Let’s be honest: predictions are a mug’s game. At the end of last year no one anticipated the run on Northern Rock.
Still, MoneyWeek’s experts did see trouble ahead for markets and offered some decent tips with that in mind. They told us to buy into the Russian consumer, blue-chip stocks, gold and oil service firms.
Given how the year turned out, it wasn’t a bad set of recommendations – gold and oil have continued to soar and blue chips are back in vogue as defensive stocks become more attractive.
Unsurprisingly, the focus this year is on how to avoid losing money: James Ferguson foresees a UK property crash and the credit crunch looms large over most of our experts’ comments. Tim Price and Dan Denning think hedge funds could shine amid the volatility, while Paul Hill and Simon Nixon look at ways to profit from weak Western currencies.
Buy into African property
by Sven Lorenz
Why should investors look at Africa? Because it’s the last emerging-market frontier. If you missed out on the Philippines in the 1980s and South-East Asia’s “tiger economies” in the 1990s, this might be your last chance to get in on a ground-floor opportunity.
Africa is the investment world’s forgotten continent. A severe and prolonged contraction of growth from 1974 to 1994 has created an entrenched negative perception. No other region is described with such sweeping generalisations as Africa’s 54 countries. The media reports mainly bad news, and bad news from one country has tended to cast a long shadow over the whole continent.
That’s why few investors have noticed that in at least some African countries a new situation has emerged. There are now 16 African states that have achieved annual growth rates in excess of 4.5% for more than a decade. And it’s not just northern African countries that are doing well. Sub-Saharan Africa, traditionally one of the world’s most troubled areas, is expected to grow by 5.3% in 2007.
Africa’s oil exporters are doing best – gross domestic product in these countries is forecast to rise by more than 10% in 2007; by 2010, the US is predicted to import 25% of its oil from Africa.
Of course, investors also tend to ignore Africa because accessing its markets isn’t easy. The only African stock exchange most Western brokers can trade on is South Africa’s. It’s there, back in August, that housing developer, Sea Kay, listed on the Johannesburg exchange.
When reading about South African property, you will mainly read reports on Cape Town’s luxurious waterfront villas. Prices have been soaring since apartheid ended in 1994, further proof that it always pays to get in when things look bleak.
Nowadays, the big opportunity in South African property (and elsewhere in Africa) lies in providing affordable accommodation to the growing black middle-class. Booming demand for oil, copper, agricultural goods and other commodities has led to ordinary South Africans enjoying rising incomes. For the first time ever, banks are handing out mortgages to those on lower incomes. Add the demand created by companies building accommodation for staff and you get a construction boom.
Sea Kay has been serving the affordable-housing market for ten years, building the kind of homes the average South African can afford as a first step on the property ladder. For eight years straight the group has been throwing off a profit. Last year, it handed over the keys for 17,000 new housing units. Longer-term, it wants to capture 10% of the entire market. Given the government plans to hire private contractors to get 2.2 million houses built over the next seven to nine years, that’s a huge slice of a big cake. Sea Kay also has long-standing connections with the black economic-empowerment movement – in other words, it’s close to the government.
Now, initial public offerings of housing developers are usually the sign of a bull market’s peak – and there’s no doubt that trouble is brewing in the world’s real-estate market. That’s why this share does come with a disclaimer: timing the right purchase price will be difficult, and there could be continued volatility. But the bigger picture is very tempting. Commodity prices look set to stay high and factors such as Chinese investments in Africa, the ongoing democratisation of the continent and debt forgiveness, all add to the sustainability of Africa’s current growth spurt.
What’s more, it’s usually South African companies that manage to break into other African markets. It is possible that one day Sea Kay will start to expand into the likes of Nigeria, Zambia or Ghana. Taken together, these countries form the world’s second-most populous continent after Asia. And once you have successfully built your presence in an African market, high entrance hurdles – such as difficult logistics – actually help protect your margins.
Give it a few years and getting into African housing development might turn out to have been as smart a bet as getting into Asian markets back in the days when most investors wrote them off as too far away, too exotic, and too risky. Timing is bound to be tricky – but for investors willing to take a risk, Sea Kay (JSE:SKY) is one to put on the watch list.
