El Nino... (Investment Opp?)

Not that I really want to become a weather forecaster, but one of the things that commodity funds keep a close eye on, and I do too, is El Nino/La Nina events and their impact on commodity supply, prices and related equity performance.

Over the past few months there have been signs of a developing El Nino event in the Pacific and this could have important implications for supply and prices for several commodities over the next 12-18 months. The US National Oceanic and Atmospheric Administration expects the current event to last throughout the Northern Hemisphere winter and into 2010.

What is El Nino? It is an abnormal warming of surface ocean waters in the eastern Pacific which causes an oscillation of pressure patterns impacting weather conditions.

What are El Nino impacts?

• Reduction in rainfall in eastern and northern Australia, as well as parts of South East Asia causing drought conditions. A strong El Nino could result in drought in India, Indonesia and Malaysia. Very hot summer weather in northern China, flooding in southern China.

• Warmer winters in the northern part of North America and cooler in the southern parts. Wetter summers in the intermountain regions of the US. Depressed hurricane activity in the Gulf of Mexico.

• Warm and wet summers in western parts of Latin America (Peru and Ecuador) likely causing flooding. Higher winter rainfall in Chile. Dryer and hotter weather in the Amazon, Colombia and Central America with wetter spring and summer conditions in southern Brazil and northern Argentina.

Why is this relevant to commodities?

El Nino/La Nina trends generally impact supply of commodities, be that oil and gas, coal, wheat, soybeans, rice, etc

What are potential commodity impacts?

Oil & gas: El Nino generally results in depressed GoM hurricane activity which could mean limited supply curtailments this hurricane season, keeping gas prices depressed if demand doesn’t pick up.

Wheat: The last two major El-Nino events have resulted in significant increases in wheat prices during and after the event. This has come in no small measure due to impact of drought conditions in Australia on wheat production and yields.

Soybean: The last two major El-Nino events have resulted in significant increases in wheat prices during and after the event. Brazilian and Argentinean production of soybean has been impacted by drought and flooding in previous events.

Rice: The last three major El-Nino events have resulted in increases in rice prices during and after the event. Chinese and Indian rice production may be impacted by an El Nino event.

A Great Answer To A Great Question.

There seems to be something wrong with the way oil is trading these days -- at least wrong if you believe it should trade based on supply and demand. Obviously, the fundamentals aren't changing as fast as the wild price swings. Much of this seems to be because the trading pits are dominated by trades of paper (financial) barrels of oil and not real barrels of oil.

Yet, you seem to be generally opposed to limitations on oil speculation. Why? And is the current method of pricing oil the best one we can come up with? Can't we come up with a better system? When I go to the store to buy other goods, the price doesn't fluctuate so wildly. Why do we have to price oil this way?

Stephen Schork (The Globe & Mail 13/07/09): I certainly agree that oil speculators impact the pricing of oil (and other commodities) in the short-run. Therefore, at times the price path does indeed decouple from the underlying fundamentals. However, in the long-run, markets will regress to the fundamentals. hence the Wall Street adage. markets fall faster than they rise.

I do favor certain new regs on speculative trading in commodities. For instance, there is a tremendous amount of derivative contracts linked to U.S. markets that are traded on the ICE exchange in London that do not come under the purview of U.S. regulators. For price transparency reasons I think that ought to change.

On the other hand, I do not like the idea of limiting oil speculation. Why?

The most important reason is that speculators provide an outlet for producers to sell risk. If you hamper the speculators ability to buy that risk then all you are really doing is forcing this systemic risk back onto the books of the producers.

Therefore, they will in turn become apprehensive when it comes to increasing their risk exposure to the market, i.e. it will retard their ability to increase their plant and equipment or said another way. it will hamper their ability to increase supply when demand warrants.

Thus, in the long-run, limiting speculation might decreased short-run volatility in the market. But it will only serve to increase it for all of us in the long run.

So... Where are we again?

