, with over 300 brands in 180 markets. It is currently organised across five regions, but from January 2008 this will see some reorganisation.

    90% of the combined shareholding in BAT owned by R&R Holdings will be distributed to Remgro and Richemont shareholders. The remaining 10% - or 3% of the issued share capital of BAT, will be retained by Reinet.

    Reinet Investments is the new Luxembourg based investment fund, which has also been offered to shareholders of Richemont and Remgro. It will start off with its 3% stake in BAT plus around R4 billion in cash and then look for investment opportunities.

    Today saw 5,742 billion Reinet Investments depository receipts listed on the JSE. It will receive and unbundled BAT shares. The price traded in a range from 1890c to 2053c.

    Richemont in turn fell by 1426c to R23,40.

    BAT’s listing will see it ranked in the top 5 companies by market capitalisation. At its current price and the decline in price of Anglo and Billiton, BAT will be the biggest company on the JSE.

    BAT Share price

    This is likely to change the composition of the JSE All Share index.

    Kind regards

    Ian de Lange
    021 9144 966

    With the current market volatility, perhaps you are concerned about your current impending retirement, or existing living annuity. My partner Vincent is going to be in Jhb on .30 and 31st October. He is available for one on one discussions. If you would like to set up a meeting, please mail your details as soon as possible to Vincent@seedinvestments.co.za

    Permalink2008-10-21, 19:46:16, by ian Email , Leave a comment

    Buffett and lots of government intervention

    When the world’s greatest investor, Warren Buffett says that “…most certainly, fear is now widespread, gripping even seasoned investors.”, its evidence of how difficult the investment environment has been. In an opinion piece in the New York Times, he said that he has no way of knowing if prices will be higher or lower a month or a year from now.

    He is an investor that understands that market prices start to move up long before sentiment or the economy.

    He also understands probability, which is why he is saying that while he can’t predict shorter term (i.e. up to one year) price movements, he can say, “what is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment of the economy turns up.”

    To this end, he reports that he is buying American stocks in his personal capacity and will soon be 100% in US shares.

    As with many deep value investors, he may be a little too soon, but given where prices have already come from, he is buying at a substantial discount.

    At some point, perhaps not right now, share prices will start to respond to government intervention.

    Global monetary authorities are doing all in their power to resuscitate the banking system.

    Some of the recent dates and action by the various monetary authorities are as follows:

    7 Sep: Paulson engineers takeover of Fannie and Freddie
    15 Sep: Banks set up a $70bn fund
    15 Sept Lehman files for bankruptcy – no action
    16 Sep: Fed to lend $85bn to AIG and take an 85% stake
    25 Sep: Washington Mutual seized by US – assets seized by JP Morgan
    29 Sep: B&B nationalised in UK, Glitnir nationalised in Iceland
    30 Sep: Irish government guarantees bank deposits
    3 Oct: Dutch part of Fortis nationalised
    5 Oct: Germany guarantees private deposits
    7 Oct: Iceland gets $7.6bn loan from Russia
    8 Oct: Fed, ECB and BOE make emergency interest rate cuts
    12 Oct: Australia to guarantee bank deposits for three years
    13 Oct: EU nations commit 1.3tn Euros to bank bailouts
    15 Oct: European central banks pump $250bn liquidity
    16 Oct: ECB widens collateral rules – slashes required rates
    20 Oct: ING Group gets 10 billion euro lifeline from Dutch government.

    Clearly monetary authorities around the world are working hard at propping up the banking system. There does appear to be greater commitment to the process. Longer term its debatable whether a government should step in to bail out a failing bank, but in the shorter to medium term, they are nervous of the spill over effect into the real economy.

    Smarter investment money typically moves against the herd –

    Kind regards

    Ian de Lange
    021 9144 966

    With the current market volatility, perhaps you are concerned about your current impending retirement, or existing living annuity. My partner Vincent is going to be in Jhb on 30 and 31st October. He is available for one on one discussions. If you would like to set up a meeting, please mail your details as soon as possible to Vincent@seedinvestments.co.za

    Permalink2008-10-20, 17:02:50, by ian Email , Leave a comment

    A look at regret aversion

    Human emotion always plays a large role in the investment process. When markets are as volatile as they currently are, then there is no doubt that emotions play even more of a role.

