intervention

Why Global Markets Could Be Derailed by the Ukraine

Turmoil in Emerging Markets hit investor confidence in January and, after a stellar February, the crisis in the Ukraine could lead to profit taking this month. Indeed, volatility spiked to a similar level and the S&P came off its all-time-high on Friday as fears started to set in.

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Libya – Oil, Water, Gold – The Real Issues

The oil price has sky rocketed over the past few months. The finger has been pointed at the troubles in Libya and claims of supply disruptions have dominated the press. However, are these claims grounded in fact or are we watching yet another sentiment driven bubble? What are the issues we should be aware of and how should we best invest in the face of such turmoil?

Expectations are often more damaging than reality

Libya’s contribution to global oil production is in stark contrast to the column inches it has been awarded in the press. As quoted by the National Journal, the country produces around 2% of the world’s oil. OPEC (Organization of the Petroleum Exporting Countries) has claimed that they have managed to “accommodate most of the shortfall” and instead attribute the rise in the oil price to fears of a shortage rather than any genuine supply issues. Oil reached a 2.5 year high last Friday. This is against a flattish demand side dynamic. Paris-based International Energy Agency and the U.S. government’s Energy Information Administration left fuel demand growth for this year unchanged and OPEC only raised their forecast by a relatively small amount (to 87.9m b/d from 87.8m b/d).

Note - this chart also highlights the Crude vs. Brent trade with the discount at record levels. Source: http://www.tradingnrg.com/crude-oil-price-forecast-recap-for-march-and-outlook-for-april-2011/

EU Sanction: A further boost for the oil bulls

On Tuesday, the EU extended sanctions against Libya to include energy companies, freezing assets in an attempt to force leader Muammar Gaddafi to relinquish power. Phrased another way, by the German Foreign Minister, this is a “de facto embargo on oil and gas”. Approximately 85% of exports are for delivery to Europe and importers will now have the task of finding potentially more distant and/or expensive alternative sources.

The pent-up downside risk

Nevertheless, many are not paying attention to the downside risk to the oil price as we move forward. Libya has Africa’s largest proven oil reserves but 75% of the country’s petrol needs are met with imports because of limited refinery capacity. Any improvement on this front, if a regime change is eventually secured, could significantly reduce imports and boost global supplies.

 Is water the next oil?

In addition to oil reserves, one asset belonging to the Libyan government which is rarely mentioned is an ability to bring water to the desert. With the largest and most expensive irrigation project in history, the $33bn GMMR (Great Man-Made River) project, Libya is able to provide 70% of the population with water for drinking and irrigation. The United Nations estimates that by 2050 more than two billion people in 48 countries will lack sufficient water, making this an enviable asset indeed.

How can the US pay for the Libya intervention?

It is interesting to note, with all the claims being made that the intervention is oil motivated that, Libya has another form of ‘liquidity’.  According to the International Monetary Fund (IMF), the country’s central bank has nearly 144 tonnes of gold in its vaults…

How to best invest: Retain context

The tide is starting to turn, Goldman Sachs has called the top for commodities in the near-term and oil fell by 4.5% on Monday and Tuesday alone (Source Bloomberg) . With this amount of volatility, short term noise can sometimes overwhelm. For a long term investor, looking for steady and stable returns, an ability to cut through the sentiment (whilst acknowledging it’s importance in driving returns in the shorter term) is valuable. Often many factors are at play and it will ‘pay dividends’ to be well-informed as they become wider known and priced in by the markets. Knowledge may be king but preparation will come up trumps.

Emerging Markets – Crucial Points to be Aware of When Investing in the “Region”

What Investor Excitement Is Ignoring….

Inflation is like sin; every government denounces it and every government practices it – Frederick Leith-Ross

One of the most interesting market moves in 2010 was the significant outperformance of US equities over Chinese, despite far weaker GDP growth numbers. What many missed is the fact that it is not absolute values but relative figures / surprises which move markets. With this in mind, is it worrying that the consensus for China’s long term earnings growth is forecasted at 18%? Not much room is left for upside surprises, but there’s plenty of space for disappointment!

Source: "The Surprising truth about Investing in the BRICs" on Nicholas Vardy's The Global Guru, http://www.theglobalguru.com/article.php?id=340&offer=GURU001.

Therefore, it is important to be aware of the issues and risks associated with the region to be able to decide not only what to invest in but how to size the investment accordingly, inline with risk / return targets. As expressed above, it is crucial to judge what you believe is already priced into the markets and what pose as upside or downside potential.

Short-Term EM Risks

Short-term cyclical factors can overshadow long-term structural trends

INFLATION: the index used to calculate inflation in EM has double the exposure to food prices than in the G10 (developed countries). Using the price of wheat as an example – an all time high was reached at the beginning of this month, highlighting the magnified pressure felt in the region which may spook investors. From another angle, fiscal policy in China led to a 30% growth in the money supply (M2) in 2009, increased by almost as much again last year, stoking inflationary fears (since with more money around, it becomes worth less and more of it is required to buy goods i.e. goods become more expensive)

ALLOCATIONS: a record percentage of portfolio managers are overweight Emerging Market equities. The combined net assets of the two largest EM ETFs are now above that for the S&P 500, despite the US equity market being ~4 times the size of the investable EM universe.

Long-Term EM Risks

Long-term demographics may negatively affect the working population

AGE TRENDS: the biggest drop in the young working age population is “set to take place in China,” a result of its one-child policy.

ACCESS TO EDUCATION: Of the top 50 universities, only 3 are based in emerging market countries and the highest stay rate is among Chinese students. This means that in order to get a top quality education, the youth of Emerging Markets may have to study abroad and if they do so, may end up staying, greatly limiting the young, well-educated working class of their homeland.

EM Stock Risks

Do due diligence on the companies you pick – you may not be getting the exposure you want

EXPOSURE: just 14% of EM market cap is represented by domestic-facing sectors (i.e. not all EM stocks give investors exposure to the rise of the Consumer and the “Domestic Demand” growth story, a main reason for investment)

GOVERNMENT INTERVENTION: Within the EM stock markets, government ownership of companies is significant. For the Chinese market, 67% of its market cap is government owned (35% in Russia, 29% in India and 14% in Brazil). Putting this in context, in the US, at the height of the financial crisis, government ownership was about 3.7% of market cap. The importance of this should not be underestimated. It means that at times, within EM, a majority government owned entity may not be acting entirely in the interests of the investors.

STOCK EXAMPLE: Petrobras (PBR):  Brazilian government and its affiliates own about 64% of common voting shares. The offering documents state that “the government, as our principal shareholder, has and may pursue in the future, certain of its macroeconomic and social objectives through us.”

INVESTMENT INSIGHT

Therefore, in conclusion: Be aware –

Short-term cyclical factors can overshadow long-term structural trends

Long-term demographics may negatively affect the EM working population

Do due diligence on the companies you pick – you may not be getting the exposure you want