Tiburon Partners LLP

We have all seen China’s PMI numbers and they look okay. Yes, they slowed a bit, but this was expected. More importantly, it looks like May’s rapid and violent de-stocking exercise has come to an end (China’s July PMI new orders versus inventories ratio saw its first increase since April). Some of the excitable financial market types who worried that China was both overheating and having a housing bubble while at the same time rapidly moving towards a crash landing now agree that China is in the process of a “soft landing” – i.e. a modest, orderly slowdown. There is some good evidence for this. Services and consumption are faring much better than manufacturing and heavy industry. Retail sales remain strong, and retail sentiment is showing a very significant improvement at the same time as pollution-creating and energy intensive industries face fairly meaningful headwinds.

This slowdown appears to be uneven and shallow. Of course, much of it is self-imposed. So, for instance the restrictions on credit extension, the property market, and energy & resource intensive heavy industry are all, in theory, easy to reverse and could all even go in the complete opposite direction if necessary – possibly on a moment’s notice, as we saw back at the end of 2008.

Although managing China’s economy is never an easy task, Chinese policymakers should be feeling pretty confident right now. They have just had two consecutive experiences of getting China’s economy to respond extremely well to government-led signals and policies. Just as the old adage “don’t fight the Fed” made its way into the lexicon I suspect that » Read more: Jeff Coggshall – July 2010

For sale: a minority interest in one undeveloped iron ore deposit, no infrastructure, dodgy neighbourhood (had civil war in recent past), management has criminal conviction for heroin offences and civil penalty for misleading the market. Offers in excess of $1.5bn entertained, mandarin speakers preferred.

For sale: shell company, ‘for carrying on an undertaking of great financial advantage, but no one to know what it is’. Will compete in the open market to buy mining assets against deep pocketed sovereign states (who have no imperative to make profits), prime managerial sponsor has no resource experience, time share on oligarch’s yacht possible for selected investors if failed political spin doctor not using it.

For sale: selection of Australian coal mines, contracted to sell majority of output at fixed, below market prices to local utilities, will require foreign investment approval, offers in excess of DCF valuation.

For sale: in the near future sundry assets unwanted by oligarch. No translation of concepts such as governance or minority rights available from the Russian. Last float down 33% in six months.

If these ads had appeared in the mining press recently, one would be forgiven for thinking that the vendors would not have been knocked over in the rush. Yet African Minerals has received an undertaking from Shandong Steel to invest $1.5bn in Sierra Leone, Vallar has raised $1bn for God knows what and Banpu has taken over Centennial. In addition, Posco has taken a stake in AMCI (Australia), KEPCO has bought 20% of an Indonesian coal miner and Adani of India seems likely to invest $1bn in a very large but currently stranded coal asset in Queensland. Even Oleg Deripaska thinks he can float more of his Siberian ‘assets’. Iron ore prices may have peaked, China may slow a little, but the land grab for resources is still very much on. » Read more: Mark Fleming – July 2010

Despite an overall lacklustre performance for the market, given strong rallies in other leading stockmarkets, there was a noticeable shift in market leadership with smaller companies starting to underperform larger companies. This can probably be attributed to the sharp decline over the preceding months in large caps and the significantly higher than expected quarterly earnings announcements that produced several unexpected upward revisions. Of less surprise but as encouraging was the dramatic improvement in terms of free cashflow, a reflection of the significant restructuring over the last 18 months, which we continue to believe has been under appreciated by investors. With capex levels now running below depreciation this trend should continue. In addition, it may also explain why the corporate sector has been significantly less animated about the recent yen appreciation.

The conundrum that lies ahead is this: » Read more: Rupert Kimber – July 2010

The portfolio was up 3.x% for the month. The greatest gains occurred in mining and alternative energy. The biggest winners were two stocks highlighted in previous reports – Linc Energy +56% (underground coal gasification) and Lynas +39% (rare earths).

The portfolio’s most profitable position was in Linc Energy, which is utilising underground coal gasification (UCG) technology to produce hydrogen and methane gases from coal seams deemed uneconomic to mine. The cost of UCG is significantly more competitive than production of coal-bed methane and LNG. However, the catalyst for unlocking value is the negotiation to sell several of its non-core assets, including Australian coal deposits Emerald and Galilee in Queensland, which alone could be worth more than $1.5 billion, a multiple of the current market capitalisation of the entire company. We expect a transaction to close shortly on the sale of the Galilee coal assets to an Indian buyer for a price above what has been expected by the market, while negotiations for the sale of the coking coal asset is on-going. Given the tight supply for coking coal on a global basis, it is quite possible that the asset is sold at a price above what we projected. The portfolio holds a 4.9% weight to the stock and is the largest holding in the portfolio.

Despite considerable recent press coverage on rare earth mineral availability, the United States and Europe have been remarkably insouciant about supplies of rare earth minerals so crucial to frontier technologies, from hybrid engines to mobile phones, superconductors, LED light bulbs, wind turbines and smart bombs. China’s commerce ministry has cut export quotas for these metals by 72% for the second half of this year. The sudden shortage in supply now threatens to » Read more: John Payne & Steven Miller – July 2010

Japan remains an investment conundrum. At the corporate level there is much to admire: healthy balance sheets improved by rising cashflow, ongoing commitment to restructuring especially in the more domestic sectors where historic overcapacity has affected returns and valuations that appear inexpensive. Ostensibly an attractive cocktail but why then are investors apparently so unenamored? Perhaps the reality is that the ongoing domestic institutional selling, leaving the foreigner as the only buyer, continues to expose the market to more cyclical factors, namely world growth rates and on this score there is cause for concern that corporate profit margins have peaked.

