One of the benefits of being a fund manager is the amount of interesting, seemingly trivial but occasionally relevant information that crosses one’s desk. For instance, did you know that if you give the keys of a 250 tonne truck to a Zambian who has previously only ridden a bicycle, he will not immediately drive it at the rated 30 kph down a narrow, steep incline? While this may not gel with empirical evidence from the London mini-cab fraternity, it goes some way to explaining why a start up mine in Zambia disappointed in its’ first quarter of production. The geology and metallurgy was fine, but productivity was low. The mine should have another 120 quarters ahead of it for the drivers to speed up, yet the market has been flushing away Australian listed Equinox knocking 20% off the market value in two days. Once again the markets prove that having a lot of information does not necessarily result in correct pricing. We view these types of events as heaven-sent opportunities to invest in a genuinely scarce resource at a cheap price, and were happy to hoover up stock from the short-termists out there.

Some readers may remember us opining on the advantages of investing in countries with stable geo-politics, which usually means that Africa does not figure much as a preferred operating location. However, recent events have forced us to look slightly further afield than Queensland or West Australia. China remains the marginal buyer of resources, and after the Rio snub – now significantly escalated by the detention of four Shanghai-based Rio employees – seems to have turbo-charged its appetite for assets in the developing world. With Chinese Premier Wen Jiabao announcing that China would accelerate its “going out” strategy, Addax Petroleum (Africa and Middle East), Emerald Energy (South America and Middle East), YPF (South America) and Angolan Oil Fields have all been on the shopping list this month. Zambia is a preferred choice in Africa with political succession at the ballot box and a relatively predictable royalty regime. All things being equal, we would prefer Australian-based assets and although corporate activity is likely to be more buoyant elsewhere, Australian listed but politically acquirable assets are still definitely attractive if the asset is good enough.

The Auto industry has finally served an ace with some stunning figures for Chinese car sales – up over 40% YoY. Inventories in most Western markets are now back to normal (aided by Government funded scrapping schemes), a lot of US capacity has been permanently shut down, and the likes of BMW have actually had to increase production levels to meet demand. While we remain agnostic about the valuations of most of the listed players, this is clearly good news for the component industry. In particular it is good news for Platinum, which we have been keen on since the price plunged on inventory liquidation last year. Car sales will move up gently, but production will rise sharply as some temporarily mothballed plants re-open. Inventories are non-existent, and most mines are still loss making meaning supply will not react quickly. A US-traded ETF is also in prospect, and if it acquires anything like the market share that its Gold focussed cousin did, the price moves could be spectacular. Still our favourite commodity…

It’s not just car sales that are buoyant in China. The property market is also on the move, and the stock market is racing ahead. 8% GDP growth this year is now a given and forecasts for 9-10% next year are not being ruled out of court. What financial crisis? Who cares about the export sector? Yes, China fever is back. Enforcement of second mortgage criteria, a small rise in the repo rate and an edict to banks to raise their NPL coverage are all clear signs that Chinese policy is preparing to move from ultra-accommodative to merely easy, yet markets – as they always do –  wilfully ignore the early signs of tightening and wait for the sledgehammer approach to come later. Valuations are no longer cheap in either Shanghai or Hong Kong, and while we do not wish to stand in the way of the tide of money, there are better opportunities elsewhere in the region where complacency over policy is less of an issue.

Angela Merkel does not like the City of London or Wall Street. Nicolas Sarkozy doesn’t like hedge funds (as most of them aren’t French). In a flagrant but potentially successful attempt to succeed economically where Waterloo and Agincourt failed, restrictive and costly Euro-regulation is coming the financial sector’s way. Contrast this with the way the automotive sector has been treated. What a shame the UK does not have one anymore.  Never mind that the Landesbanken are probably some of the worst serial offenders for irresponsible lending. Populist and nationalist measures are likely to pass, and banking profitability in the West will take a hit. At the same time the price will have to be paid for some of the ridiculous corporate lending that went on in 2007. Private Equity managers are taking advantage of the lack of banking covenants to wheedle discounts from senior lenders when the equity by all rights should have been wiped out months ago – EMI and Citigroup come immediately to mind, but other examples are numerous. It’s bad enough to make a duff loan, but being unable to foreclose and being out-manoeuvred by a management team with nothing to lose must really rankle. Asian banks made few of these gifts wrapped up as loans, and will not have to spend the next five years disentangling themselves. Advantage Asia yet again.

Does anyone remember the phrase ‘bear market rally’? It was all the rage a couple of months ago, but now we are all true believers. We would not want to decry the positive nature of the current US reporting season, but would point out that not only were expectations very low, but also that most of the surprise has been at the reduction in costs rather than increasing revenue. As one man’s cost is another’s revenue, at the macro level one cannot shrink oneself to greatness. It is also undeniable that some of the cost benefit has been from low commodity prices which in many cases are already rising again. Many Asian markets have regained pre-Lehman levels and there are an increasing number of siren calls for the Western markets to follow suit. Again, we would make a couple of observations. First of all, if one removes the financial sector from the computation, we are already back near those levels in many cases. We would also point out that the West (ex Australia) has just been through the worst recession in a generation, and that reverberations from the same will continue. Savings have to rise, consumption has to fall, and leverage is history. You cannot extrapolate the debt-fuelled history of Western economic growth from 1982 to 2007 into the next decade. We expected markets to have a quiet summer, digesting the gains of the second quarter. We were way too cautious. Animal spirits have returned big-time and it is time to get very selective again as there is a little too much greed in the system. Making money in the first half was easy. It will be a bit tougher – but certainly still possible – in the second.

• Previous Entry: Irrational exuberance
• Next Entry: Jeff Coggshall – July 2009