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    Long run performance numbers

    On an annual basis JP Morgan produces a report on the performance comparison of various local asset classes. They asses the total performance across various time periods of equities, property unit trusts, home repayments, bonds and fixed deposits.

    For most of the asset classes the data goes back to 1960 – hence a period of 49 years.

    It’s a useful exercise to assess the history and variability of returns across various asset classes in an attempt to assess probabilities of returns going forward.

    It’s useful to understand history in order to plan an appropriate asset mix.

    As investors know, equities fell in 2008 for the first time since declining 11,2% in 2002. One needs to go back as far as 1970 to see a similar percentage decline in one calendar year.

    However on a 5 year basis and for longer periods, equities have outperformed other asset classes, especially after tax.

    On a pre tax basis bonds outperformed equities over the last 15 years. This comes from a period when equities were expensive and bond yields high and starting to fall with the decline in inflation.

    The chart below indicates the performance over various time periods of the 3 main asset classes when compared to inflation.

    Naturally assessing returns over longer periods smoothes out the shorter term volatility. An investment into equities is far more volatile than cash, but it is interesting to note the relatively high volatility of bonds.

    Because of the high volatility equities should not be used as a short term investment medium.

    This leads on to another interesting measure, which is the long term wealth effect. While 49 years is a lifetime, it is important to remember that an investor aged 60 has an investment horizon of 30 years.

    JP Morgan calculates that a basket of consumer goods in 1960 costing R1000 would cost R55 370 at the end of 2008.

    An investment in:

    • Fixed deposit would have yielded R94 920
    • Government bonds, R108 500
    • Equities, R1 973 590.

    While the compounded wealth in the bank or bonds would have hardly kept ahead of inflation, capital invested into equities produced a far superior result.

    So the higher variability of returns of an investment into equities has in the past paid off with investors having received a far greater reward.

    It also highlights the importance of the cumulative returns and not the 1 month, quarter or annual returns on long term wealth preservation against the biggest negative factor, i.e. inflation.

    Please don’t hesitate to contact us, if you would like to discuss your asset allocation and investment planning in an environment that is starting to produce opportunities.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-30, 17:04:42, by ian Email , Leave a comment

    Inflation Remains Sticky

    Tito Mboweni’s announcement earlier in the year to increase the frequency of MPC meetings has resulted in today’s release of inflation data being more keenly anticipated than it would have been otherwise. With the MPC meeting today and tomorrow, today’s inflation numbers will be used by the committee to help determine what their decision will be in terms of possible changes in the repo rate.

    However, while inflation used to be a key determinant in the MPC’s decision making framework, it has been somewhat cast aside, as growth (or lack thereof) becomes the key focus.

    Inflation for the 12 months ended March 2009 came in at 8.5%, slightly under last month’s 8.6%, but just above consensus of 8.4%. We have now had two consecutive months where inflation has been higher than consensus, and two months where inflation hasn’t dropped significantly. When economies slow down it is typical for inflation to drop as consumption decreases. We have not seen this occur. Taking a closer look at the inflation numbers, and being cognisant of local current affairs it becomes apparent that there are a couple ‘sticky’ areas in the economy, areas where inflation isn’t falling as it should.

    Year on year changes to food and beverage, home maintenance, and electricity, among other items that have a large component of ‘administered prices’ have been driving inflation. We have all heard in the past couple weeks of the Satawu strike in the transport industry, and the demands of NUM for a 15% pay increase for employees in the gold and coal sectors. Their demands may or may not be fair and realistic, but in economic terms if these sectors aren’t improving productivity significantly to account for above inflation wage demands, then they will be contributing to higher levels of inflation.

    Inflation expectations (which are inextricably linked to recent inflation levels) are what drive wage demands, and previous high inflation levels have stoked expectations. It will be extremely difficult to convince union leaders that below inflation wage increases are the way to go!

    Another area which has seen an above average inflation increase over the past year is the public transport sector, which saw prices increase by 13.8%. This even as petrol decreased nearly 15% over the same period. Clearly wage increases and other factors influenced this price change.

    Despite inflation remaining some distance above the 6% targeted maximum level, we expect the MPC to drop the repo rate by another 1% tomorrow. The economy is contracting, and the need to provide a stimulus to help it grow. Dropping the repo rate to 8.5% will result in a situation where we are nearly sitting with negative real rates. This phenomenon hasn’t been experienced in South Africa for at least the last decade.