    As investment consultants, we need to be aware of these various emotional biases, and how they affect decision making. Ian has looked at some biases, and I will today look at another bias that can affect investors, and that is regret aversion.

    Regret aversion, as its name suggests, is where investors avoid taking decisive actions, as they fear that their decision will prove to be sub optimal.

    This emotional bias can affect even the most intelligent investors, and a quote attributed to Harry Markowitz goes like this:

    “I visualised my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimise my future regret, so I split my retirement plan contributions 50/50 between bonds and equities.”

    Here, the father of modern portfolio theory creates a sub optimal portfolio to minimise the regret that he’ll feel if he takes a decisive action on where to put his retirement contributions.

    Regret aversion manifests itself in one of two ways:
    • Errors of commission
    • Errors of omission

    Errors of commission occur where an investor takes misguided actions. Errors of omission, on the other hand, are where an investor fails to make a decision (to avoid making an incorrect decision) and experiences an opportunity loss through being indecisive.

    Errors of commission are typically more acutely felt, as they are more obvious than the errors of omission.

    Results of regret aversion include:
    • Investors being too conservative, to avoid making losses. This results in long term underperformance.
    • Investors shying away from investments that have significantly declined in value, as they may fall further. This is counter intuitive, as declines in prices generally offer investors a more attractive entry point (as long as company fundamentals haven’t significantly declined).
    • Holding onto losing investments too long, as they don’t want to admit that they are wrong. This is similar to loss aversion.
    • Investors exhibiting herding behaviour. They are less likely to feel regret if they aren’t the only one to make the mis-judgement.
    • Investors preferring well known companies over less well known ones. Investors often associate well known companies with being less risky than less well known firms, even if the risk return profile is in favour of the less popular company.
    • Investors holding onto winning stocks for too long, in the fear that they may miss out on further gains.

    While this is an emotional bias that is difficult to rectify, it is important to identify that the bias exists. Being aware of a weakness allows one the potential to rectify it, while keeping ones head in the sand only helps to perpetuate the bias.

    Take care,

    Mike Browne

    Permalink2008-10-16, 17:35:02, by ian Email , Leave a comment

    Retail sales and corporate outlook

    In getting a sense on the outlook for trading conditions from specific companies, I looked back across a cross section of companies that have recently reported results or trading updates. The official retail sales reflect that the Reserve Bank’s tighter monetary policy and general economic conditions are starting to have an impact.

    The update on retail sales reflects a growing negative trend.

    South Africa retail sales

    Source: Nedbank economic unit

    Bloomberg reported today that sales at US retailers dropped in September by the most in 3 years, due to mounting job losses, plunging home prices and the deepening credit crisis.

    For a cross section of companies, it is not always that apparent that sales are slowing to the extent indicated.

    AVI is a R5 billion food company with brands like I&J, Willard’s, Five Roses, Provita, Baumanns, Denny mushrooms etc.

    At the AGM today, Chairman Angus Band commented on the trading conditions, saying, “Revenue for the quarter ended September 2008 was 18% higher than the same period in the prior year. Revenue gains were supported by higher selling prices in response to rising input costs and reasonable volume gains in most categories. In general gross margins remain under pressure at current commodity

    Datatec, an IT and telecommunications company, reported 6 months results to August. Operating profit gained 12% to $54,3m, while underlying EPS were up 19% to 22,5USc. The CEO, Jens Montanana commented that despite deteriorating conditions, the group delivered strong first half performance.

    As to the outlook they acknowledge the challenging conditions, uncertain outlook and not sure how it will affect the IT and telecommunications markets around the world. They do think however that communication technologies are often leveraged in periods of slower economic growth as a means of improving productivity. Perhaps!

