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    True Inflation?

    If you speak to any housewife (or person who’s in charge of household spending) about the cost of living they will inform you, in no uncertain terms, that the inflation rate that the government publishes on a monthly basis is not the same as the inflation that they experience day to day. They will argue that real inflation is far in excess of reported inflation.

    For people who aren’t ‘at the coal face’ in shopping malls on a regular basis (but who possibly fund the expenditure) these accounts can be explained away using a few sound arguments:
    • Improving standards of living (i.e. buying the same amount of, but more expensive, goods and services) – therefore expenditure grows quicker than inflation.
    • Growing households (i.e. buying more of the same priced goods and services as the family unit grows) – therefore expenditure grows quicker than inflation.
    • Different inflation rates for different income brackets / different regions. It is true that different baskets of goods grow at different rates.
    • Anchoring of prices and not realising the impact of compounding inflation over long periods (a loaf of bread bought for R1.00, 25 years ago, would now cost R7.69 using the reported inflation rate of 8.5% pa).

    While all of these are sound arguments, and will more than likely explain at least a portion of the story, The Economist has produced their own (light hearted) inflation index for a range of countries. Similar to the Big Mac Index – which looks at the relative strength of a variety of currencies against the US dollar based on the price of a Big Mac – The Economist has produced a Big McFlation Index!

    In this light-hearted review they calculate the annual percentage increase in the price of a Big Mac across a variety of countries. The logic behind the argument is that a Big Mac is a fairly standard product across the world, that hasn’t changed over time, and includes a wide variety of inputs (agricultural commodities (beef, bread, lettuce, cheese), labour (blue and white collar), advertising, rent and real estate costs, transportation, etc).

    The Economist then compares the inflation rate of a Big Mac with that of the official inflation rate in these countries. The results are shown in the image below:

    As you can see, most countries have been underestimating their inflation rate on this measure (i.e. price of a Big Mac has been increasing faster than official inflation). In some countries the difference is particularly high, and in some the official rate is higher than the Big McFlation rate.

    You can see that on this measure South Africa has been underestimating inflation by just over 2% per annum (just over 40% on a cumulative basis). Countries with a higher nominal inflation will typically have a greater error in this type of analysis.

    If The Economist’s index is a true reflection of reality then it is even more important for investors to invest in growth assets that are able to grow at a rate faster than true inflation as opposed to cash which, on an after tax basis compared to the Big McFlation Index, is guaranteed to lose you purchasing power over the long term.

    For a link to the full article, and to be kept up to date with investment and economic news click through to our Facebook Fan Page and click ‘Like’ at the top.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2011-03-31, 16:13:05, by Mike Email , Leave a comment

    Inflation continues to head higher around the world

    Current and impending inflation levels are getting to the stage where major central banks need to start hiking their ultra-low interest rates. The general outlook is that the European Central Bank will hike its interest rates next week by 0,25% after the ECB President made a surprise announcement earlier in the month.

    The ECB base interest rate is currently at 1%.

    At this stage the US is likely to remain cautious on hiking interest rates, given the low core inflation rate that it tracks. CPI is at 2,1% and core (see definition below) at 1,1%

    The UK has inflation running at 4,4% and this is putting pressure on the Bank of England to raised rates from their ultra-low 0,5%

    Chinese inflation

    Add to this the inflation problem in China. Food inflation has been culprit, although prices of some of the main components like corn and rice are down about 10% from their highs. However it’s not only food prices that have been the issue. Excluding food, inflation rose 2,6% in January, which is the fastest in 10 years.

    Overall inflation has risen from 1,5% at the beginning of 2010 to the current 5%.

    Chinese inflation starts to become a global issue given that China is a large exporter of finished goods. Over the last two decades wage price hikes have not really taken hold, countered to a large degree by productivity gains. However this is not necessarily going to be the case in future.

    A recent report from Standard Chartered Bank of its clients in China said that they expect wages to increase between 9% and 15% this year. The report also indicated that 45% of firms are finding it harder to recruit workers despite generally paying more than the minimum wages.