    Potential situation assuming a 1% drop in the repo rate:

    Negative real rates bring on an increased incentive to invest and take risks as the cost of borrowing drops below the level of price appreciation. Theoretically speaking therefore borrowing at the depressed levels and investing in goods that appreciate at the rate of inflation will give you a positive real return. Obviously this isn’t as straight forward in reality, but negative real rates do encourage an increase in risk appetite.

    An increased appetite for risk is something that Mr Mboweni will be aiming for, so don’t be surprised to see a drop in interest rates tomorrow (Thursday 30 April).

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-04-29, 18:20:09, by Mike Email , Leave a comment

    Mixed company trading updates

    While markets were hit by the news on the ongoing swine virus scare, US markets opened up in positive territory on reports about growing consumer confidence. Locally we saw a few companies come out with trading updates. As usual these were mixed and it’s always interesting to follow these and get a sense how companies are finding the current environment.

    Liberty International was hit on the confirmation of the much speculated rights offer. Like all UK property companies, it has been hit exceptionally hard as property prices have declined substantially. In the announcements today Liberty said that the IPD index, which is a measure of the price of physical property, fell 35,6% in the 18 months to December 2008 and a further 8,9% in the 3 months to March 2009.

    In addition to financial turbulence, other factors cited included: difficult conditions for achieving property disposals, obtaining finance, an increased level of tenant defaults and a greater reluctance by tenants to make decisions on new lettings.

    As at March Liberty International’s properties were valued at GBP6,4 billion a decrease of GBP0,6 billion since the beginning of the year alone. Against this asset value it has debt of GBP4 billion.

    The company is looking at a number of steps, including the raising of GBP500-600 million by means of a placing of new shares. The Gordon Family, which controls 21,7% of the ordinary shares will dilute down. They will be taking up a total of GBP40 million.

    Given the gearing, the decline of some over 40% in property prices has an enhanced effect on the value of shareholders equity. This accounts for the decline in price from R195 to around R50. It fell by 10% today to R52 by late afternoon. This is back at levels seen in June 2000.

    Cape based asset manager, Cadiz issued a trading update for its financial year to March 2009. Diluted headline EPS are expected to drop 23% to 33%. But it does say that it has reported a significantly improved second half. This is mainly due to its decision to repatriate its foreign currency investment in October 2008. The price gained 0,5% to 186c.

    Spar issued a trading update for its 6 months to March, saying that headline EPS should be up between 20% and 22%. The shares fell 1,8% to R54.

    Cashbuild reported its 3rd quarter operational results, saying that revenue was up 29% with existing store contributing 19% and new stores 10%. Shares were flat at R66.

    Paracon Holdings announced that its interim to March should reflect headline EPS down between 15% and 25% over the previous period. The price fell back 5c to 115c

    Reports in the US indicated that the annual decline in home prices slowed in February for the first time since 2007. While still negative, the S&P/Case-Schiller index declined 18,6% year on year compared to a record of 19% in the previous month.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-28, 17:04:43, by ian Email , Leave a comment

    China announces gold purchases

    The Financial Times reported that China announced today that they have been acquiring gold, adding to their reserves and now own over 1000 tons. This acted to lift bullion back up above the $900/oz level. It’s currently trading at $907/oz.

    For many years now most central banks have been net sellers of gold, preferring to hold US dollars instead.

    However most central banks have dramatically reduced their gold sales under the current central bank gold agreement which expires in September. According to the World Gold Council, the only major seller has been France which has sold 64 tonnes. Russia is a buyer, having acquired 51 tonnes in the last 6 months.

    China’s purchases over the last few years takes them from owning 600 tons in 2003 to 1054 tons according to Xiaolian, head of state administration of Foreign Exchange. It therefore becomes the world’s 5th biggest holder.

    Reports have been speculating about the possibility of China acquiring the 403,3 tonnes that the IMF can and has announced that it will sell. However the IMF still needs to go through a process of approvals first and this sale may not occur.

    With China’s total value of its gold holdings at only $31 billion, this is still very small relative to their total foreign exchange reserves of some $1,95 trillion. The bulk of this is held in US government debt and China has been concerned about the extent to which the US is printing and the possible effect on their bond exposure.

    The biggest demand in 2008 and into the first quarter of 2009 was from identifiable investment. This into investment vehicles such as gold exchange traded funds. In the March quarter investors acquired 469 tonnes of gold dwarfing the previous record of 145 tonnes in 3rd quarter 2008.