    Pick n Pay announced that it is finalising its August interims. Pick n Pay is closing the Score Supermarket chain and therefore on its continuing operations is expecting headline earnings per share for continuing operations to be up between 10% and 20%.

    Food companies and retailers are more defensive

    Cashbuild reported an update for the quarter to end of September. Revenue was up 29% compared to comparable 2007 quarter – existing stores contributed 25% growth in revenue. Units sold were up 31%, so there was some margin compression.

    SAB Miller provided a trading update for its 6 month period ended September. The group recorded a 3% growth in volumes with organic lager volumes marginally ahead of the prior year – up just 1% in the second quarter, off a high comparable base.

    A presentation by Liberty this week reflected the correlation of their news business flows and growth in disposable income. Their projections to 2009 reflect a negative trend from more recent peaks. Their next slide reflects a growth in total lapses. Part of their action plan is to keep costs below inflation

    Correlation between profits and share prices

    o In the long run, share prices are driven by corporate profitability. The correlation is very high.

    o At extreme times, emotions drive prices – both on the up and on the down, around the true intrinsic value. This is what we are experiencing now.

    o But, prices are very quick to price in upcoming bad news, and so while there is a high possibility that companies will be reporting slowing earnings over the next 2 years, the share prices will anticipate long in advance. A large dose of that anticipation has already occurred.

    Its difficult to say at this stage how much is just negative outlook on profits and how much is outright pessimism and panic, but we will continue to assess as the weeks and months unfold.

    Kind regards

    Ian de Lange

    Permalink2008-10-15, 17:21:11, by ian Email , Leave a comment

    Some comments on valuations

    Benjamin Graham, a professional investor, father of value investing and mentor to Warren Buffett. Graham wrote the books, Security Analysis and The Intelligent Investor. He came out with a way to look at the overall market’s price to earnings ratio – i.e. a measure of market valuation.

    Instead of only looking at the PE ratio one year forward or one year back, rather he took the current price over the last 10 years average earnings adjusted for inflation.
    Averaging earnings will naturally smooth out earnings spikes and in time of recent history when the earnings trend moved up sharply.

    To this end, it will provide a more accurate trailing valuation of the market.
    Robert Shiller, who is professor of finance at Yale University, tracks what he calls the Graham PE. After last week’s decline, the Standard and Poor 500 stock index is priced at 15 times earnings. The long run average – going back to 1881 is 16,3 times.

    But so many times in the past, markets coming from an expensive point don’t get to fair value – invariably they overshoot on the downside.

    The 1982 market bottom saw this Graham PE at 6,6 times, and the index has apparently sunk below 10 times for several long stretches since 1945. The S&P500 is currently trading just above 1000. In order for the 10 year average trailing PE to decline to 10 times, the S&P 500 would have to drop to around 600 times.

    Barrons has just interviewed, Jeremy Grantham who co founded asset manager GMO in 1977, which now manages in excess of $100 billion – a market bear for 3 years now.

    Titled, “Still Holding Back”, he was asked a number of questions, including, “Is the crisis playing out the way you thought it would?”, part of his answer on the issue of valuations was:

    “The terrible thing – after all this pain – is that the U.S. equity market is not even cheap. You would imagine that, given the amount of panic, that it would be. But it started from such a high level in 2000 that it still has not yet worked its way down to trend, although it is getting close. But the really bad news is that great bubbles in history always overcorrected. So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging.”

    Source Wall Street Journal
    Jason Zweig – who edited the revised Intelligent Investor.

    The fact is however that on a global scale, markets have already come down sharply. But, if the history in the graph above is anything to go by, down and sideways markets tend to unwind over more years than just the 8 that we have had.

    We will be watching the extent to which global governments can keep printing paper to buy out bad assets, prop up banks, and generally try and inflate about the problem. I have always said that long term this is beneficial for owners of real assets – i.e. property and cash generating businesses with low debt to equity.