June has come to pass with the swift speed that only Father Time could attain, and here we are still watching as the tumultuous markets work through their innate differences in a most vexing fashion. The famous "sell in May and go away" adage did not apply, and as we look back from our semi-annual perch piecing together the sparse similarities of historical precedence to some how map our way in an effort to gain some long-desired foresight, we need not be afraid. For the markets ALWAYS have this stubbornly magical, yet preordained habit of moving from the lower-left to the upper-right. From morning to noon and into the night... (*This rhyme is best served with a recent Andex chart. Feel free to scroll down to a recent post of mine in which you will find a wonderful reminder of what markets tend to do)

Asset selection is very very important from this point going forward. Easy to say, difficult to apply. There are many different theories on what a portfolio should look like... How to "learn from this one and finally build something that will guarantee principle value retention." It seems to me that all of these sudden preservation and V&L shaped recovery strategies are an explosive way to market a short-term reaction to the problem. Whereas, I am really interested as to what those select few who have stayed to their original investment policy in the face of adversity are up to. As they tend to be the ones skating to where the puck will be, where the rest of those "reactionaries" are busy adjusting course to where the puck is going.

People tend to chase performance by selecting investments that outperformed over the last 1,3, and 5 years. The best thing you can do for your current portfolio is to look at what you own today, and decide if its what you want to own tomorrow. Think about your future…

Moving on to a side-note.

In 2008, for the first time in human history, the majority of the world’s people lived in cities. And cities for the foreseeable future will continue to grow faster than the countrysides surrounding them. Globally, the number of people living in cities of 1 million or more will grow from about half a billion in 1975 to almost 2 billion in 2025. As a result, cities have assumed a central role in the urbanized world of the 21st century. They are wielding more economic power, developing greater political influence and increasingly employing more advanced technological capabilities to enhance their operations... This is an absolute and finite and indisputable reason why Globally competitive markets will continue their march from these lows. The continued urbanization of exisiting economic powerhouses, along with the creation of a middle-class in developing countries, will put a strain on supply and add to the demand for natural resources, services, and pretty much all industries across the board.

So, if the words of financial Armageddon have not pierced your heart and left you frozen in a state of asset-shock, then where do we begin? What story do you believe in? Look into your own portfolio and ask yourself these 2 questions:

- What investments do you want to own in the next 1,3, and 5 years?

- What are you concerned about for the next 1,3, and 5 years?

Alternative Energy? ♦ Municipal Bonds? ♦ Gold? ♦ Social Security going bust? ♦ Inflation running rampant? ♦ Deflation? ♦ Oil? ♦ Taxes going up? ♦ Monthly income? ♦ The dollar?

As the old guy next to me used to say: "A car could look sporty, but if it don't got it under the hood, then all that exterior jazz will just get blown off when the race starts..." So to should a portfolio need to have the best underlying story driving all the other parts, to not only finish the race, but to win the darn thing. It's the least you could do for yourself. Honest.

You're not as smart as you think you are... Investing Wisdoms.

The following is from an email a colleague sent to me. It has great rhyme and reason, and I feel it is a great reminder for anyone who invests in the stock market.

Our emotions are our biggest enemy, at least when it comes to investing. We should all know this. If you don’t, stop making your own investment decisions right now.

Our emotions lead us to do the opposite of what we should be doing. They lead us to buy high and sell low. They make us excited when we should be scared, and scared when we should be excited. They make us slaves to the stock market; they let the market become our master.

The market is there to serve us, and not the other way around. It is okay to have emotions; we’re human, after all. But what we really need is an investment process. This is system of rules that we follow that keeps emotion in check.

Now, I hate republishing old articles. But a few, the ones that focus on the process, I’ll recycle (and improve upon) for a long, long time. I wrote the following article, in 2007. I included it in my book. I’ve shared it with readers in the past. And I even wrote the flip side of it in October 2008, addressing the impact of a cyclical bear market on out psyche by cyclical bear market.

I’m not offering it now to provide a hidden message that I think the current (cyclical) bull market is over. I don’t know that. I just want to remind you (and me) that a rising market has an impact on our psyche, our analysis and our decisions, and we need to be aware of it.

You are not as smart as you think you are; psychotherapy for (cyclical) bull markets
Lately I’ve been getting this powerful feeling that everything I touch turns to gold. Every time I buy a stock, it goes up. Did I finally figure out the stock market game? Did I find a secret way to follow Will Rogers’ advice: Buy stocks that go up, and if they don’t go up, don’t buy them.

No, I didn’t get much smarter, and my stock-picking skills haven’t improved that much over the past year. I was simply a willing participant in the latest (cyclical) bull market. A bull market makes you feel smarter than you are the same way a bear market makes you feel dumber than you are.