    This chart from the World Gold Council reflects central bank sales under the 2nd central bank gold agreement.

    Source : World Gold Council

    The World Gold Council has reported a substantial increase in investor interest, driven by renewed search for effective portfolio diversifiers and growing concerns over the outlook for price stability.

    While gold is volatile over the shorter term, the medium to longer term supply and demand fundamentals continue to be attractive.

    Have a wonderful long weekend

    Kind regards

    Ian de Lange
    021 9144966

    Permalink2009-04-24, 16:57:01, by ian Email , Leave a comment

    Politics Effect on the Markets

    This topic is something that most people wonder about, especially in times of political uncertainty and during elections. In the broadest sense, and over the extremely long term, policy and the effective implementation of policy will no doubt have an extremely material and profound influence on the strength/weakness of a country’s stock markets.

    At the very least there needs to be basic market rights in order for a market to operate. From here further other institutions will either serve to assist in the functioning of markets, or detract from them. Democratic, capitalism focussed economies have historically been then ones that have shown the best performance over time but because of the general lack of regulation over time, can be prone to exponential growth and (as we have been witnessing) severe contractions.

    As we move into the shorter term, we see the effects of politics becoming more muted. This phenomenon should not be surprising, as it generally is the case with every factor affecting the markets. Short term fluctuations in sentiment may result in generating the news flows for the day, but the longer term ‘big picture’ items are the ones that shape the way that the events are recorded in history.

    Typically the reason that we don’t see daily announcements making too much of an impact on that day’s market performance is that there will generally be an element of expectation that the event will happen already priced into the market. We find that when announcements or events are totally unexpected there can be large movements.

    Two international examples to illustrate this point would be the disaster of 9/11, and the election of Barrack Obama as president of the USA at the end of last year. The planes crashing into the Twin Towers was completely unexpected, and as such had a massive direct effect on stock markets around the world. The election of Barrack Obama, while maybe not priced into the markets when he was an underdog competing with Hillary Clinton to be the Democratic representative, would gradually have been priced into the market as the chances of him winning the election grew stronger and stronger. Being priced into the market essentially means that investors were placing greater emphasis on how Obama’s policies would affect the economy, various sectors, and each company in turn, and also how effective he would be in getting his policies implemented.

    Locally we saw that when NPA decided to drop charges against Jacob Zuma there wasn’t much impact on the market, as many investors would already have priced this outcome into their analysis. While the market did fall for the day, it wasn’t materially different to other global markets.

    Even more recently we see healthy markets today, and a stronger rand. The market strength can be attributed to world market performance over the past 2 days (we were closed for the day of voting), and the strength in the rand (currently sitting at 8.92) is probably an indication that the global community were impressed with witnessing what have so far been peaceful, well supported elections.

    I hope you had a good voting experience yesterday.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-04-23, 15:37:07, by Mike Email , Leave a comment

    Shares are long duration assets

    Value investors around the world are getting excited as prices decline. The type of investors that does not buy shares with the hope that they will be up in price next week, but rather looks to buy into quality companies at very attractive prices, is getting excited at these current cheaper valuations.

    But the same volatility that is attractive to value managers is that element that scares most other investors.

    The long term chart of the JSE All Share index from 1985 gives an indication that while the trajectory of prices is up, there is substantial price volatility.

    Portfolio construction will sometimes attempt to alleviate this volatility by combining other asset classes that have a lower volatility with a lower expected return. A balanced fund for example could include property, bonds and cash. The inclusion of assets other than listed shares will dampen both volatility and long run expected returns.

    But don’t make the mistake of measuring the performance of a balanced fund to that of an equity fund over a discrete period of time, especially over a period of time when equity prices fell back, and incorrectly conclude that a balanced fund will always deliver superior performance.

    It is exactly because the shares of a listed company are volatile that an investor expects to receive a premium in return over bonds, property and cash.

    The volatility comes about because a share price is the represent value of future cash flows. Because a share does not have a maturity date and dividends typically grow over time, the duration of shares is very long. The longer the duration of an asset the higher the volatility.

    The only way to increase the probability of receiving the share premium return is to buy assets when they are as cheap as possible. We know that they are far cheaper than 12 months back, but they may not be the cheapest they will get.

    For investors looking to increase exposure to cheaper assets, a common practical method is to phase funds in.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-21, 17:40:43, by ian Email , Leave a comment

    Central bank intervention adds to currency volatility

    Global equity prices fell back again, reaffirming that prices are still in a broad sideways pattern. With global companies, economy’s and countries under pressure, central bank authorities are still on the path of easing interest rates and trying to increase the general stock of money.