    Kind regards

    Ian de Lange

    Permalink2008-10-14, 19:02:58, by ian Email , Leave a comment

    Governments step in to buy assets

    Governments have stepped in over the weekend after last weeks massive declines in global equity prices. The US Federal Reserve, ECB, The Bank of England, Swiss National Bank, Japanese Finance Minister, all vowed to provide hundreds of billions of dollars to support their countries global banking system.

    The US Treasury and Federal Reserve had felt like they were out on a limb, while the rest of the world thought that the problem was passing them by. But the weekend saw meetings in Europe of the heads of UK, Germany, France etc.

    France and Germany committed 960 billion euros to guarantee interbank loans and take stakes in banks.

    The UK took large stakes in Bank of Scotland and HBOS, effectively ceding control to the government. It will also assist Lloyds TSB.

    Naturally after the announcements of what appear to be substantial backing from all major government’s global equity markets rallied up.

    The German Dax gained over 10%, while the CAC 40 put on 11,6%.

    The Hong Kong Hang Seng index gained 10,24%.

    The US market also opened up and the S&P500 is trading up 5,6%.

    Government’s have a high degree of ability to buy into troubled, highly geared banks, provide liquidity, be outright buyers of so called toxic assets. These actions will probably not eliminate risk. As one fund managers discussed with us this morning, risk does not necessarily disappear - rather risk tends to pop up somewhere else, when squashed in one place.

    Perhaps the extent and level of commitment that governments are now showing to tackle this problem, may prove to be the bottom of the market.

    But time will tell.

    They are agreeing to commit a lot of funds to the problem, but it still pales when compared to the extent of losses already seen.

    In the 1990’s Japan tried to prop up the bad lending practices of banks, but it just served to prolong the problems.

    Locally the rand is at R9.17/USD.

    Crude is up slightly at $75,7/barrel.

    Gold fell back to $832/oz

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2008-10-13, 18:07:27, by ian Email , Leave a comment

    Debt Obligations mount

    Global markets were under massive pressure this week. Costs are mounting daily, and Bloomberg is reporting that the additional costs that the US government has to sink into Fannie Mae and Freddie Mac plus the bailout package, is ballooning the US budget deficit to an estimated $2 trillion.

    Morgan Stanley’s chief economist is estimating a $2 trillion budget deficit – and on the basis that the US economy is R16 trillion (but contracting daily), this is an enormous 12,5% of GDP. This level is apparently more than twice the previous record of 6% set in 1983 and gives an indication of the sheer size of the hole.

    Some are estimating total losses across the entire US financial system at $3 trillion. But perhaps this number may also prove to be too low.

    In many respects greed compounded on greed, especially on Wall Street, which was being force fed on a diet of cheap capital from monetary authorities, who were too scared to let the original bubbles in the late 1990’s implode.

    The consequence according to Pimco is this:

    “America in all its resplendent free market capitalistic glory is on the auction block with few bidders. How this came to be is obvious in retrospect: too much exuberant leverage, not enough regulation; too strong a belief in asset-based prosperity, too little common sense that prices could go down as well as up; excessive “me first” greed, too little concern for the burden of future generations; a political morass unworthy of our Founding Fathers. You may have more to add to the list, but frankly there isn’t enough time. Historians can sit back and reflect, but at this very moment, America is for sale and there is fear and trembling in the auctioneer’s voice.”

    Now that the house of cards has fallen in on itself, governments find that they have no real option but to step up to the plate and do what is necessary. Their involvement is accelerating.

    What does this mean?

    Well for one, this could mean the start of the end of the US Federal Reserve, a private institution, established in 1913. Despite its size, it does not have the capacity. It may not be a bad thing, given the doubtful integrity of its origins.

    Government assumption of assets and debt obligations will rise as it is forced to take on more of the private sector. And here lies the current conundrum. The yield on the US 10 year Treasury has been declining to a multi decade low level of 3,4%.

    This is the yield accepted by lenders to the US government. Naturally where the US government requires more capital, on top of an already shaky balance sheet, lenders will want adequate compensation.

    So while it’s surprising that yields got as low as 3,4%, this may be explained by the recent flight of capital out of risky assets.