    Source: Wells Fargo

    Inflation in the US

    Monetary authorities in the US target core CPI. This is inflation excluding food and energy costs. In the US food is a relatively small component of the inflation basket – just 15%. Housing is the biggest component at 42% and this weak market post the financial crisis is helping inflation at the lower levels.

    While headline inflation is currently running ahead of core, over time the spikes in headline have not passed through to core inflation.

    However there are definite components of inflation that hurt. The chart below reflects the massive hike in energy and education costs in the US over the last 10 years. While these 2 items are not direct components, they are included into 2 of the components.

    Source : Dshort

    With massive doses of global money creation, higher inflation into the future is almost certainty. The world has experienced the positive influence of deflation from China over the past 2 decades, but even if this persists, it is unlikely to be at the same level over the next 2 decades.

    When it comes to identifying investment risk, one of the bigger risks is that inflation will persist at higher rates into the future . Accordingly investment portfolios and asset allocation must take this possibility into account.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2011-03-30, 16:52:32, by ian Email , Leave a comment

    Picking from the cookie jar...

    The correction we seem to be recovering from was over 10%. The JSE has recovered some 5% since the last bout of panic selling on the 15th March. There are still many bargains about however. Let us find the following as at Thursday 25th March:

    1. Largest 100 shares on the JSE that are
    2. Reasonably valued and
    3. Going for more than 10% discount to their recent highs, and
    4. Displaying strong signs of recovery according to
    4.1 recent 5 and 10-day moving average crossovers,
    4.2 recent 1 and 2-week resistance breakouts
    4.3 the emergence of back-to-back advancing days.

    This seems a complex search, but with three mouse clicks we get the list below:

    RMH recently restructured its shareholding, so ignore that. The list is sorted by discount from recent highs ("HI" column). BIL is at a historically low P/E of 11 and a favourite of ours. But we also like LEWIS as it is a consistent dividend payer and the 4.6% yield is almost a dead-cert. LEW is going at a 12.1% discount to its recent highs, despite having risen 6.7% ("5D" column) in the last 5 days. LEW is colored red as our systems deem it to be the best opportunity, followed by the shares coloured in green. FPT is a consistent revenue growth, earnings-per-share growth and dividend payer but remember it's a property stock and the 8.7% yield is thus taxable.

    If you like this approach to intellegent stock picking and timing, come see us at our next seminar or see our videos at www.powerstocks.co.za

    Permalink2011-03-25, 14:57:33, by dwaine Email , Leave a comment

    Soe thoughts on gold

    Whenever we run presentations and have a time for questions, invariably there is one on the outlook for gold. While gold ownership in SA has typically not been an attractive investment, there remains a strong emotional attachment to this asset class.

    But lets examine the case for this metal.

    Gold has been in a steady upward price pattern for the last 12 years. After falling to a low of around $250/oz in mid 1999, the price of this yellow metal has been steadily increasing.

    Over the past 11 years, in US dollar terms, the price has compounded up at 15,3% per annum. Because gold pays no interest or dividends, this is the total return for an investor holding this asset. This return has actually been very good compared to say global equities, which gave investors a dollar return of 4,8% for the last 10 years.

    Investors into local shares achieved a dollar return of approximately 18% over the last 10 years – so this puts some perspective on gold’s 11 year run.

    US investment bank, Goldman Sachs has a current forecast for gold bullion at $1480/oz. in 3 months, a 6 month forecast of $1565 and 12 months out at $1690/oz.

    One main reason for them remaining upbeat on the price is the fact that the Federal Reserve continues to keep the interest rate below the rate of inflation – i.e. running negative rates of interest. This tends to be dollar negative and asset price positive.

    Gold producer, AngloGold reported to Reuters that they are looking for a price of $1600/oz. towards the end of 2012.

    Investors that are bullish on the price have the option of buying either the metal itself, or investing into a mining producer. Over the years, except for certain spikes, mining companies have generally not been fantastic investments. In general their costs have continued to rise and given the fact that they mine a wasting asset, a large component of their costs is on exploration and new acquisition. This in order to replenish a wasting asset.

    Today Goldfields announced a voluntary purchase offer in Lima, Peru to buy shares that it does not already own. If the offer is taken up in full the cost will be $420 million.

