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Interesting comments from Franklin Templeton fund manager Mark Mobius, a guru and pioneer in emerging and frontier markets, and whose blog I make it a point to always keep up to date with. The nice thing about Mr. Mobius is that he’s always on the move– a true globetrotter–the importance of which he links to the need in frontier investing in particular to spend “additional time and due diligence to assess the quality of the management team including more frequent on site visits to evaluate the business effectively.” To me, Mobius sees himself as an explorer almost as much as he does a traditional fund manager. He’s taken to blogging and even to Twitter much like Lewis and Clark took to their journals. To that extent, such mediums can be seen as a snapshot in time of an attempt to discern and envision the future–the underlying essence of money management. He relates, for instance, the following forward written by the late Sir John Templeton:
“People don’t think about problems in the context of history. They think that today’s worries will always be there and that existing conditions can’t change. I encourage people to try to foresee the future by considering the dramatic changes we have seen already. Emerging market investing as a frontier sport has made way for international investing, the search for bargains.”
Reuters notes in its coverage of the Ivory Coast’s first election in over a decade that “if it goes smoothly, analysts expect it will unblock foreign investment in construction and telecoms and enable reforms to an ailing cocoa sector that feeds 40 percent of world demand. It may also trigger a rally in Ivory Coast’s $2.3 billion Eurobond (due in 2032), Africa’s largest and one of its most high yielding (roughly 10.2 percent), issued in April in exchange for defaulted debt.” The country has been effectively split between a rebel-held north and a state-controlled south since a 2002 civil war. Similar to Botswana’s dependence on diamonds, the Ivory Coast’s fortunes are tied to cocoa (six million of Ivory Coast’s 21 million inhabitants make a living out of cocoa, according to the IMF), a concondrum the country hopes to alter by eventually diversifying its revenue into the rubber industry, power generation and oil exploration. “With respect to investment, there is a lot of interest in Cote d’Ivoire, but people are waiting to see what happens,” said Wayne Camard, the International Monetary Fund country head. “There could be substantial inward investment as well as local investment once security, and belief in the system, has been re-established.” Cocoa prices hit their highest level in 33 years on the back of Ivory Coast’s low output, and many analysts wonder whether the country’s ability to meet rising demand will ever be adequate given the woeful state of its infrastructure and other supply-related issues. That said, Blooomberg notes that “donor nations have linked the scrapping of $3 billion of Ivory Coast’s $14 billion in international debt to an overhaul of the cocoa industry,” meaning there is certainly incentive for more state investment going forward that would theoretically improve the industry’s aggregate supply.
A recent Reuters piece on the imminent dual listing of Tunisie Telecom on the Tunis bourse and a European bourse mentioned that “financial analysts say Tunisia could unleash a surge in investment, especially into its stock market, if it eases or removes currency controls.” Foreign companies have long considered such controls, which make it difficult to repatriate capital, as a major obstacle to investment. Yet two ongoing and impending events–one being Tunisia’s application to the European Union for “advanced status”, which would give it preferential trade terms; the other being a planned switch to a fully convertible currency in 2014–have all but cemented the continual easing of restrictions on capital movement. But as the herein linked piece on political succession points out, Tunisia’s political future is all but certain–always a cause for concern regardless of how solid present and near-term macro fundamentals look.
A recent post by Vivian Lewis of Global Investing highlighted some interesting comments made by Guy Monson, CIO and Managing Partner of London-based investment manager Sarasin & Partners, while speaking at a conference in Singapore, in which he outlines the likely effects of a possible outcome to the November 11-12 G20 conference in Seoul: “Although uncertain, a very positive outcome would be an announcement by the G20 that they have agreed to some cooling appreciation of the Renminbi along with some appreciation of other Asian currencies,” Monson said. Yet this would be a “gradual and controlled rebalancing,” he warned, “requir[ing] 24-36 months to take effect, with Asia to experience extremely strong international liquidity inflows over the next 12-18 months.”
Monson’s macro outlook and thesis is nicely laid out in the linked piece co-authored with Subitha Subramaniam, the firm’s Chief Economist and Partner. His preference for global equities (both developed and developing) relies on the continuation of “sizeable” global imbalances which are destined to persist, he argues, “[since] stubbornly undervalued dollar pegs across Asia and the Middle East not only supply low dollar interest rates today, but also promise them in the future – an anaemic U.S. recovery is expected to delay interest rate normalisation well into 2011/2012.” The result, Monson contends, “is a period of what we are terming ‘hyper-convergence,’ where already higher growth rates, due to favourable demographics and an ability to leapfrog technology generations, are magnified and propelled even higher by a powerful low interest rate shock, with negative or very low real interest rates creating a virtuous cycle of ‘hyper-growth.’” Specifically, he articulates:
“There are countless examples; retail sales are rising by an extraordinary 27% in India, 24% in Indonesia, and 17% in Turkey year on year, while capital spending is still rising more than 24% year on year in China, 19% in India, and 16% in Indonesia. All of those economies, along with most of the emerging world, are operating with real interest rates (after inflation) that are at or close to zero or, in China, India and Turkey’s cases, actually negative. In fact, with few ‘brakes’ to stop economies so long as currencies are pegged, growth is almost unstoppable, with intra-emerging market trade surging.”