    Chart: US 10 year Treasury yield

    In the years ahead, it’s highly unlikely that lenders will be prepared to accept a 3,5% yield. As Pimco’s Bill Gross concludes, inflation and longer dated bond yields are likely to rise.

    Note the multi decade decline in this yield from its peak in 1981. The trend going forward is likely to be up.

    I have time available from 10:00am for 2 meetings in Durban on the 16th October. Please mail me if you would like to discuss your investment planning.

    Kind regards

    Ian de Lange
    021 9144 866

    Permalink2008-10-10, 18:06:57, by ian Email , Leave a comment

    The endowment effect

    Earlier this week I discussed, the investment behaviour bias known as the availability bias. Another bias that investors bring to their decision making is what has been termed the endowment bias. This is the theory that people place a higher value on an asset once their right to that asset has been established.

    In other words people, and more specifically, investors, place a higher value on an investment that they own relative to that same investment if they did not own it.

    The term “endowment effect” was coined by Richard Thaler, now at the Graduate School of Business at the University of Chicago

    An owner implicitly or explicitly demands a premium for an owned asset.

    For instance, in one well-known series of endowment effect experiments, researchers, Kahneman, Knetsch and Thaler (1990) found that randomly assigned owners of a mug required significantly more money to part with their possession (around $7) than randomly assigned buyers were willing to pay to acquire it (around $3).

    In a follow-up, there was a 3rd group known as Choosers. Choosers were not endowed with a mug. Instead at each of the prices that buyers and sellers considered, the Chooser was given the choice between receiving that amount of money or the mug.

    Choosers behaved MUCH closer to buyers than to sellers. This suggests that the endowment effect does not stem from buyers, but from sellers over-valuing the goods once they own it.

    This bias is also referred to as the status quo bias.

    This bias is very evident in an owner of a business, looking to sell. Having built up emotional attachment to the business, and when it comes to selling, a business owner invariably has a higher notion of the value than the potential buyers.

    But in the cup test it’s evident that this bias goes even beyond the emotional attachment – its instantaneous and even apparently felt by those who buy and sell for a living.

    The bias is inconsistent with standard economic theory which says that a person’s willingness to pay for an asset should be equal to their willingness to accept compensation for that same asset.

    The effect of this bias is seen in an investor’s approach to shares that have been inherited, received by way of share options or merely acquired at various prices. Even after taking into account the impact of switching costs and taxes etc, there is this natural bias to retain an asset in a portfolio.

    You may have practical examples of this type of bias in your own investment management.


    Ian de Lange
    021 9144 966

    Permalink2008-10-09, 18:06:18, by ian Email , Leave a comment

    World Influence on South Africa

    I’m sure that the phenomenon where investors believe that their markets are driven primarily by local events is prevalent throughout world. While this is the case most of the time in large developed markets, it is rarely the case in smaller emerging markets. South Africa is no exception.

    As the world economy has become more integrated we have seen that correlations between global equity markets have increased, particularly among countries that have similar characteristics. As an emerging market, we are particularly affected by flows into and out of other emerging markets. At the same time we have a resource heavy market, which ensures that we have a similar profile to other resource heavy markets.

    An illustration of this point is shown in the graph below where I have compared the returns of three indices (all in USD) from 31 December 2002 until 7 October 2008. They are the MSCI Emerging Markets, MSCI South Africa, and MSCI Australia. As you can see the general direction and movements of the indices is common. Australia has been used as a proxy for a country with a heavy resource weighting.

    Sure there are country specific risks, but unless there is a drastic departure from the status quo, the major influence to smaller stock markets will be global trends.

    As investment consultants we need to understand these dynamics and correlations to ensure that our clients’ portfolios are structured optimally. If you invest into broad market portfolios that have similar characteristics as our market, then your portfolio won’t be diversified. There can be specific opportunities in these markets that aren’t represented locally which should be pursued, but merely purchasing an emerging market tracker fund isn’t going to ensure that your portfolio is adequately diversified.