    AngloGold reported that their all in cost of producing an ounce of gold is already higher than $1000/oz. and this is likely to increase by more than $100/oz. year in year.

    At these and higher gold prices, gold producers can be profitable and should the price continue to rise and companies start to demonstrate a willingness to pay out higher dividends, then these businesses can be attractive investments. At current price multiples, investors are already pricing in high expectations.

    Our view is that while the dollar price of bullion will remain volatile, we have not yet seen the top. We continue to hold a small portion within the Seed Flexible Fund, but not as yet any gold producer.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2011-03-22, 16:54:48, by ian Email , Leave a comment

    Green shoots

    As of yesterday, which liquid (actively traded) JSE shares with reasonable valuations (according to P/E, P/Book) had fallen at least 10% in this last correction and were now making new 1-week highs (5-day breakouts), and had just (within last 3 days) crossed their 5-day and 10-day moving averages? Our clients answered this question yesterday morning with two mouse clicks to reveal the below interesting basket of diversified shares:

    LEWIS is interesting for patient investors as it is trading at 16% discount ("HI" column) to its last high and (you cant see on this chart due to width restrictions of the picture) it has a "D" in its CONSISTENCY column since it is a consistant dividend payer, having posted ever-increasing uninterrupted dividends of 19% per annum growth for the last 5 years (10 reporting periods). One could argue its current 4.9% yield is almost "in the bag" so to speak. It is one thing buying good shares at discounted prices, but it is even better if they have solid dividends and/or earnings-per-share growth records.

    We track the earnings per share (EPS, Revenue, and dividends-per-share (DPS)growth track records of each JSE share going back 11 years and that group of shares that have shown at least 5 years dividend or earnings (or both) growth consistancy as a group, outperform the index comfortably for both capital appreciation and dividends. As you can see from the above list as but one exmaple, these desirable characteristics are not necessarily the domain of large-cap shares only.

    If this style of intelligent share selection interests you then look at our demo videos over here.

    Dwaine van Vuuren
    MD, Powerstocks Equity Research

    Permalink2011-03-18, 17:03:44, by dwaine Email , Leave a comment

    Fleeting moments in time...

    The current earnings season coupled with the current correction are revealing brief moments in time to be savoured by those savvy investors in the know… Have a look at the chart below of BHP BILLITON, the largest diversified global mining company in the world, that just posted excellent results and is sitting on piles of cash, so much cash in fact that it is embarking on a share-buyback program.

    BHP makes up about 13.2% of the FTSE/JSE Africa Index of 318 shares (the JSE), the largest contributor, next to ANGLO which is at 10.8% of the index. As such its daily gyrations and bull/bear trends have an enormous impact on the JSE TOP40 index.

    The decline in BHP the last two weeks, has brought its historical price/earnings ratio (P/E) down to an astonishing 10.7x. The chart above shows blue shaded areas whenever BHP’s P/E visited below 12x which is demarcated by the horizontal green line. This valuation for BHP has occurred only 16.3% of the time over the last 15 years incorporating 3 bull markets and 2 bear markets. The lows reached by BHP yesterday have occurred a fleeting 10.7% of the time.

    From an investors perspective, these fleeting moments all served as excellent buying opportunities. In fact, one could argue they catalogue the best 16% of the time to be investing in this counter. Oil spikes can come and go, brief economic slowdowns may visit from time to time – but the industrial revolutions in China and India will continue which will drive demand for iron-ore, coal, steel and all manner of minerals and resources mined by BHP. Sooner or later, valuations of BHP will become irresistible and the buyers will come back which will have a big impact on the JSE and Top40.

    To see how to find many more such opportunities, visit our page on Sharenet for sample demos and videos or see us at www.powerstocks.co.za

    Permalink2011-03-11, 16:56:13, by dwaine Email , Leave a comment

    Looking back at bond performance

    The annual Credit Suisse Global Investment yearbook was released last week. This report tracks the performance of 19 markets with data compiled going back from 1900 to the end of 2010. The report computes a 19 country world equity and world bond index in a common currency.