Sven Lorenz is a fund manager and investor. His blog is at Undervalued-shares.com
Avoid Britain’s housing market
by James Ferguson
Two opposing tensions will dominate the financial world in 2008. On one hand, large, well-funded blue-chips are excellent value, on many measures as cheap as at the 2003 lows. Stocks look especially good compared with assets such as government bonds, which are near cycle-low spreads unlike corporate and emerging market bonds. Property looks the most overvalued of all, though doubtless some overleveraged private equity and hedge funds will ultimately provide the biggest downside shocks.
Against the cheapness of stocks we have to balance an increasingly desperate-looking banking and credit provision scenario. While banks assure us the worst is over, money markets show otherwise. If banks won’t lend to one other without demanding an extra 100 basis points (one percentage point) to cover the risks, why should we believe them when they say, as UBS did in October, that further write-downs on the scale of its third quarter would be “highly unlikely”?
UBS was at least true to its word. After writing off $3.4bn in the third quarter, the fourth quarter’s $10bn write-down was of a new scale of awfulness. It emulated CitiGroup by announcing at the same time as the next tranche of losses the new capital injection needed to keep them in business. CitiGroup had to pay the government of Abu Dhabi 11% on its convertible bonds to get that injection. UBS paid 9% to the government of Singapore for its funds.
It’s unlikely these banks have revealed all, just what they could recapitalise at the time. So what might other banks be hiding and what rate of interest will they have to pay to stay in business? Whatever the answers, the result on the high street will be far higher rates on hard-to-get loans.
The end of cheap money will dominate 2008. Stocks will periodically sell-off as the US and UK flirt with recession as consumption stalls. Then they’ll rally each time off their low valuations, but won’t go anywhere until late in the year.
Government bonds, especially short-dated ones, will do well, perhaps surprising us at how low risk-free rates can go. But government bonds will underperform as the commodity rally falters with slowing global growth. As the bond market has been telling us since summer, it’s not inflation we need fear but recession.
The true carnage will be in those areas where cheap money had been driving the gains. Private equity will return to the hole from whence it came and many leveraged hedge funds, mainly in the credit market and commodities, will either have their funding withdrawn to such an extent that they can’t operate, or in a few cases will blow up in a headline-grabbing way.
As Warren Buffett says, it’s only when the tide goes out that you can see who wasn’t wearing shorts. It beggars belief that such a period of artificial largesse didn’t lead to some poor, not to say illegal, behaviour.
But the true face of 2008 will be the collapse of the UK housing market. Prices have been overvalued for a good two to three years and that was on the basis of low borrowing costs. Mortgage rates in 2008 will be double the 2003 lows.
The buy-to-let market will crash, leaving a huge gap between the prices at which sellers want to sell and those buyers are willing to pay. 2008 will see the resulting crash in transactions. The crash in prices is likely to be 2009’s story.
James Ferguson is an economist and stockbroker at Pali International. He also edits the Model Investor newsletter
A bad year for sovereign wealth funds – so buy ‘stuff’ instead
by Dan Denning
Next year will be much better for hedge funds than sovereign wealth funds (SWFs). Why? Hedge funds actually did pretty well in 2007, performing slightly better than the market in a volatile year. With central banks desperate to restore order to the credit markets, expect more volatility in 2008.
No one is sure how the credit crisis will hit the real economy. This makes for a lot of ups and downs, as credit spreads widen and central banks print money like mad and feed distortions into commodity and currency markets.
Those are perfect conditions for skilled hedge-fund traders, but not so perfect for managers of SWFs. These government-run pools of foreign currency reserves like to invest in financial assets, at least judging by the 2007 score card.
Dubai International Capital sunk $1.1bn into wealth management firm Och-Ziff, while the Qatar Investment Authority bought a 20% stake in the London Stock Exchange and a near-10% stake in the operator of Norway’s bourse. Large bets on banks and bourses may seem a bad idea, given the “unknown unknowns” lurking in the credit landscape.