    The fact that we have a new president has barely caused a blip on market movements, rather the fact that those institutions which invested into South Africa (and other emerging markets) need to lower the risk of their portfolios, and increase their liquidity. The easiest way to do this is by selling their stock holdings in emerging markets (South Africa included).

    On the local front today, investors with large offshore cash holdings will be the most happy as the rand fell between 3 and 4% to other major currencies. The ALSI opened around 4.5% lower than yesterday’s close, and then trudged along until 1pm when 6 central bankers (lead by the US Federal Reserve) announced that they would all be cutting interest rates by 0.5% in order to stimulate global economies, which had the effect of pushing the market up 3.13% in 7 minutes! The market trended up, and at one stage was up 1.07% for the day, before it fell back, and ended the day down 2.81% at 20 954, it’s lowest close since 15 August 2006!

    Take care,

    Mike Browne

    Permalink2008-10-08, 18:02:12, by Mike Email , Leave a comment

    Availability bias

    All investors approach markets with certain biases. A complete study known as behavioural finance has developed, which is essentially the application of psychology to finance. Investors will do well to understand some of these cognitive biases that can result in sub optimal performance.

    One such bias is known as Availability bias

    This is a mental shortcut that allows people to estimate the probability of an outcome based on how prevalent or familiar that outcome appears in their lives.

    Many times investors inadvertently assume that readily available investment ideas represent unbiased indicators of statistical probabilities.

    This can occur across a few categories, i.e.:

    o Retrievability

    Ideas that are retrieved most easily also seem to be the most credible

    o Categorization

    People attempt to categorize or summon information that matches a certain reference.

    o Narrow range of experience

    This occurs when a person possesses a too restrictive frame of reference

    o Resonance

    This occurs when certain situations resonate with an individual, which in turn can and does influence their judgement.

    A good example of Availability bias to investing was portrayed in a working paper in 2002 by Odean, and Barber entitled, “All that Glitters: The Effect of Attention and News on the Buying Behaviour of Individuals and Institutional Investors”

    They ask a question. “How do individual investors choose the stocks that they buy?”

    Because the task at hand is huge, with over 7000 US shares to choose from, they proposed that individual investors were more likely to be buyers of attention grabbing stocks than institutional investors. They looked at 3 indications of how likely stocks are to catch investors attention. i.e. through large trading volumes, large market movements and daily news.

    You can think for yourself. So often the same shares pop up on lists of daily large volumes or always seem to be in the news.

    By studying stockbroker accounts across 4 categories of investor and found their findings confirmed their hypothesis. They also found that investors who have a bias to available information don’t typically benefit from it.

    Information that is routinely and readily available is typically, but not always, avoided by the professional investor, who has processes to rank through the full universe of investment options.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2008-10-07, 19:42:59, by ian Email , Leave a comment

    Panic selling

    There is no doubt that at times like today, portfolio diversification is essential. Market participants have been panic sellers. Today the rand fell massively as waves of selling hit both equities and the currency – presumably mostly foreign.

    Markets have seen panic selling in the past – yes there are always very good reasons at the time, but at the extreme, its largely psychological or investor behaviour that drives price down.

    When investors sell Anglos down 11,3%, Northam down 21%, Arcelor Mittal down a massive 26%, Sasol down 9,5% and Metorex down 24% in one day, there is no consideration to the profitability outlook of these companies by the owners.

    Its simply weak shareholders very quickly morphing into panicky sellers. With no buyers around, the weak sellers have no option but to accept much lower prices.

    The sellers scream to the stockbrokers – Get me out at any price!!!. I need the cash now back in my bank account. I don’t care what price I get.”

    Selling leads to more panic selling.

    The general concern has led to fear, the fear to panic and rather soon despair is going to set in. Invariably this marks the bottom of the market.

    The rand weakened to almost R9/USD. Now at R8,85. At the beginning of the year it was R7. The last time, the rand was at this level was back in 2002.

    So how should long term investors assess the current market

    We may not have seen the bottom of this market, and it may be a few years yet before things look “normal” again, but a long term investor in a business will look for cash flow generation – both now and into the future.