    A Standard Bank fixed income report announced that in addition to the UK, the US and Switzerland, now Canada and Sweden may also soon look at quantitative easing – a euphemism for the printing of money.

    Source: Ecowin and Standard Bank

    The graph reflects the percentage change in US monetary supply versus that of Canada.

    As soon as central bank rates go as low as 0,5% there is very little point in going to zero.

    The ECB is likely to drop their interest rates by a further 0,25% to 1% in early May. Rates are also at historic lows

    Quantitative easing is simply designed to increase the stock of money and as the Standard Bank report indicates, “We see this policy as a deliberate attempt to devalue local currencies against local goods and services.”

    It will also ensure devaluation against other things like foreign currency.

    Bond managers, Pimco said this about the possible quantitative easing (QE), “The basic rationale behind a QE program is an acknowledgement that Milton Friedman was right when he said “inflation is always and everywhere a monetary phenomenon,” and that in order to generate inflation, all a central bank has to do is print money.”

    As central bankers have escalated their intervention in the currency markets, it is exceptionally difficult to anticipate short term currency movements.

    Thus far monetary easing by governments around the world has not had a perceived impact on asset prices. They want to avoid the scenario in Japan, which really only embarked on printing of money in 2001, some 11 years after the start of the downturn.

    The jury is still out.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-20, 17:26:08, by ian Email , Leave a comment

    The JSE has seen some strong moves up

    While the local equity market remains in a bear trend, technical analysts are looking for possible continuing upside. With very little consensus as to the direction of the markets, it is highly probable that various indices give so called false breakouts. For longer term investors with capital to invest and looking to accumulate values are attractive.

    The industrial index is up 17% from its 9 March low.

    JSE Industrial 25 index

    The financial index is up by some 30% from its low on the 9 March. This major percentage bounce up give a clear indication of the volatility in prices.

    A few examples of shares that have seen big moves up from recent lows include:

    o Standard Bank made a low of R60 and is up at R86 – up 43% from its low.

    o Implats closed at 11859 at the end of February – it is up 37% to its current R163.

    o The JSE stock closed at R28 at the end of February. It is up 31% to R50.

    These are extremely high gains in a short period of time. There are some indications that the down trend is being broken, but at this stage we still think that this is going to be a sideways trading market. This is fantastic for longer term accumulators of real assets

    Have a fantastic weekend

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-17, 17:26:29, by ian Email , Leave a comment

    US foreign capital flows

    With the US government requiring substantial amounts to meet its fiscal deficit and knowing that they have somewhat distorted bond market dynamics by being both a buyer and an issuer of bonds, a useful report is their monthly TIC – Treasury International Capital report,

    The TIC report gives an indication of the net flows in and out of the US – The Wall Street Journal says that, “Financial market analysts consider the monthly data from the Treasury Department to be a significant but imprecise gauge of how easily the U.S. can finance its trade deficit. “

    The numbers do come out late - just yesterday the data for February was released.

    The end of 2008 saw substantial inflows into the US – in the period September to November foreigners bought $320 billion of US Treasury bills.

    This slowed dramatically in January. The most comprehensive category is the TIC flows, which includes bond, equities, short term securities, agency debt and changes in banks dollar holdings. For the month of January it came in at negative $146 billion – see chart below, which reflects data to January

    There was some expectation of an improvement, but the overall net flows again declined in February by $97 billion.

    This is a huge reversal from 2007 and 2008 where for the full year the TIC report reflected a net inflow of $617billion and $611 billion respectively.

    Of the total issued treasury securities, China is the largest foreign holder. In February they owned $744 billion followed by Japan with $662 billion.

    This trend gives an indication as to why US treasury bonds performed last year, but also why fundamentally we think that they are weak, given the lackluster demand from foreigners.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-16, 17:45:21, by ian Email , Leave a comment

    Managing Return Expectations

    Managing expectations is an important part of investment management.

    The above statement is a simple one, and one can be forgiven for assuming that it is an easy concept to follow. It is human nature to continuously push the boundaries of possibility, and this can be manifested in the investment world through the pursuit of improving returns while lowering the level of risk.

    In this regard most investors, no matter how experienced, will desire to improve their returns, and it is this desire that will sometimes lead to the confusion of what is desired, and what should be expected. Where the difference between the desired return and the realistically expected return is large, and where the desire far outweighs the rational expectations, we find ourselves set up for disappointment.