Our primary concern for several months has surrounded earnings forecasts, especially for next year when clearly the benefits of inventory restocking will be removed resulting in a lower base effect and therefore requiring strong sales to post a positive sales number. Analysts have remained very optimistic and have retained target prices that now look attractive given the recent market decline but this still appears overly ambitious as » Read more: Rupert Kimber – June 2010

June saw significant volatility during the month with slower growth anticipated for China acting as the main catalyst to drive resource equities much lower mid-month. The CBOE SPX Volatility Index or VIX ranged from 24% mid-month to 35% at the start of June and also by month end. Correlations between asset classes remain high by historic standards and implied volatilities continue to trade at a premium to actual.

One measure of economic activity, the Baltic Freight Index, is down 40% over the past month. Despite a huge injection of both fiscal and monetary stimulus, Europe looks moribund and US growth appears to be slowing. First quarter US GDP growth was revised down from 3.2% to 2.7%. In addition, two-year Treasury yields stand at a record low yield of 0.6%, which was not even seen during the depression and the 10-year yield has fallen below 3%. These low Treasury yields are clearly incompatible with most economists’ estimates of 3% annualised growth for the next few years. In Europe, the financial system remains under duress across Europe and according to the Bank of England’s June Financial Stability Report, banks in Europe and the US need to re-finance/roll-over $5 trillion in debt by » Read more: John Payne & Steven Miller – June 2010

Investors cannot stop worrying about debt. And this is the case no matter whether it is Southern European sovereign debt, Fannie and Freddie’s US mortgage obligations, or the upcoming aftermath of China’s lending binge last year. I can’t tell you for sure exactly how many, or which potential parts of this moving jigsaw puzzle are factored into expectations – and neither can anyone else. But there are a few interesting things to point out.

Remarkably, a Greek default and significant further weakness amounting to an effective “double dip” are now already factored into many managers’ “base case” scenarios. For instance, in recent surveys no less than 80% of fund managers expect a Greek default or restructuring some time in the next couple years, as well as bank recapitalizations in Spain, and serious problems in most of the rest of Europe. Investors have firmly embraced the notion that if we are having a recovery, it sure isn’t a normal one.

Asian markets have sold off (partially as “growth proxies”) and China continues to face » Read more: Jeff Coggshall – June 2010

The electorates of Europe are just starting to realise the reality of the coming austerity measures. Conjecture about cuts amounting to billions of $, £ or € and tax increases are now becoming a reality. Significant reductions in policing and schools are happening, pay cuts to fund (reduced) pensions and tax rises that make a difference to everybody are now coming home to roost. The private sector is also starting to realise how big a client government is – and how generous it has been in the past in its behaviour as a customer. It seems almost inconceivable to us that this does not precipitate the much-feared double dip recession.

So are European Governments tightening too early as the US has been saying? The answer is a resounding no. There is never a ‘good’ time to go cold turkey – in this case on debt – but the longer you leave it, the worse it is. The politician’s favourite fable of a vigorous recovery that leaves economies in a position in a year or two to take a major fiscal tightening on the chin and not go down is wishful thinking of the worst kind. It merely adds more debt in the interim and if there has been any kind of recovery in that period, dilutes the political will to make the difficult choices that have to be made. While the Germans are donning a hair shirt with possibly too much relish, » Read more: Mark Fleming – June 2010

For so many people, the world seems to be ending. Europe will collapse when Greece, Spain, Portugal or all three default and Germany will exit the Euro leading to tremendous global financial instability. Other dominoes will fall. Then, later on the US current account deficit will widen as a result, leading to a further, unsustainable global imbalances. As the Eurozone problems have no obvious solutions and markets are now forcing the issue, it is assumed that significant cyclical damage is yet to come.

At the same time, in China, the leadership appears to be mainly preoccupied with domestic issues, such as cracking down on perceived property market speculation. The measures have been forceful and frequent and there is no reason to think they will stop before » Read more: Jeff Coggshall – May 2010

Global equity markets recorded one of their worst months of performance since the 1970s. Alternative energy and natural resources were not immune. The MSCI Global Materials and Energy Index fell 12.1% while the S&P Global Clean Energy Index fell 18.4% while Tiburon Terra posted negative performance for May, down some 9.4%.

Although the portfolio had a low net long exposure in alternative energy coming into the month the weak economic outlook in the EU and concerns over sovereign debt in Greece, Spain, Portugal and Italy contributed to that sub-sector falling heavily. Elsewhere the portfolio’s holdings in Australian resource companies were hurt by the Australian Government’s decision to implement a Resource Super Tax on mining companies. The mining sector also suffered as a result of the Chinese government moving to slow the luxury residential property market in tier one cities. With transaction volumes taking a nose dive, we believe that Beijing has now achieved its objective of slowing the market in this sector and will probably relax its policies in the coming months. The portfolio had in place short exposure to international » Read more: John Payne & Steven Miller – May 2010