Common purpose

I’ve just returned from a business trip to Abu Dhabi, Dubai and Saudi Arabia. Saudi in particular is driven by a common purpose, to prepare for a post-oil world, with financial services being identified as helping to achieve that end. Saudi is the fastest growing market save India. It has a thriving domestic equity culture where public markets provide a public good, namely wealth redistribution. Its regulators seem proactive and engaged to profile the opportunities for financial services and where retail investors are so sophisticated they need private market and thematic exposures to lure them onto public market platforms. It’s exciting.

Distance and perspective

But it’s not just finance. Sport, as you know, is racing ahead (apparently Ronaldo has found some form). The film industry is booming with box office receipts having surpassed $1b. On the day I arrived thousands of ‘Swifties’ had gathered in ‘listening rooms’ to hear the first drop of Taylor Swift’s latest album. And on the day I left, Saudi staged its first ever opera. Now I will discuss the Middle East and Saudi more in time, but I wanted to focus on the Far East today, namely China. At least it seems far away from my vantage here in Oxfordshire, UK. But from downtown Riyadh it seemed an awfully lot closer. And not just in terms of physical distance.

For the sake of the children

As you know, our beliefs and preconceptions can often blind us to accepting reality, change, or new ideas. One idea we in the West have grown accustomed to is that ‘strategic competition’ and ‘positive investment returns’ struggle to co-exist in China. But I wonder how much of this narrative is just down to the numbers (poor stock returns mostly), and what might happen if those numbers reversed? Might a new narrative then emerge? Well, I suspect we might soon find out as the numbers look likely to change quite markedly. And if they do, I would like to propose a new narrative, one more like that of a divorced couple. They may never be friends (nor like the other’s new partners much), but they commit to get along ‘for the sake of the kids’.

We need to talk about China

We can’t ignore China. It matters to many things, not least global inflation and the price of money. And there has been some pretty significant changes in China recently. Take for example the State Council’s release of their “Nine Guidelines for Capital Markets”. Note the timing of its two previous statements, 2004 and 2014, just prior to major moves in Chinese stocks. For years Chinese markets have suffered from the vicissitudes of domestic retail investors. This directive aims to solve for that and create a more sustainable investment framework for durational capital, the development of index investing and expand on the investment policies of the National Social Security Fund (it’s no longer just for plunge protection). It seems the stock market is becoming a policy lever one that if pulled, should help improve wealth effects. And should this coincide with the other, far more significant lever: property, then new narratives such as ‘recovery’ and ‘reflation’ may also emerge. Narratives that would likely make the job of the Federal Reserve more tricky. And higher rates all the more sticky.

Property QE?

There have been a number of measures aimed to improve housing demand recently. These stem from the whitelist program, to cities removing ownership restrictions. Rate cuts have also been hinted at. More powerful could be reports that China’s ruling Communist Party has vowed to study measures to digest the nation’s housing stockpile, and actually cut housing inventory! This sounds a little like what the US did post GFC. But instead of being the buyer of last resort for mortgage or debt related instruments, it plans to buy the underlying collateral itself. What might that do to price of said collateral. To confidence? To consumption? To copper demand?

A very, very big hole

The Chuquicamata copper mine in Chile is the largest hole ever dug. In fact, copper mines generally are the biggest holes that we, as a species, have ever made. That explains why few want them dug ‘next door’, that new mine applications are hard to attain and why there is a worrying lack of future mines planned. Copper grades keep falling, most easy copper resources have been exploited and when interest rates rise (see full employment, state largesse and China pivot and property recovery for clues), so too does replacement cost. Meaning existing mines become scarcer. And valuable. This at a time, of course, we will need more copper than ever before. In fact we need to mine more copper in the next 22 years than we have in the entirety of the past 5,000 years of human history. A fact not lost on BHP it seems. Nor is it a fact attained by paying thousands to a Wall Street commodity analyst. But for £17 for Ed Conway’s book, Material World, which I (still) believe becomes the touch-stone for the greatest mean reversion of our careers.

A reversion that partly explains why the UK could become the trade of the decade.

Scarcity

BHP is signaling that it’s easier to buy existing mines than to build new ones. But while mine permits are scarce, even more scare (over time) could be those people – the miners – to mine them. Those engineers, geologists and blue-collar types who are not only in huge demand at mining firms, but also on construction sites, on windfarms, and weapon manufacturers. Why? Because college age graduates want to become app-developers, not spot welders. They want topknots, not tattoos. Tesla’s not trucks. And those industries face an enormous generational cliff – far more workers are retiring than are being replaced. And as we’ve said many times, Nvidia can do a lot of amazing things, but it can’t swing a hammer. So BHP may be on to something. It may be onto the real scarcity in the AI/clean energy value chain.

Not mines per se, but miners.

You miss every shot you never take

Howard Marks's short memo (actually a podcast) on "The Indispensability of Risk" is worthwhile listening to this week. The point he’s trying to make is there can be no reward without risk, and often the biggest risk you take is by not taking risk! He cites Chess Grand Master Magnus Carlson who would say, “not being willing to take risks is an extremely risky strategy”. You miss 100% of the shots you don’t take. Quite. And yet, few of you seem to be taking much risk: in gold, in copper, commodities, in China. Or even in Europe, EM or the UK. So, grab your passport. Come to London. Maybe catch a ride with Larry Ellison, the world’s fifth wealthiest person, who two days ago announced he’s taking a $1B ‘bet on Britain’.

Risk free? Really?

One thing that infuriates me is when people call the 10Y risk-free. What’s riskless, exactly, about the possibility of destroying purchasing power over time? Now, this is not to ignore the important role bonds (can) play in asset allocation. During periods of no/low growth or deflation (which often coincide) they outperform but to assume they always have a roll, is, well, risky. In the 1970’s they were termed ‘return free risk’. We may not be in the 70’s, but we’re also not in recession. We have full employment, Military Keynesianism, muscular industrial policy, the world’s largest construction project and China could be making up with its ex-wife, for the sake of the kids.

Letter to my banker

To the guardian of my savings who announced this week they were selling UK stocks to increase their Private Equity (PE) exposure, I ask: “have you done the math"?

Since we’ve already established that volatility is very much dependent on the measurement used, lest the frequency of such measure. So the myth of smoothed returns is very much that. A myth. Let’s apply the same measure to public equities. And let’s compare that outcome to the cash returns currently achieved in PE, around 11%. Now, the FTSE has an average yield of 4%. Say you bought a basket of dividend stocks with a yield of 5% (quite easy) that grow their divi by 5% and buyback 5% per year (of course it’s never that simple, but bear with me). By year 7 it’s double digit and by year 10 it’s +13%. Not bad, considering you don’t need any price appreciation or leverage to achieve it. But as leverage is commonly utilised in PE, let’s add a little (to keep this fair), say 30% (with a 6% coupon). By year 4 you will have nearly doubled your cash-return, after 10 it’s near 20%. And that’s assuming these stocks haven’t been bid for at +50% premium (which is the current UK average) by PE.

If you are happy to sell low and buy high that’s fine. But I’m selling you...