    One is able to extrapolate from history that over the long term one can expect different return profiles from different asset allocations. These return profiles also come with their own risk profiles that one needs to be cognisant of. Key here is that these expectations are based on long term data. With markets going through both good and bad periods there will be shorter periods (perhaps extending to the medium term) where returns will be both above and below what is expected.

    In periods when above average returns are achieved, one must be careful not to extrapolate these special returns into the future. This will result in your expectations not matching the reality.

    On managing expectations between relative and absolute returns it is important to separate the component returns.

    On a portfolio level one should be looking at absolute returns, i.e. returns that are benchmarked to inflation / cash. This type of benchmark is desirable as ultimately your long term investment goals should be geared towards a real return benchmark.

    Each of the component asset class returns should be compared to relative indicators, i.e. returns that are benchmarked to indices / peers. An equity manager, for instance, can’t be expected to give positive returns when the market is down 30%.

    The asset manager should then be responsible with making the asset allocation call between the various asset classes, overweighting cheap assets, and underweighting expensive assets.

    A manager who is able to generally select investments that beat their peers, and asset classes that are cheap will be able to, over time, achieve the desired long term absolute and relative return targets. Key again is the long term time period, as any investment thesis needs time to reach its maturity.

    Enjoy the rest of your short week.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-04-15, 17:35:16, by Mike Email , Leave a comment

    Conflicting views have resulted in a sideways market

    On an ongoing basis there is a debate as to whether the markets have made the bottom or whether there is a lot more to come. For the time being however the local market is trading in a largely sideways pattern and has been doing so now for some months. It’s only natural for investors to be confused because extremely successful investors have totally contrary views.

    Negative global equity view

    Successful investor and one time partner to George Soros, Jim Rogers was again espousing his views on Bloomberg.

    Rogers has been correctly bearish on equities for some time. He still says that while he is not sure whether this will be as bad as the 1930s, markets have not yet made a bottom.

    He thinks that no matter what happens to the world economy he will be benefit by owning commodities and specifically agricultural commodities.

    Positive global equity view

    On the other hand Ken Fisher, extremely successful US based money managers and ranked on the Forbes list of 500 richest Americans has a contrary view.

    In his latest commentary he says this, “Why aren't people buying stocks when stocks are cheap? Investors refuse to think a few years out to the resurgence of the economy because they're busy staring at their feet. Look up and out. This huge bear market has presented huge opportunities. Beyond simple cheapness, we're on the cusp of the biggest global monetary and fiscal stimulus relative to the world's GDP in history. There is a wall of money coming. And then a boom!”

    He goes on to say that there are problems, but there have always been problems.

    He cites 5 shares that he believes are trading at very good value such as Magna International that is trading on 5 times 2010 earnings and 2 times cash flow.

    Also Marathon Oil trading at 7 times 2009 earnings and 3 times cash flow. It’s on a 3,6% dividend yield.

    It’s the vastly conflicting views that quite frankly are making for the up and down market that we are seeing at the moment.

    These markets require patience and some element of varying asset allocations.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-14, 17:43:42, by ian Email , Leave a comment

    Is the poor economic data already factored into asset prices?

    The economic numbers coming out from South Africa and the rest of the world are quite dismal. Yesterday manufacturing numbers were released for February which reflected a very bleak picture. All economic charts paint a very weak picture, but we always need to remember that these are mostly rear looking.

    Johan Rossouw from Vunani concludes, “The manufacturing industry is in deep trouble and there can be little doubt that by the end of the first quarter of 2009 the South African economy will find itself solidly in recession.”

    Nedbank economists say that “the latest manufacturing numbers reflect a very weak picture for the second largest sector of the economy.”

    Both these economists along with others continue to expect a further 1% drop in official interest rates in April.

    Source: Vunani Securities

    South African production numbers mirror global industrial production, which has also fallen off a cliff from the 4th quarter of 2008.

    Source : Wachovia

    The main catalyst was the demise of Lehman Brothers on 15th September 2008, after which credit markets froze and producers clamped down. Its now almost 6 months after this event.

    Ever since the IMF started calculating global GDP series in 1970, global growth has not been negative. Wachovia in the US is projecting global 1% negative in 2009 with every G7 economy in deep recession.

