The bear market in credit favors tangible assets, starting with Gold Bullion...
DIFFERENT DAY, same three "Fs", writes Dan Denning for the Daily Reckoning Australia – namely Food, Fuel, and Finance.
These three investment themes intersect, interconnect, and generally get all tangled up. Expect more tangling to come.
First, fuel. Crude oil just reached above $119 per barrel, a new nominal record. The latest big story driving the price was that British Petroleum (BP) shut down a key pipeline from the North Sea that carries nearly 40% of the UK's daily oil output.
The shutdown came thanks to a strike at a refinery that supplies nearly one-tenth of Britain's refined fuels. The strike at the Grangemouth refinery is important, because the refinery also produces power that goes to a neighboring facility which processes oil coming on land from at least 70 oil wells off shore in the North Sea.
A strike shuts down power. Power shuts down the refinery. And if the refinery ain't refining, you don't pump crude oil to it. It all makes perfect sense in its own way.
The strike at the refinery is a finance issue. The employees apparently want better pensions. The company who runs the refinery, Ineos plc, does not seem willing to oblige. The resulting impasse has led to 15 straight days of higher fuel prices for British motorists.
This little fuel crisis has nothing to do with an actual shortage of crude oil (though production from the North Sea is falling). It does, however, show how quickly a "system of systems" can be laid low by any interruption, man-made or otherwise. In the modern world, there's a thin line between light, mobility, and abundance on the one hand, and darkness, immobility, and scarcity on the other hand.
For its part, oil is rising on both supply issues (in Nigeria), demand strength (everywhere), and Dollar weakness (seemingly perpetual). On that score, some of oil's 40% rise this year (and 20% in the last three weeks) probably anticipates that the US Federal Reserve will cut its target funds rate again when it decides policy for the next month on Wednesday.
But has the Fed already reached the limits of effective monetary policy via interest rates. It's kind of a Zen issue at this point; because if a target rate is lowered yet banks still won't borrow or lend, have rates really been cut at all?
The US Fed, like all other Western banks – including the Reserve Bank here in Australia – finds itself helpless to control inflation in two key components that do not usually figure in so-called "core inflation" - namely food and fuel. Yet as you know, food and fuel prices are, indeed, rising. For consumers at the margin, increases in food and fuel prices are very real factors on the household bottom line.
Nor are the increases in food balanced by declines in the price of imported white goods and electronics. You can't eat a dishwasher.
There is now a great deal of speculation in the Aussie press that the RBA should abandon its inflation targets. Pundits worry that the RBA will slam the economy into recession by raising rates to contain inflation that it can't really contain anyway. Rate rises won't contain price gains in food and fuel; they'll just make houses more expensive, or so the argument goes.
We don't have an answer for the Bank here at the Old Hat Factory. In fact, we're not even sure there IS an answer. A decade of low interest rates has led to a surge in global growth (not least in population). That's led to an increase in demand for real resources. Fiddling with the money supply may reduce investor's appetites for speculation, but it is not going to make people in China and India less hungry.
The idea that fixing the price for money solves all economic woes is central to the Age of Finance. But maybe, along with the age of cheap oil, we've passed the peak of cheap money. Maybe we've already hit Peak Finance!
"For the past three decades," reports Justin Lahart in the Wall Street Journal, "finance has claimed a growing share of the US stock market, profits and the overall economy. But the role of finance – the businesses of borrowing, lending, investing and all the middlemen in between – may be ebbing, a shift that would redefine the US economy."
We can only hope. The business of making money by moving money around is nice work if you can get it. Especially during a bull market in credit. But it doesn't really add economic value. Nothing real is produced, and obviously, the capital itself hasn't been allocated more efficiently.
Just ask investors in mortgage-backed securities or bank and brokerage stocks that have taken billion in losses on bad loans.
The bubble in finance is popping just like the bubble in Dot.Com stocks popped. The deflating of the finance bubble has much bigger real world consequences, however. And in the stock market, the stocks that led the last bull market never lead the next one.
We wouldn't waste too much time picking through the rubble of the financial sector. Instead, you want to figure out what's going to lead the market up next. The trouble is, the market itself may not be headed up at all. The major indexes could move sideways or down, in real terms, over the next few years. Passively owning "the market" through an index fund will probably be a losing strategy.
We reckon that the bear market in credit favors tangible assets instead. We also reckon that investors who have outstanding investment returns will get them by focusing on asset quality, low debt levels, businesses with regular cash flow, and businesses that have a competitive advantage of some sort.
That all sounds pretty routine. And truly, there's nothing revolutionary about it. But it's amazing how many fund managers have been getting by on rising index values alone.
Time to start working for your money again boys! Let's hear it for good old fashioned securities analysis.
And as for tangible assets, "Golden future emerges for precious metals," reads a headline in today's Financial Review. The fundamental appeal of Gold as an inflation hedge still looks a good place to start.