Feeling smart makes you do the opposite of what you should be doing. The euphoria of the golden touch is a dangerous thing because it can make us careless. We forget about risk since we haven’t seen it in a while and focus only on the rewards. You have to actively make yourself aware of the four-letter word R-I-S-K!
How do you do that? My favorite way is to remind myself how dumb I am. I pull out an annual return report of a company on which I lost a boatload of money and masochistically try to read it from cover to cover, reliving my errors.

We all have these stocks, the ones we lost a lot of money in because we were overconfident. We tend to forget about them during a bull market. But I suggest you remember them now, so you’ll have fewer of those names to remember in the future. Risk is still there; it is just hiding under the joyful sentiment of the bull market.
Believe me, it will show its ugly face. It is just a matter of time.

Discipline counts

In a bull market, it is easy to forget about selling discipline and then turn into a “buy and forget to sell” investor. Every time you sell a stock, you look dumb because it usually goes up afterward.

I recently sold several stocks. Shamelessly, paying absolutely no attention to the fact that I sold them, they went higher. I don’t feel smart about those sell decisions. However, when I bought those stocks, I set valuation targets. When they approached the targets, I quickly reviewed their fundamentals. They had not changed much. The decision was obvious — sell.

Cyclical bull markets teach us not to sell, while cyclical bear markets teach us not to buy. If you let the market tell you what to do, you have no process.
But the bell doesn’t ring when bull or bear markets are over.

You cannot worry about marking the “top” in every sell. My objective is not to buy at the “bottom” and sell at the “top.” My objective is to buy a great company when it is cheap and to sell it when it is fairly valued! I suggest you do the same.

-Courtessy of Vitaliy Katsenelson.

To Benefit From The Knowledge Of Historical Trends.

There is a firm belief that the following is happening (or will happen) in connection with the current economic stimuli being applied to the global economy. I feel it is necessary to look into what the real effects of this stimulus are, without speculation or political suggestion driving ones conclusions:

1. Central banks worldwide are flooding the global economy with liquidity to stave off deflation and stimulate economic activity. This is particularly true of the United States, which is central to the global economy.

2. This monetary policy will result in a significant increase of M2 (typically viewed as the total currency in circulation, deposits and money market instruments or other cash equivalents), which will debase currencies, but in particular the U.S. dollar.

3. The price of gold will increase, anticipating the effect of the M2 increase and inflation.

4. The price of energy will increase, being an essential input of an inflating economy.

5. A more broad-based economic recovery will then begin resulting in a rise in share prices world-wide.

6. Insurance companies, which are more levered to the stock market (compared with banks)as a result of, among other things providing guaranteed returns on variable annuity products, will benefit next as their capital position backing those policies grows in connection with rising share prices.

7. Credit conditions will improve, lifting the prospects of banks globally.

*Current actions taken by governments around the world are designed to create an inflationary effect in the global economy, stimulating economic output and consumer spending.

*Historically, industrial output contraction has been followed by significant output increases which have driven economic growth and market returns.

Asset Allocation Designed To Benefit From An Economic Recovery:
Certain sectors and companies will benefit earlier and more substantially than others in the event of a market recovery. And it's within these names that you will find the greatest value and successes in rebuilding your portfolio holdings over the next 5 years and beyond. Once again, tactical, active management is needed now more than ever before.

(Due to licensing constraints, I will not be listing the individual names of companies I am following, but send me an email if you would like to hear more.)

Regards.

Bubbles To Recovery...

I sat with a senior advisor and partner at my firm last week. The topic of the conversation was "bubbles", and the usual action/reaction process that takes place when they "pop". He was an advisor back in the 1970's, and he's quite astute when it comes to this particular subject. (This is also proven through his uncanny ability to miss each bubble-bursting that his taken place since... I.E. Dot Com, 9-11, LTCM, etc...)

Firstly there is a predictable behavior when bubbles reach their peak... That is, no matter who you are, whether you are a novice or an investment professional, the story ALWAYS sounds good and convincing. For example: In the dot-com bubble, anything "tech" related was a great story. "This company specializes in this", and so on... Eventually, everyone starts to see it as a very compelling idea. It is a trick on our emotional nature that, even though our rational minds are telling us: "OK, this company is run by two college kids, went public last week, no proven revenue, but is located in California and specializes in something computer related... This is crazy to even consider, BUT, Greg my neighbor has made 200% so far... And the technology they are developing is cutting-edge as they say... I'll do it! Sell the tractor, back up the truck!!!"

Bubbles:
They start as a reasonable, but unproven idea at a reasonable price.
They end as a sound proven idea, but at an unreasonable price.