    While the economic news is horrific, we do need to keep in mind that graphs of commercial, residential and stock prices also reflect massive declines. And so the confirmation of the poor economic data now being released now is by and large already in the prices of assets.

    MSCI World Index

    The drawdown of some 50% and more in asset prices has been severe. All investors need to gauge their actual performance relative this.

    We would like to take this opportunity to wish you a blessed Easter weekend.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-09, 14:04:16, by ian Email , Leave a comment

    A Look at the G20

    For years now, influential groups of world leaders have been known according to how many member countries there are in the group, generally using “G” as a prefix. The first such grouping that I am aware of is the G8 (originally the G6 until Canada and Russia joined) that had their first summit in France in 1975. These groups typically meet to discuss key global issues, but generally lack the formal authoritative structure to implement decisions that other international organizations like the UN command.

    The G20 (of which South Africa is a member) is a group of countries that comprises 85% of the world’s GNP, and two thirds of the world’s population. It therefore allows for the majority of the world to be represented by a fairly small grouping. The group was established as recently as 1999 and discusses key policy items relating to the promotion of international financial stability.

    A special meeting of the G20 was convened in London at the beginning of the month and attracted a lot of attention due to the current financial climate. Part of the attention was drawn due to the large riots held in London over the period that the meetings took place.

    The meeting in London looked at how the countries should deal with the current global slowdown. There is a recognition that co-ordinated action is required to pull the world economy out of a potential recession as the inter-connectedness of the global economy is such that one country’s actions in isolation won’t have the desired result. While this need is recognised, there are various view points on how this should be achieved, with politicians from each country trying to get their agenda onto the table. The latest meeting has been characterised by the US and Japan calling for more deficit spending to generate economic growth (and not worrying for now about future inflation threats), while Germany and France have been at the forefront of those opposed to the unconstrained spending.

    Calls at the previous meeting (held in November 2008) to avoid implementing protectionist measures seem to have fallen to a large extent on deaf ears. The call was made as in the long term free trade improves the GDP all trade members, but trade restrictions can appear to be beneficial to the protectionist country in the short term, and as such many politicians use this as a tool to improve popularity. The World Bank found that 17 members had implemented trade restriction measures since their mid November meeting!

    It is clear that this group is perhaps not as efficient as it could be in an ideal world. We do, however, need to be realistic as to what this type of group can achieve. Merely participating in the dialogue improves relations and improves the probability that something will be done to advance international financial stability, which wouldn’t be the case if there was this setup.

    Take care,

    Mike Browne
    021 9144 966


    Permalink2009-04-08, 18:29:23, by Mike Email , Leave a comment

    IMF gold sales fact or fiction

    Gold appears to be acting contrary to the general market direction. As soon as risk appetite increases so appetite for safe haven gold declines and vice versa. One of the reasons for the decline in bullion last week was the mooted sale of gold by the IMF – International Monetary Fund.

    The mooted sale of gold was to help fund the IMF in the planned $50 billion for aid to the poorest countries.

    However while the IMF is a large holder, it’s not that easy for it to sell.

    The IMF is the worlds third largest holder of gold with some 3217 metric tons – 103,4 million ounces.

    However the bulk of this gold cannot be sold without restitution to members. This is the portion of gold holdings acquired since the Second Amendment of the IMF’s Articles of Agreement in April 1978. The portion that falls outside of this amendment and is available for sale is only 403,3 metric tons – it’s unlikely that the IMF will be quick to sell this down.

    The bulk of its holdings were acquired prior to this Second Amendment through 4 main types of transactions listed below.

    Therefore before the IMF can sell the bulk of its gold, 85% of the fund’s country shareholders need to approve the proposal. The US has a 17% vote and therefore a veto right.

    The IMF gold was obtained by:

    o Prescribed that 25% of the initial quota subscriptions were in gold – this is the largest source.
    o All payments of charges – e.g. interest on members use of IMF credit were normally made in gold
    o A member wanting to buy foreign currency could sell gold to IMF (the major user of this provision was SA in 1970-1971)
    o Payments for credit previously extended could be done in gold.

    The IMF states that its policy on gold is governed by the following principles:

    o As an undervalued asset held by the IMF, gold provides fundamental strength to its balance sheet. Any mobilization of IMF gold should avoid weakening its overall financial position.
    o The IMF should continue to hold a relatively large amount of gold among its assets, not only for prudential reasons, but also to meet unforeseen contingencies.
    o The IMF has a systemic responsibility to avoid causing disruptions to the functioning of the gold market.
    o Profits from any gold sales should be used whenever feasible to create an investment fund, of which only the income should be used.