    Over the 111 years the real return on the world index was 5,5% per year for equities and 1,6% per year for bonds. On a cumulative basis this additional 3,9% over an extended period makes a big difference.

    We all know the long term story for equities – i.e. investors who maintain a long enough investment horizon will invariably be rewarded for the additional risk taken on.

    But there have also been protracted periods of time where this has not held true and the performance from supposedly lower risk bonds has been on a par with that of global equities.

    In fact we are coming out of such a period.

    Bonds have been excellent performers over the last decade and indeed from 1980

    In the US from 1980 to the end of 2010, the inflation adjusted return from government bonds was an annual 6%. This a far superior return compared to the preceding 80 years where the real return was only 0,2% per annum.

    A similar result occurred in the UK where from 1980 to 2010 government bonds produced an annual real return of 6,3%. Over the preceding 80 years UK government bonds had produced an annualised real return of -0,5%.

    Therefore in these 2 countries at least government bonds have exceeded investor expectations over the last 30 years, while the performance from equities has generally been disappointing, especially when both these asset classes are adjusted for risk.

    Taking all 19 countries into account, over the 111 year period, equities have produced an annual 3,8% superior performance. However over the last 10 years for the most part government bonds have been a better asset class than equities, with equities producing an a -3,2% equity risk premium.

    Looking back there are good reasons why government bonds have done well over the last 10 and indeed 30 years. Structurally the US and UK started moving away from big government to smaller government in the late 1970’s to early 1980’s. By starting to squeeze down inflation, boosted with China starting to come on board as a production powerhouse, the environment was created for interest rates to drop from high to low rates. Lenders to government benefited as interest rates fell.

    There are periods when bonds can be very risky in real terms.

    Looking back in time at the cumulative percentage decline in real terms for an investment in US equities and US bonds, gives an indication of just how risky bonds can be.

    The chart below reflects that after the 1929 stock market crash, shares (in blue) fell to a low in July 1932, which in real terms was 79% below the September 1929 peak.

    This was extreme. But look at bonds in red, where the major decline started in December 1940 declining some 67% in real terms to 1981. The UK had a similar experience where bonds slid from 1946 to 1974 – losing 73% of their value.

    Should investors be wary of bond performance

    As with all investment asset classes the returns are not experienced in a linear fashion. This also holds true for bonds where there have been extremes in real return performances.

    We have generally come through an extended “golden era” period for bond performance – see the chart below.

    The danger now is that investors look back over the last 10 years and even up to 30 years and extrapolate the superior bond performance into their projections. Given the much higher base, lower value, it is highly unlikely that these same returns will be repeated again over the next 10 years.

    Kind regards

    Ian de Lange
    021 9144 966

    Source: Credit Suisse

    Permalink2011-03-07, 17:31:46, by ian Email , Leave a comment

    Any bargains about?

    With the JSE down a mere 2.2% from its recent high, you may think there are no more bargains about. But digging beneath the skin, we looked for shares from the top-100 that were consistant dividend and/or earnings-per-share growers and trading at more than 10% discount to recent highs:

    The PVM column, where we rank shares' valuations by looking at their P/E, book value and price/sales ratios, shows that WBO and TRE are undervalued at this point. Whilst this list may possses shares with endearing qualities (consistant track records of dividends and earnings growth is good for yields and capital appreciation)the issue comes downt to timing your purchase. We believe this recent correction has bottomed out, so the tide is rising is your favour.

    However the MA-TREND columns show that all but RES have crossed up through their 5-day moving average and TRU, CLS and TRE have just recently crossed their 10-day moving averages. Also, TRUE and TRE have just recently had their 5-day moving average cross up through their 10-day moving average. The DONCH columns show that TRU and CLS have just broken 5-day (1 week) resistance levels (new 5-day highs)whereas TRE is approaching a major resistance level.

    TRU looks attractive as it is trading 12.4% below its recent high and displaying renewed strength, having booked 6 back-to-back advancing days in the last 2 weeks (Sin column). The amount each share is trading below recent highs is listed in the "HI" column.

    For more innovative ways of looking at trading and investing opportunities in the market by combining funadamentals with technicals, see our JSE Share Watchlist demo videos on our Sharenet landing page.

