How can you have inflation with such a large output gap? This is a common refrain from anyone still in possession of an economics textbook (full disclosure – I have never owned one) and one that seems intuitively sensible. More supply than demand should push prices down, right? The problem with this cosy assumption is, however, twofold. It is directly contradicted by a few episodes of recent history and relies on an assumption of trend and potential growth rates, which as is usual with practitioners of the dismal ‘science’ involves nothing more sophisticated than putting a ruler over the last few years experience.

Remember the 1970s in the UK? The winter of discontent, 3 day weeks, blackouts – and rampant inflation (not to mention the golden era of rock music, 1968-1976). The oil shock was the catalyst, but the whole unsavoury episode is a clear reminder that stagflation is possible. Inflexible work practices and barriers to the free flow of trade and capital contributed as well, but we think that it is premature to declare it all right now, especially as we see all the ingredients for a spike in commodity prices down the track as ever-growing Asian demand drains the wishing well of supply where there has been a hiatus in investment courtesy of the GFC.

The concept of potential growth of an economy seems theoretically sound and easy to calculate, providing one can estimate changes in the size of workforce and productivity. The latter is conceptually straightforward for (say) an auto factory. Not so trivial to work it out for (say) an advertising business. Yet now most of the western world’s economies are dominated by the service sector. This surely should cast doubt on any projection of future productivity growth and therefore the capacity an economy to grow, let alone any estimate of a longer term trend rate. Extrapolation of the last twenty years is likely to be flawed as it is difficult to see another couple of decades of fast, disinflationary growth fuelled by easy money availability from what turned out to be hopelessly over-leveraged financial institutions. The emergence of China as a manufacturing powerhouse has been a key factor in depressing prices of manufactured goods and spurring consumption-led growth in the West. As China moves up the wealth, wage and consumption ladder and input prices rise it seems less likely that this will continue to be the benign force of recent years. We may well be at a secular turning point where manufactured goods cease to fall in price – a fire and water moment? We retain our mid to long term inflationary bet with our holdings in gold and platinum.

All property investors love a bargain, and six months ago one was spoilt for choice. Opportunities to buy a dollar of assets for 50 cents – or in some cases, 15 cents – abounded. This was a geographically widespread phenomenon, which has recently disappeared in most countries as market prices have soared and dilutive equity issues have proliferated. There is one glaring exception and ironically in a country with very little oversupply of commercial property and a resilient economy. Australia is the last bastion of discounts to NAV, somewhat ironically as the sector has historically traded at a big premium, unlike the UK or US where the newly arrived premia are an unusual phenomenon and clearly represent an increasingly bullish view on yields as rents are likely to remain pressured by material oversupply. The Australian property investor is still shell-shocked. They were sold a lemon over the last decade by the financial engineers dressing up a straightforward collection of buildings as a structured financial product, and the bursting of the bubble has left a lot of collateral damage. Some of the most beaten-up names such as Goodman and Mirvac have rallied as balance sheets have been repaired, and made a lot of money for the fund, yet the office trusts languish near recent lows despite clear signs of an improving physical market. There have been very few cranes sighted on the Sydney or Melbourne skyline this decade, and unemployment may well have peaked already. Contrast this to Dubai or the City of London where oversupply and falling demand are rampant. This is currently our only long property investment in the region.

Renewable energy will be an investment theme for the foreseeable future and we are very attuned to some recent developments that have the potential to revolutionise energy production and go some way to reducing the speed at which homo sapiens rapes the planet. The two areas we would highlight, both represented in the portfolio, are underground coal gasification and wide band photovoltaic cells. The former is not a new concept, but the first attempts over the last 50 years or so in Russia and the U.S. were dogged by (avoidable) environmental issues and many people now ignore the possibilities. Yet it is now possible to safely burn coal deposits underground that are too thin and/or deep to mine conventionally with a minimum of capital expenditure or environmental risk but with a far greater overall efficiency than by any form of conventional mining. Like coal bed methane (where we have also made decent money over the last couple of years), this is a sector which vested interests tend to denigrate, not because it doesn’t work but because it threatens their business model. Buy before the sector gets proper coverage. The second technology is less commercially advanced, but has the potential to triple the efficiency of conventional silicon cells by accessing the ultra-violet and infra-red sectors of the electromagnetic spectrum as well as the visible portion. Again, existing players in the industry with no intellectual property downplay the possibilities. We regard it as a cheap and potentially very profitable option. Tiburon is about to launch a Renewables specialist fund. Please call for more information.

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