    In fact in a time when the IMF sold 1/3 of its then gold holdings – 1976 – 1980, the price of gold was a in a very strong bull market.

    Over the recent years sales have been called for but typically come to nothing. The US apparently blocked a previous attempt to sell IMF gold in 2005.

    If history repeats then any actual sales of gold into the market will be non existent or small and will not be market disrupting.

    Kind regards

    Ian de Lange
    021 9144966

    Permalink2009-04-07, 17:44:33, by ian Email , Leave a comment

    Adding up the bailout cost

    On a daily basis and post the G20 summit, global governments continue to develop plans on how they will provide funding to prop up lenders in an attempt to reverse the deflationary impact. A Bloomberg report at the end of March compiled an analysis of the total that the US government and Federal Reserve have spent or committed.

    That total now runs at $12,8 trillion.

    This is very close to the annual GDP of the US, which is officially at around $14,2 trillion per annum – but highly likely to contract in 2009.

    Of the $12,8 trillion some $4,1 trillion has been incurred.

    Across the water to the UK, they are in a bigger pickle. With a UK recession far worse than originally expected, deficit levels are expected to be just as huge as in the US. In November the deficit was expected to be at 8% of GDP. Now when the budget is presented on 22 April, this is expected to be above 10%.

    A Standard Bank foreign exchange report today made this statement, “We believe that major central banks, led by the Fed and the Bank of England, are devaluing money. They are doing so to avoid deflation and because they cannot bear the cost of much more fiscal easing.

    What happens if the central banks succeed in devaluing money? If money is devalued, its price will fall against local goods and services which is, of course, what’s needed to avoid deflation. But it will also devalue the price of money against other things as well, like assets. This may be part and parcel of the reason why many asset prices are rebounding right now.”

    The US bailout has been channelled across 3 main US institutions, The Federal Reserve, The FDIC (Federal Deposit Insurance Corporation) and the Treasury.
    The following table details how the Fed and the government have committed the money on behalf of American taxpayers over the past 20 months, according to data compiled by Bloomberg.

    With all the printing of money, its very apt to consider a statement apparently attributed to Austrian economist, Ludwig von Mises, who said, “It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself by believing that he has discovered a wonderful new method of heating his premises.”

    The overreaching of government should help drive an investors asset allocation

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-06, 18:42:57, by ian Email , Leave a comment

    The principle of mean reversion is important

    I attended 2 presentations today. In the first we discussed various economic scenarios that may well play out. Given the world as we understand it today, there was higher emphasis on the negative news, without assessing the valuations of various asset classes.

    The second presentation from a very successful fund manger made the point that the one additional certainty in life, besides death and taxes is - mean reversion.

    Of the 2 main issues that investors need to focus on, i.e. economics or mean reversion, the latter is the more important one.

    But just what do we mean by mean reversion?

    Lets look at some detail to clarify.

    US investor, Vitaliy Katsenelson wrote a book called, Active Value Investing. He has studied the US markets over the last 100 years and isolated periods of time as being either:

    o Bull markets
    o Bear markets
    o Range bound markets

    All typical bear markets, except for the deepest one from October 1929 – July 1932 have been classified as long range sideways or range bound markets.

    The 2 main components of the total return from an investment into a share are:

    o Earnings growth, which in turn produces dividends; and
    o The change in valuation multiple, i.e. change in PE.

    Mean reversion is the principle that valuations are mean reverting. i.e. they oscillate over time around a mean.

    Looking back over all bull markets, it becomes evident that these were no caused by a growing economy, earnings growth, low interest rates or inflation, etc, but by the starting valuation.

    Both in bull markets and in range bound markets, it was found that the principle driver of returns was the starting valuation. This is essentially what we discussed yesterday with Pick n Pay. It’s the principle of buying when a company is cheap and selling when it reaches fair or above fair value.

    When the starting valuation is expensive, then no matter how positive the economy in respect of growth rates, low inflation, low interest rates, an investment tends to produce poor returns.

    Conversely when the starting valuation is attractive, then despite relatively poor economic growth rates, higher inflation and interest rates etc, an investment has a high probability of producing attractive returns.

    Chart 1

    Source: Active Value Investing

    Chart 1 reflects starting and ending PE ratios taking 10 year average earnings. Both bear and range bound markets start with expensive valuations.

    Bull markets start with low valuations.