    Dwaine van Vuuren
    PowerStocks Equity Research

    Permalink2011-03-04, 15:53:40, by dwaine Email , Leave a comment

    Manager Outlooks

    Today we spent the morning listening to four successful asset managers (and it was interesting to hear each of their thoughts) discuss how they are positioning their portfolios to best deliver excellent risk adjusted returns.

    I will take a look at some of the more insightful comments made. While I will mention some of the ideas in their portfolios it is important to remember that each investor’s individual circumstances are crucial when assessing whether an investment is appropriate or not. Also, the managers stressed the importance of a portfolio approach, i.e. sometimes the best ideas (at the time) aren’t the ones that generate the returns. Importantly, investors need to construct their portfolio as a portfolio of assets, rather than a haphazard collection of ‘good ideas’ without regard to sector, size, and cycle constraints and dynamics.

    • Commodities are important – but those commodities that are consumed have an advantage over those that are merely used or stored. In this regard, companies producing/mining commodities like sugar, wheat, paper, and even oil and coal have an advantage over those mining resources like copper, iron ore, gold, etc. If there is a global slowdown consumers will still need to eat and fuel their vehicles and other machinery, but can stop building and other industrial activities which would affect the demand for most hard resources.

    • Developed market (US) growth is precariously positioned – oil is a major input into the global economy (particularly developed economies) and it literally does grease the wheels of growth! All developed economies have evolved to be heavily reliant on oil, and emerging countries are generally increasing their reliance on so called black gold. It is interesting to note that a 150% increase in the oil price over a rolling 2 year period has always been followed by a recession in the US. We have just passed this mark recently, so we will see if the trend continues.

    Source: Atlantic Asset Management

    • A large increase in the oil price is disinflationary – contrary to popular belief. Over the short term there will be inflationary pressures from a large increase in the oil price as it has first and second round effects on the inflation numbers, but over time any major move in the oil price will slow the economy down (and potentially even into recession) which is typically followed by lowering inflation (chart below). In the chart we have tracked the change in oil price against future inflation over time.

    • Yield is important when investing – as it provides a valuation framework with which you can compare asset values against each other. Across the entire spectrum of assets (equity, property, pref shares, nominal bonds, inflation linked bonds, cash, etc) the most certain variable when investing is typically the yield at which you buy the asset. There will be more risk on the yield of some assets than others, but these are compensated by a higher expected return over time.

    • Prospects are an important consideration when investing – as investors need to be confident that they will receive their yield. While it is more difficult at assessing the future prospects than past events, growth (for equity and property) and sustainability of yield (for all income producing assets) is important over the long run. Good quality institutions will typically perform better than poor quality institutions over time, but one needs to ensure that one doesn’t overpay for any asset. To quote Adrian Saville, “the surest way to turn a good company into a bad investment is to overpay for it.”

    Ultimately there were many other pearls of wisdom that came about from our discussions with the different managers this morning. After a day like today we come back to the office and attempt to distil all the ideas to help us refine and mould our investment views.

    To receive link to a regular dose of reading material that we find insightful on a day to day basis become a FAN on our Facebook page by clicking here. These posts are also tweeted on our Twitter page, follow us @Seed_Invest.

    Take care,

    Mike Browne
    021 9144 966

    Permalink2011-03-03, 17:40:16, by Mike Email , Leave a comment

    More on Berkshire

    According to the book, The Money Masters, the original investors into Warren Buffet’s investing partnership would have turned $10 000 in 1956 into $300 000 by the time he dissolved in 1969. The original partnership saw him receive 25% of the profits above a 6% annual return on capital. On these numbers the approximate compounded annual return was 27,5%

    Each year Buffett wrote to his co investors saying:

    “I cannot promise results to partners, but I can and do promise this:

    a. Our investments will be chosen on the basis of value, not popularity.

    b. Our patterns of operations will attempt to reduce permanent capital loss (not short term quotational loss) to a minimum.”

    When valuations became extremely stretched in 1969 and Buffett was unable to find bargains, he dissolved the partnership, giving investors back their capital plus their proportional share in Berkshire Hathaway which was one of the funds principal holdings and where Buffett was instated as chairman.