    Some investors look at buying a company now that will in say 3- 5 years provide a 10% dividend income on the original capital invested.

    They therefore seek out companies at prices that have a high probability of providing this level of income stream,

    It may be a simplistic way to approach investing, but its an approach used by a successful investment manager, and in my view contains 2 important elements.

    o A focus on the current valuation when buying, which is critical for long term superior performance.
    o A focus on the income generated from an investment.

    A company priced on a 1,5% dividend yield, requires a 46% per annum increase in its dividend per annum over 5 years to reach 10%. It appears expensive and the probability of receiving a 10% yield in 5 years time is very low.

    However a company priced on a 5,5% dividend yield only requires a 12,7% per annum increase over 5 years for the dividend yield to run at 10% of original cost. A far better prospect.

    An investor receiving 10% tax free yield on his initial outlay 5 years ago, is far less concerned about daily and monthly price volatility

    At some point in time, excellent value plus a shakeout of most of the weaker sellers will provide an underpin to prices. But we are not quite there yet.


    Ian de Lange
    021 9144 966

    Permalink2008-10-06, 18:15:37, by ian Email , Leave a comment

    Offering lower prices for assets

    Even with the high volatility, investors have a wide choice as to where to allocate their capital. The likely return generated is less a function of the asset class itself, but rather more a function of the price paid relative to the value at the time of purchase.

    Let’s consider 2 well known assets

    You may hear the maxim, location, location, location. But when buying a property, what will an astute investor really focus on.

    Yes he will look at the location, but more importantly he will assess:.
    o Quality of the tenants in place – large companies preferable to small.
    o The type of lease in place – longer leases better than 12 months leases.
    o The escalations – Percentage increases or upward only.
    o That current lease rentals are not above the norm for the area.
    o Perhaps he will also look for a catalyst such as additional bulk that he can add to the property upon purchase.

    Then he will discount the future expected rental income at an appropriate discount rate, and arrive at a reasonable value for the property. The higher the discount rate, the lower the value.

    He will make offers at or preferably deep below his assessment of the value.

    In times of market euphoria, there will be few sellers that will want to sell to him, but when times toughen, weak sellers will be enthusiastic sellers.

    A private business
    A businessmen looking to buy private businesses will go through a similar exercise.

    He will assess management, quality of income, growth trends of the income, balance sheet structure of the business etc and ability of the company to generate free cash flow and still grow its business.

    Then he will run all the data through a discount model, taking into account the value of the assets that already exist on the balance sheet, to determine a reasonable value.

    Where there are few other potential buyers, he will have the luxury of making an offer below his assessed far and reasonable value.

    The profit in both instances is made when the asset, be it a property or a business is purchased.

    Private deals by their very nature mean fewer potential buyers. This in turn plays to the buyer’s advantage in securing the best price for the asset.

    Turning to listed businesses

    Exactly the same, except for one crucial point – more potential buyers for the same assets. Even where the investor wants to pitch his price to the seller at a 20% discount, he’s never going to conclude a deal. There are too many competing buyers for the same asset.

    This is the main reason that for the most part a listed business trades at a premium to an unlisted business.

    The better time to buy is when competing bidders for the same asset dry up and sellers get more desperate. In other words it’s preferable for an investor of a listed business for prices to come back to where he would like to pitch his price.

    This is achieved at both a market level, at a sector level, and also on a company by company level. Its contrarian in nature.

    To this end, panic situations start to look attractive entry levels.

    Seed is an advisor to investors with living annuities, preservation funds or discretionary funds.

    Have a great weekend


    Ian de Lange
    021 9144 966

    Permalink2008-10-03, 18:07:19, by ian Email , Leave a comment

    Investment decisions in times of uncertainty

    When local and global markets feel like the equivalent of being in war torn Iraq on a bad day, then it’s the type of environment in which it is extremely difficult to make quality investment decisions. Difficult but not impossible. Difficult, but in many cases still necessary.

    So many people struggle to make definitive quality decisions.