But SWFs aren’t like other market participants. They are long-term investors (as opposed to hedge funds), more interested in safe places for large sums of capital than big year-over-year returns. SWFs also claim that their large pools of capital – the top five funds make up 70% of total assets of about $3trn – make markets more stable. These pools of capital, they say, bring the calm waters of liquid cash to dried up sectors.
Maybe. But SWFs all have the same problem: they mainly have US-dollar war-chests at a time when the Federal Reserve is cutting the floor out from under the dollar to save US borrowers. It can’t be fun owning a large stockpile of cash that is losing buying power by the second, yet having no real place to put it.
Abu Dhabi has $1.3trn, Singapore $331bn, Norway $315bn, Saudi Arabia $300bn, Kuwait $250bn, and China $200bn. By 2008, the SWFs may find they’re all cashed up with no place big enough for them to go.
So where should you go? Watch what hedge funds are buying (see Tim Price’s column below); and buy ‘stuff’ and companies that produce stuff. Despite an expected recession in the US, I still like energy and basic materials.
The supply of paper money issued by central banks will grow much faster than supplies of gold, crude oil, or the high-grade hematite iron ore of Australia’s Pilbara region. So buy stuff and sell paper. But which stuff?
The revaluation of big miners is nearly complete. BHP, Rio Tinto, Vale, and Xstrata all enjoyed a good 2007. Investors bought the “stronger for longer” commodity story and are paying more for these stocks, on an earnings basis, than you’d expect after three years of rising base-metals prices.
With the majors now courting each other, it looks like it will take deep pockets or a lot of borrowed money to hit the premiums demanded by shareholders of any of these firms for approval of a merger.
Mid-level producers might be a better bet for investors. The majors are keen to buy production that can be brought on-line quickly and generate earnings in the next two years. Hence their interest in each other. But once consolidation takes place at the top, the path is clear for junior producers to become targets.
These juniors may not have the lucrative project pipelines of a Rio Tinto or Xstrata. But in 2008, proven resources of base metals and minerals will continue to command a premium. I like Australia-listed gold and uranium miner Oxiana (ASX:OXR), which trades on a current p/e of below ten, and copper and zinc miner Kagara Zinc (ASX:KZL).
Dan Denning is the Melbourne-based editor of the Daily Reckoning Australia
Hedge funds will ride out choppy markets
By Tim Price
As Dan Denning points out above, volatile markets can be good for hedge funds. But what is a hedge fund?
Alfred Winslow Jones was one of the first ‘hedgies’, back in 1949. He realised you don’t need full stockmarket exposure to make decent returns. Rather, you can select preferred investments (say, Ford) and less favoured ones (eg, General Motors), then go long (buy) the former, and short (sell) the latter. Congratulations. You are now running an equity long/short hedge fund.
If your portfolio consists only of a long position in one stock and an offsetting short in a different but related one, you’re not vulnerable to market risk – just to the risk your long underperforms your short. What the media call ‘hedge funds’ do not represent an asset class of their own: hedge-fund managers can trade equities, bonds, currencies, commodities, and many other assets, with varying timeframes.
But they have a few things in common. They’re often based offshore to avoid proscriptive regulatory oversight, for example. They are typically partnerships, limited to the very wealthy. They sometimes borrow money to boost returns on strategies that would otherwise earn slim profits. And they invariably pay managers higher fees than ‘traditional’ funds, usually 2% of assets under management and a 20% ‘incentive fee’ on profits.
If that seems steep, note that all hedge funds (and funds of hedge funds) report performance data net of fees. What should matter to all of us is the after-fee return. A number of funds of hedge funds are now listed in London, so retail investors as well as the super-rich can benefit from this approach. These bundle several hedge funds into one vehicle, in which investors simply buy shares via the stockmarket (for more, see The Association of Investment Companies).
The London market offers access to both funds of hedge funds and listed hedge funds. Some worth a look include Absolute Return Trust (advisers: Fauchier Partners), with year-to-date returns of over 23%; Altin AG (advisers: Alternative Asset Advisors/Banque Syz), with year-to-date returns of over 26%, but in US dollars; Invesco Perpetual Select Trust (advisers: Invesco Asset Management), with year-to- date returns of over 26%; and Thames River Multi Hedge (advisers: Thames River Capital), with year-to-date returns of over 29%.