    Three years later the stock market slumped and in the early to mid 1970’s Buffett via Berkshire was able to buy into a range of listed companies at good prices.

    Now Berkshire’s listed stock holding has a book value of $33,7 billion and a market value of $61,5 billion. This includes 12,6% of American Express Company, 8,6% of Coca Cola and 10,5% of Munich Re.

    Berkshire last added to their Coca Cola shares in 1995. It is carried at a book value of $1,3 billion (market cap of $13,1 billion). In that year they received $88 million in dividends. These dividends have increased each year and in 2011 they expect $376 million (+-2,8% dividend yield). Buffett is expecting this to double in 10 years.

    Buffett recommends looking less at earnings per share than at return on capital when making assessment of value.

    Long term interest rates indicate overall fair value levels.

    An interesting point made in the book is that Buffett has a theory that the Dow Jones is worth ones times book value if you expect US Treasury Bills to yield an average of 11 percent in the future, 1,3 times if the expectation falls to 8,5% and close to twice if you expect Treasury Bills to yield 5%.

    This essentially speaks to the discounting of future income streams at different interest rates where in a lower the interest rate environment, investors should be willing to pay more for businesses.

    Looking at the book value of the S&P500 in the US, this has declined from over 4 times at its peak in March 2000 to now below 2 times, having dipped to below 1,5 times in 2009.

    Right now 1 year treasury yields are exceptionally low. The 10 year US Treasury yields 3,4% and the 30 year 4,5%. While this is likely to pick up, at these levels Buffett says shares can be priced at twice book value and still be fair value.

    if you wish to discuss your local and offshore investment planning, please do not hesitate to contact us.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2011-03-02, 17:21:18, by ian Email , Leave a comment

    Warren Buffet's annual report

    Warren Buffet always makes some good points in his annual shareholder letter accompanying the financial results of the listed company that he controls – Berkshire Hathaway. It is a widely followed letter with Buffett as the largest shareholder being one of the richest men in the world.

    Berkshire is a company with a market cap of approximately $216 billion.

    Buffett took control of the company in 1965. Over the 46 years the book value of the company has compounded from $19 to $95 453, an annual rate of 20,2%. He measures this book value increase against the compounded increase in the S&P500 index, which over the same period has compounded by 9,4% per annum.

    Berkshire Hathaway was originally a textile operating company. Now the company that Warren Buffett controls is essentially a holding company into a range of underlying investments and operating businesses. It is not necessarily unique because it is essentially a closed end investment company that invests into a range of underlying operating businesses. But it is unique in terms of its sheer scale.

    In order to have full access to the operating businesses cash flows, Berkshire prefers to own its subsidiaries outright.

    Some of his comments from the report

    “Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of “great uncertainty.” But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain.”

    He goes on to say that politicians and pundits have constantly moaned about terrifying problems facing America, yet its citizens live 6 times better off than when he was born some 80 years ago.

    His enthusiasm for America when most others were negative 2 years back, led him to conclude one of their biggest deals in 2010 – the acquisition of Burlington Northern Sante Fe for $26 billion. This is the second largest railroad business in the US.

    He notes in his report on this railway operation that, “Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel-efficient than trucking is, which means our railroad owns an important advantage in operating costs.”

    On performance goals

    “Charlie and I believe that those entrusted with handling the funds of others should establish performance goals at the onset of their stewardship. Lacking such standards, managements are tempted to shoot the arrow of performance and then paint the bull’s-eye around wherever it lands.”

    On their dividend policy

    “..not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years. Instead, we have retained all of our earnings to strengthen our business, a reinforcement now running about $1 billion per month. Our net worth has thus increased from $48 million to $157 billion during those four decades..”

    Buffett knows that he needs to continue to do large deals because the job gets more difficult as the numbers get larger. The company will need both good performance and major acquisitions.

    I will look at a few more points on this large conglomerate tomorrow.

    Kind regards

    Ian de Lange
    021 9144 966

    Permalink2011-03-01, 15:36:28, by ian Email , Leave a comment