Sound familiar? Look at the "potash" story. Great story. Feeding off of the "world food glut" problem. It also fits in nicely to the China and India story, whereby, China has the largest population in the World, and has a quickly developing middle-class who will demand higher grades of protein (beef, chicken, etc...) Imagine the economics that goes in to matching this increase in demand. It blows your mind. So, the developed world gets wind of this and follows the supply chain right back down to agriculture and of course the fertilizer companies. POW. You have a small fert company in rural Saskatchewan that suddenly becomes a heavy-hitter on the world stage, and a very large weighting on the Canadian Stock Exchange. (Eerily familiar to what Nortel did during the dot-com era... Look at Nortel now. Once worth a few hundred dollars per share, now in the pennies.)

Of course times are different now, and China hasn't even begun to wake from it's long slumber, so the story remains strong. (But, that doesn't mean we wont see future bubbles forming in this sector. We just have to be much more active in how we manage our investments. Passivity will surly lead to personal destruction in this new and interesting economic environment.)

After the recent "correction" we've experienced in the markets around the globe, the number one focus should be on recovery. The 5 year plan... Probably the most important 5 years your assets will experience for a life time. Let's look at 2 possible recoveries and the conditions that need to be met to succeed:


V-shaped Recovery:

“When a downturn in growth is followed by steep upturn”

Historical Precedence:
Zarnowitz Rule: Deep recessions are almost always followed by steep recoveries.
This was exhibited over the last four recessions. The shallower than average recessions of the early 2000’s and 1990’s were followed by shallower than average recoveries. The deep recessions of the early 1980’s and 1970’s were followed by steep recoveries.

Conditions needed for a V-Shaped Recovery:
Sustained recovery in U.S. consumer spending, including housing, autos and other durable goods with no significant increase in household savings. Significant Government spending and investment stretched out over several years. Significant increases in private investment. Strong export growth resumes, trade deficit shrinks further.


L-shaped (sideways) Recovery:

“When a steep downturn in growth is followed by several years of sluggish recovery”

Historical Precedence:
Financial & Global Recessions: An IMF study found that recessions caused by financial crises tend to be followed by slow recoveries. Similarly, recoveries from globally synchronized recessions are generally weak. After Japan’s real estate and stock market bubble burst in the 1990, its financial system was crippled. Economic growth averaged 0.5% over the next 10 years. This was dubbed the “lost decade".

Conditions needed for an L-Shaped Recovery:
Very sluggish recovery in U.S. consumer spending with a significant increase in household savings. Significant Government spending and investment stretched out over several years. Modest increases in private investment. Export growth resumes and trade deficit stabilizes.


Be Proactive Regardless of What You Expect from the Market:
What performed best going into the bottom will not likely perform the best coming out of it. Make sure you are comfortable with your asset allocation and security/fund selection. AND, if the story of something becomes too convincing, take a step back, maybe some profits as well, and watch for the inevitable bubble to grow and burst. With "preservation" being a key element to ones retirement future, having a bullish yet contrarian mind to these things may prove vital to your recovery. 'Luck.

Lets Talk Economy............. (Shall we?)

The Sky Is Falling....

It must be true. It’s in the newspapers, on TV and the radio. The economy is in trouble. Stocks, mortgages, banks, insurance companies. All falling and/or failing.

But, falling from where? The biggest economic boom of all time? The biggest housing boom of all time? The easiest loan requirements of all time?

Business is not down, it’s just different. The media, with their mysterious ways of relaying half-truths and impartial information, have impressed upon us to graciously "miss the point", thanks in part to the number 1 controller of our actions: Fear.

For example, when you hear the negative statistic on the news that home sales are down 33%, it actually means that FIVE MILLION homes will be sold this year. The only unanswered question is: Who will get that business? The media portrays gloom when actually there’s still PLENTY of opportunity – just not as much as before.

The low hanging fruit of two years ago is now much higher in the trees.

There’s plenty of business in the marketplace – just not as much as there was during what was the biggest housing and economic boom of all time. As a result, businesses are adjusting to current market conditions. (And this is especially reflected in the stock market, which has been and will always be the leading indicator of commerce... Investors should take heed.)

Since no one can predict the future, and the economic growth or slowdown answers are not yet apparent, senior management must react to present-day situations. Finding those who are doing so should be a primary focus of investment strategy going forward... Survival of the Fittest! and all that jazz...