Listed single-manager funds include BH Macro Limited (BHMG) (run by Brevan Howard) and MW Tops Limited (TOPS) (run by Marshall Wace). One interesting aspect of these closed-ended funds is that since the capital initially raised represents ‘permanent’ capital, investor redemptions do not force the managers to sell assets.
So they are in some ways superior to traditional hedge funds courting the ultra-high net worth. Given the likelihood of choppy market conditions ahead, that could be a real advantage.
Tim Price is director of investment at PFP Wealth Management. He also edits The Price Report newsletter
Why not get into debt in 2008?
by Simon Nixon
The main aim next year for investors is to avoid losing money. That’s easier said than done and the credit crunch has made it tougher than usual.
Who could have imagined depositors in a high-street British bank would find themselves worrying whether they would get their money back? Or that parts of the commercial paper market – usually seen as the next best thing to cash – would cease to function?
Trying to spot safe havens in these conditions is tough. Various investments look cheap on a fundamental or historical basis: UK and European stocks, for example, look reasonable. The snag is that, so long as this credit squeeze continues, there’s nothing to stop assets getting a whole lot cheaper.
It’s not just a matter of how much the credit crunch feeds through to the real economy, triggering a slowdown or recession. It’s a question of what assets investors will be forced to start dumping to meet margin calls, or how much cash they will hoard, as their credit lines are squeezed.
So far the pain has spread from US mortgages to UK commercial property. What will be next? Throw in the possibility of serious currency turmoil next year and the outlook is grim.
The safest investment next year will be one that has least exposure to the deteriorating global economy, that is not at the mercy of fickle global investors, and is likely to be on the right side of any currency realignment next year.
There is only one asset that unambiguously fits the bill: local-currency denominated emerging-market government debt. That may seem a strange choice, given the way emerging-market assets have behaved in previous crises. But the world’s changed since the late 1990s in ways that should see them come through the crisis unscathed.
First, many emerging countries resolved, after the trauma of the late 1990s, never again to allow themselves to be prey to the whims of international investors. They pegged their currencies to the dollar at competitive levels, allowing their domestic economies to boom on the back of growing export markets, and they accumulated vast reserves that would allow them to defend the exchange rate and underpin their government bond market.
That makes these countries among the best credits of any government. The US has a mere $80bn of reserves; Brazil has twice this amount; Russia has $500bn and China an eye-popping $1.5trn.
Not only are default risks on these countries’ debts low, but they also offer a very attractive bet on global currency realignment next year. As domestic economies have boomed, emerging countries have been issuing bonds in local currencies, and so tapping local savers, rather than international investors.
The local-currency government-bond market is now deeper and more liquid than the emerging-market dollar-denominated bond market. It is the local-currency bonds that will gain most if, as expected, many emerging markets abandon their dollar pegs next year.
Some economists think it will take revaluations of up to 30% to bring emerging-market currencies in line with where they should be trading. Some argue that emerging market government bonds already look expensive as they trade at average spreads of only about 270 basis points above US Treasuries – far from the double-digit spreads of a decade ago.
But that misses the point: it is US government bonds that now represent the greater risk to international investors; and plenty of tightly priced developed countries present a greater credit risk.
You can’t just call up your broker and ask to invest in emerging-market debt. But there are funds you can buy. Ashmore, the emerging-market debt specialist, has two Luxembourg-based funds open to UK retail investors. And it recently launched a London-listed closed-end fund – Ashmore Special Situations – much of which will initially be invested in emerging-market government debt, although over time this will increasingly be invested in distressed debt and private equity.
Simon Nixon is executive editor of Breakingviews.com
Sterling will plunge – but your profits needn’t
by Paul Hill
At the depths of the recession in the early 1990s the UK was referred to as the “sick man of Europe”. Unemployment was above 2.5 million, property and equity markets had collapsed, while sterling was artificially overvalued at near $2. This was unsustainable – the pound’s strength meant that UK exports could not compete globally to help offset the dire state of the domestic economy.