    Valuations have become a lot more attractive from their highs in 2000 – i.e. prices have fallen substantially. It may still take some time to unwind fully, which means that the large up and down range bound market may persist.

    Have a wonderful weekend


    Ian de Lange
    021 9144 966

    Permalink2009-04-03, 17:39:51, by ian Email , Leave a comment

    An example of buying an asset at an attractive price

    When investors allocate funds to an investment manager, they are looking for that manager to make decisions that will generate superior risk adjusted returns. At this time of high volatility many investors are nervous and prefer to avoid buying into real assets, but lets look at one good example of a an asset that has oscillated between cheap and expensive over the years.

    At its core investing not about speculation, or trying to anticipate what a price will do in a week’s time or even 6 months time. A value investor will try and buy an asset at the best possible price and retain that asset until such time as it gets expensive at which time they will look to sell and buy another other cheap assets.

    Yes it’s easier said than done and NO investor will ever be able to always buy at the bottom and sell at the top.

    It’s more a matter of getting the odds in your favour.

    Let’s take the example of Pick n Pay as depicted below. Here the price in red is bracketed by the earnings of the company at a 12 PE (blue) and a 20 (PE).

    When the price touches the blue line, the company is valued at 12 times earnings. When it touches the red line it’s valued at 20 times earnings. So at times the price of Pick n Pay shares has been very expensive and moved at and through the 20 times earnings level.

    At other times it’s been far cheaper and fallen closer and through to the 12 times earnings level.

    Source Inet and SIM

    Buying at a low PE of around 12 times earnings is no guarantee that subsequent returns will be good. But historically buying at an attractive valuation has substantially increased the odds of favourable returns – often doubling in 3- 4 years.

    Conversely buying at a far richer valuation of around or higher than 20 times earnings increases the odds of poor subsequent returns.

    On an ongoing basis most value fund managers cannot ascertain where the market is likely to be, or indeed if the JSE All Share index will reach 25 000 or 30 000. More importantly they will want to consistently try and buy assets as cheap as possible.

    The current environment is providing one such opportunity for value managers to do just that.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2009-04-02, 18:05:06, by ian Email , Leave a comment

    Paradigms Shifts that Shift the Landscape

    Throughout history new trends that develop and continue to hold true in the medium term result in people questioning the existing paradigm (previous trend that has existed for a longer period) and its viability going forward. This line of questioning occurs not only in the world of investments, but across many spheres.

    The conundrum that everyone faced with a potentially changing paradigm is whether the trend is merely being altered temporarily, or if there is indeed a paradigm shift occurring. Getting this call correct can ultimately have long term consequences on your actions. One such potential ‘big picture’ question that Ian touched on yesterday was “Is the capitalist system dead, or are equity markets mispriced?”

    Knowing the definitive answer to this question would result in you being able to position your investments accordingly to capture to most upside. The problem that we, as investors, face is that there often isn’t a definitive answer to these questions, and even if they is they often don’t become apparent to the general public until a long period of time has elapsed, hence your insight may go unrewarded, and even criticised, for a lengthy period.

    Further complications arise when a new paradigm is evident, but where the outcome has been interpreted incorrectly by the rest of the community. Here the dotcom bubble and commodity price bubble are good examples in the investment world. Technology, computers, and the internet have clearly revolutionised the way that companies and people do business and live there lives, however it is evident that in the run up of the dotcom bubble, the shifting paradigm was clouding investors’ ability to separate the paradigm from the valuations.

    This (the paradigm shift cloud) is where we potentially find ourselves today. While not going so far as to declare that capitalism is dead, it is clearly evident that the role of government (on a global stage) is growing, and is going to continue to grow in the years to come. This is in stark contrast to the declining role that they have been playing over the last couple decades or so, and will resultantly probably produce a starkly different landscape in the next couple of decades.

    Having a handle on the potential scenarios that could unfold over the ensuing years, and how to benefit from these changes (there is always opportunity) will be key to assisting you to evolve.

    Potential scenarios of global deflation, stagflation, country default, changes in the supply and demand dynamics of financial instruments as a result of previous returns, and how the changing demographic interprets the world will influence how you should position your portfolio.

    Being able to accurately project which scenarios will unfold, and how they will influence global markets is a nigh impossible task. However, having an idea of the potential changes and how you would potentially react to them is crucial if you wish to be prepared for the coming years of change.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2009-04-01, 18:27:31, by Mike Email , Leave a comment