Before I start my regular quarterly report I should mention that I believe that this may be the most singularly important letter I have ever written to my clients since joining the exchange in 1980. Prior to joining stockbrokers Beardsley Bishop I worked for 18 months as the silver clerk for a London Bullion Market firm having moved there from Marshalls Moneybrokers where I trained as a London inter-bank dealer and prior to that with the Chartered Bank so I believe that I may be in a unique position viz-a-viz the current market scenarios unfolding today some 30 years later. The 9% growth rate in China today and the opportunities in the asean region were well known by our forbears at Chartered and HongKong & Shanghai and if I had to back two banks that I think will benefit the most from today’s opportunities I would certainly back both Standard Chartered and HSBC in preference to the less specialised opportunists. I recollect that in 1978 overnight rates reached between 15% and absurdly 35% at times so I am hesitant to correct those bulls who maintain that rates will stay forever in single figures. In the early 1970’s exchange firms were closing down around the secondary banking crisis brought about by chaotic lending, muddled economic thinking from No. 11 Downing Street, real inflation which ultimately engineered the single biggest move in bullion prices in history thanks largely to Nelson Bunker Hunt and his brother cornering silver and the Soviet Union entering Afghanistan sending gold to trade as high as $855 pto. The real reason then, arguably, for the invasion was to stimulate bullion so that the soviets could buy grain on the open markets to cover the failed harvests and I recollect that my firm bought gold and silver in vast quantities from Metallgesellschaft, the East German business fronting the soviet master plan. It was all very John Le Carre! There are striking similarities with the current scenarios unfolding in the world although the characters have changed as have the flags. The main point that I am attempting to make is that I believe that bullion will become the big news story over the coming years as problems with derivatives and debt combine to effect the liquidity that is prevalent today. One nameless analyst recently suggested that gold should be trading at $1800 pto on a comparative basis to copper. I am not sure whether this is relevant but I do know that historically gold has moved for different reasons on around 10 occasions since the Gold Standard. With increased demand from China, Japan and India the supply is drying up and when the derivatives positions start unwinding as Warren Buffett has predicted then gold will be treated as a real currency which recently in the West it has not. Central banks (not France) have been net sellers for the last 25 years and it is only a matter of time before things get very interesting.
Since writing my year-end report M&A activity in London has continued relentlessly fuelled by the extraordinary and excessive growth in Private Equity. Daily speculation sparked by hedge fund activity has created a bewildering stock casino whereby valuations are often thrown to the wind. Last year the UK’s favourite pharmacist Boots merged with Alliance Unichem creating Alliance Boots and not withstanding the obvious merits in the merger of cost savings and better European coverage not a single retail analyst in London had a significant ‘BUY’ recommendation after the event. In fact many analysts forecasted target prices as low as 650p in the weeks prior to the private equity approaches that catapulted the price from £8 to over £10. Similar patterns have emerged in many other companies such as Scottish & Newcastle, ICI, Royal Sun Alliance to name just a few and just this last week Sainsbury, Barclays/ABN-AMRO/Royal Bank of Scotland have all been in the spotlight. It astounds me that only last week I watched a banking analyst on Bloomberg TV talking about a wave of consolidation in the banking sector referring to the interest in ABN-AMRO. I doubt many hedge fund dealers even know that the Dutch banking giant consists of Algemene Bank Nederland, Amsterdam Rotterdam Bank, Mees & Hope, Pierson Heldring & Pierson, and a host of smaller dutch banks, many of whom were major City/Amsterdam names only ten years ago or so! How long can all this speculation and consolidation continue? Well, the answer has to do with valuations, accounting, liquidity and a host of other factors not forgetting sentiment and my dread topic, regulation.
Following on from the argument that cash is the main driver of markets there’s no reason then that the markets should correct at all but as we all know bubbles are burst for the very reason that they have to at some time. The current scenario in stocks, property and art prompts me to believe that 2007 could pan out similarly to 1987. A summer fuelled by takeovers then was quickly vanquished by a 23% correction in a day with a real hurricane thrown in for good measure. The bears (I am bearish but not recommending 100% cash like some scribes) forecast higher interest rates, a property crash (see Ohio), a slowdown in China, military action against Iran/Syria and an escalation in the Middle East involving Israel, turbulence in the currency markets and a host of other catalysts forcing an asset implosion. Inflationary fears persist in the western economies. Bulls on the other hand will continue to support the speculators and the excessive valuations not supported by traditional analysis. The majority thus continue to subscribe to the view that the trend is their friend as did the lemmings of course once upon a time.
In this backdrop and forever changing environment I have changed my strategy by amending my intended portfolio weightings to equities 85% cash 15% and fixed interest zero. The consensus weightings are UK equities 55% overseas equities 20% fixed interest 20% and cash 5%. But with the yield on many equities now trading in close proximity with their underlying debt instruments and with a higher interest cycle in the offing I see little merit in considering this approach. Five year AAA/Aaa £ Eurobonds yield around 5.7% whereas 10 year AAA/Aaa bonds yield somewhere around 5.4%; none of the treble AAA/Aaa bonds in £ appear very attractive in an inflationary environment. Yields in Euros bonds and US$ Eurobonds are even lower. Marks & Spencer, as an aside, have just issued a new 5 7/8% coupon £ Eurobond maturing in May 2012 at just under par (current yield 6.04%) but Standard & Poor and Moody’s have rated Marks with a low BBB/Baa2 rating. The risk to reward for many household names in the bond markets do not equate to the perceived risk taken by many equity investors. This week Moody’s have downgraded 44 banks including ABN-AMRO to Aa2/3 ratings transmitting alarm bells amongst banking analysts and annoying prime and sub-prime lenders. My weightings thus differ from many of my peers. Currently my ideal portfolio would have international equities 85% and cash 15%. The equities element, albeit higher than the consensus weighting, would be large capitalised international businesses split as follows; int’l miners (Rio’s & BHP Billiton) 15%, gold miners (Randgold, Anglo American & Hochschild) 5%, int’l oils (BP & Royal Dutch Shell ‘B’) 10% and other equities to 55%. In the coming storm predicted liquidity is going to be very important indeed as will be flexibility. Selling general equities (i.e other than miners and oils) and moving to short-term cash instruments is the likely scenario unfolding as current hedging instruments will become too unpredictable for many investors. I should indicate that in the banking sector I remain negative on domestic banks in view of the recent developments in the US sub-prime market which is quite clearly probably mirrored elsewhere although the triggers have yet to be pulled.
So gold looks interesting at $678 (January price $630 pto) and I continue to recommend Randgold where Goldman Sachs initiated a ‘BUY’ stance on 23rd February with a target price of 1635p. Hochschild is another London-based gold stock destined for growth this year.
With FTSE100 index trading in 6000-6450 range don’t be surprised if the next major move is down. It is time to nail one’s flag to the mast and I am in the Buffett Navy under the sub-commands of Messrs. Marc Faber and William Bonner.
As I said in January “the ride in 2007 could be very volatile” and it looks very likely still. No-one can predict for certain how or when the correction will come but I do believe that now is the time to prepare the defences.
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