Then in September 1992, a group of currency speculators led by George Soros made a fortune booting sterling out of the European Exchange Rate Mechanism (ERM) on Black Wednesday. The pound plunged, gradually nursing the nation back to health.
A similar, although less dramatic strategy, is being adopted by the Federal Reserve to protect American jobs in the run up to next year’s presidential election. As the dollar has weakened, the US is now a “low-cost producer” compared to its Western cousins – just witness the acute pain being felt by Airbus (Europe’s largest aerospace firm) in trying to compete with US rival Boeing.
I mention this because Britain shares many of the same ailments as the US (house prices on a knife edge and a hefty current-account deficit). It looks as if the US is around nine months ahead of the UK in economic terms; so I believe sterling is set for a fall – especially against the euro and even the dollar.
Sterling has also been the target of carry traders, who have chased higher-yielding currencies’ yield after borrowing cheaply elsewhere (such as in Japan). But with UK interest rates falling, this speculative element could also unwind.
In fact, devaluation has already begun, with the pound down to below e1.40 from e1.48 in the summer. If I’m right and the UK follows America into an economic slowdown and sterling continues to slide, then this will be good news for UK exporters (particularly to Europe) – and will also provide a timely boost for London-listed stocks with large operations abroad.
Companies that should benefit are drug maker GlaxoSmithKline (GSK), defence group Qinetiq (QQ) and retailers Kingfisher (KGF) and Kesa Electricals (KESA), which all derive substantial revenues from overseas.
My top pick would be GSK. At £13 it is trading on a 2007 p/e of 13.5 (attractive for such a science-rich firm), pays a healthy 3.9% dividend yield, and has a strong pipeline of new drugs.
Avoid domestic firms (especially consumer-reliant stocks) that import significant quantities of goods from abroad, such as M&S and Next. If you also wish to keep cash levels high, in preparation for buying opportunities once conditions settle, then depositing some money in a high-interest euro bank account would be a sensible approach to protect against any plunge in the pound.
Paul Hill runs the Precision Guided Investments service
Why you still need to buy gold and silver
by Dominic Frisby
In the first half of 2008, I expect gold and silver to be top performers. When (not if) gold breaks through its 1980 high of $850, which I expect before the end of January, it will draw new attention and could move quickly to $1,000.
When it breaks $1,000, which I anticipate by April-May, it will be big news. People will start to grasp the truth about inflation, fiat currency, money-supply growth, gold’s lasting purchasing power, and its use as money – and more buyers will come on board.
Institutions, many of which currently own none, will raise their precious metal holdings to 5% or 10%; this tiny market could quickly become flooded with buyers and speculators. Investors will look at silver lagging gold, and think “Silver’s a lot cheaper, yet it goes up by more”.
Silver is a much smaller market and, if institutional money moves in, it will rocket. I expect $20-$22 an ounce for silver, maybe even $25 by May. Of course, if this scenario plays out, we will most likely also get a nasty correction later. If gold hits the mainstream news, it would be a sensible contrarian move to take some money off the table.
Despite gold’s strong performance, junior miners have been weak of late. Many have returned to August lows, even though such stocks are usually expected to outperform the metal. I suspect this underperformance, while partly due to rising mining costs, is also because many investors have lost their appetite for risk, while Canadian tax-selling has also hit home this month.
But the firms themselves are progressing; most have announced more drill results, furthered their exploration, made more acquisitions, and moved closer to production. Their key asset, gold, has become more desirable – and yet the firms have largely got cheaper. That means there are some bargains out there.
Tax-selling pressure will dry up by Christmas and many investors who sold for tax reasons will buy back. So, even without a big move in gold, we should get a bounce in the sector in January and February. If we get four-digit gold, the juniors should do well.
For now, I’d stay with those at a late stage of development or early in production; the explorers will make their move later in the cycle. The easiest way to play precious metal miners is through the Market Vectors Gold Miners (US:GDX) ETF, which more or less tracks the HUI index of unhedged gold firms.
Dominic Frisby is a private investor in junior miners and energy stocks. Read more from him in Money Morning each week