    At the best of times they do many things to avoid having to make decisions. In times like we are having, there is a perfect excuse. And I understand – this is not an easy environment.

    Those in some form of transition stage, e.g. moving from one employer to another to possibly resigning now or soon, will need to make some decisions regarding their investments.

    Global turmoil won’t pause while decisions need to be made.

    The deluge of information makes decision making difficult. The extent to which that information is negative, means making a quality decision even less probable.

    Douglas North, a 1993 Nobel-laureate in economics, teaches a concept called “asymmetric information.” It basically says that there are still two streams of information: good and bad. He also says that a person’s success is still primarily determined by getting in the right stream.

    And this is hopefully what we have consistently tried to do. Not professing to always be right, but to try and look through the noise that serves no real purpose.

    On a regular basis I receive mails from individuals that go something like this, “I am x years old, have accumulated RX million, but now I don't know what to do. The current market environment makes me nervous and so I think I will sit it out in cash.”

    Or alternatively comments like, “I am extremely nervous. I can’t sleep at night worrying, and so think I should sell everything and move it into cash, until the outlook gets a bit clearer.”

    The argument goes that at some point in time, the rain will stop, the clouds will clear, the sun will come out and it will be a far easier environment in which to make a decision. That may be the case in a small part, but there is ALWAYS future uncertainty.

    I always say that the important thing to do is to take a step back and assess. The fundamental value question is what cash flow is the asset that I own generating, what multiple of this cash flow am I now paying and is this reasonable in the longer term scheme of things.

    For those retiring now with cash on hand, you have a fantastic opportunity. If you are requiring assistance with retirement planning, don’t hesitate to contact me.

    I am in Durban on the 16th October meeting with potential clients. Contact me if you would like to set up a meeting.



    Permalink2008-10-02, 17:50:24, by ian Email , Leave a comment

    Lonmin gets (partially) deserted by Xstrata

    Resource companies (especially platinum counters) have experienced extremely favourable conditions for the last several years, but they have struggled since mid May of this year as the price of various commodities peaked, and started to fall.

    One such consequence of both the fall in commodity prices, and the global credit crunch is that Xstrata abandoned their bid for platinum giant Lonmin. Lonmin is South African based company, with its primary listing in the UK on the FTSE, and a secondary listing on the JSE.

    In August, Xstrata announced their hostile GBP 33 per share offer for Lonmin, and the share price immediately jumped up over GBP 34 (from GBP 23.19). Lonmin rejected the deal saying that it undervalued the company, with investors clearly speculating that Xstrata would raise its bid. This is where the share price traded for most of August, until the possibility of the offer not going through started to work through the market and the share price fell back to GPB 22.74 at close yesterday.

    Xstrata came out at the end of yesterday, saying that in the current climate it would struggle to raise the required finance (estimated at around GBP 8bn) on acceptable terms to complete the purchase of Lonmin.

    After Xstrata’s announcement, Lonmin came out to say that they believe that much of the decline in platinum price can be attributed to forced sellers of platinum investors (read speculators), and negative global economic sentiment. This is true, and the fact that platinum is a traded commodity (as opposed to for instance steel whose price is set once a year) means that speculators can get involved, which results in the metal price being much more volatile. Despite the decline in platinum price they remain well positioned with long-life and high quality assets as well as being the lowest cost producer in the Bushveld.

    As with most M&A (merger and acquisition) activity the target company is usually the one to benefit from the buyout, and the purchaser is the one that struggles. It was no different in this case, and the decision by Xstrata to pull out of the transaction resulted in its shares falling 1.9% after spending most of the day in the green (remember they would typically have struggled with the acquisition, and so no deal is good for their shareholders), while Lonmin fell 20.3% at my last check in London trade!

    Since the announcement, Xstrata has in fact upped its stake in Lonmin to 25% of the company, which in all likelihood means that they aren’t going to be walking away from a takeover just yet.

    Enjoy the rest of your week.

    Kind regards,
    Mike Browne

    Permalink2008-10-01, 17:54:31, by Mike Email , Leave a comment