While intra-EM trade may underpin further P/E rises among developing equities, “hyper-convergence is not trouble free,” Monson notes. “It brings with it growing pains in the form of unsustainable increases in asset prices, and surging domestic wages and inflation.” That said, as Goldman Sachs economist Robin Brooks noted, the propsensity of various Asian governments to accumulate surpluses as a percentage of its monetary base is varied, suggesting to me that the long-run ‘hangover’ of this artificial, dollar-pegged low-interest boom across the developing world will not be uniform, a thought investors should be mindful of.
The Bank of Thailand’s decision to keep its key, one-day bond repurchase rate (1.75%) unchanged–effectively an attempt to ease the rampant baht appreciation (it recently hit a 13-year high versus the dollar)/pressure on exports discussed here earlier–followed its decision last week, per Bloomberg, to “[scrap] a tax exemption for foreign investors in domestic bonds to slow capital inflows that have pushed up emerging-market currencies.” Yet according to Santitarn Sathirathai, a Singapore-based economist at Credit Suisse Group AG, “it’s only an exception to the trend of hiking rates.” Indeed, late last month the state’s finance ministry opined that the rate “may climb to 2 percent by the end of the year and 3 percent next year.” Yet as long as core (1.1% y-o-y) consumer price inflation remains removed from the high-end of the Bank’s target range of as much as 3%, and state price-influence remains in tact (per Businessweek, in June “the government extended state subsidies on mass transportation and energy costs for six months, while the commerce ministry controled prices of key consumer products to help reduce the public’s burden following political clashes in the second quarter that killed at least 89 people”), it’s conceivable that rates stay stagnant. That said, as The Economist pointed out two weeks ago while citing a fascinating study authored by two economists at Goldman Sachs which looked at the pace at which central banks in emerging Asian economies built up reserves by buying foreign currency (and then scaled the absolute amounts in question by the country’s base money supply in order to determine a net effect), Thailand–along with Malaysia–have had the most “appreciation-friendly” regimes in Asia since 2006 (to boot, China’s intervention in relation to the size of its economy has been relatively small, the piece shows). With all of this in mind, is a carry trade into baht-tied assets still viable, absence of the 15 percent tax exemption be damned? Given the impending round of quantitative easing in at least one developed country, the emerging/frontier market flow may still have a ways to go. “The Fed’s quantitative-easing speculation is back in focus and that means growing optimism of more inflows into Asia,” Hideki Hayashi, a global economist at Mizuho Securities Co. in Tokyo, told reporters today.
Regardless of your short-term view on rates, one way to currently play Thailand may still be through its bustling financial services sector. During the first half of this year, for instance, the country’s banking sector realized 61b baht in net profits–a 42% increase y-o-y–on the back of strong net interest margins (NIM, i.e., the difference between interest income and interest expense expressed as a percentage of interest-bearing assets) and a continually declining non-performing loan– NPL–ratio (a proxy on underlying asset quality). These results continued into the most recent earnings period, as analysts’ “outlook for Thai banks remains bright as strong loan growth should continue in the fourth quarter and into the start of next year after healthy economic growth.” And while in theory rising rates may be NIM-negative (for liability-dominated balance sheets, a rising interest rate environment–and thus a flattening yield curve–suggest a given bank’s net interest margins will be comprimised given the cost of deposits outpacing asset yields), Suphachai Sophastienphong, chief economist at Siam City Bank, pointed out in August that in reality this is probably not the case:
“Empirical evidence in Thailand appears to contradict the prevailing orthodoxy that changes in interest rates and the slope of the yield curve (changes in the levels of long-term and short-term rates) will have significant impact on banks’ net interest margins. Over the past half a decade net interest margins have been hovering around 3 percentage points, reflecting, in the view of many pundits, less-than-competitive pricing behaviour and inefficient intermediation–irrespective of the shape of the yield curve . . . Even in parts of the developed world, the correlation between bank profitability and the yield curve has weakened considerably over the past few decades thanks to deregulation, securitisation and the use of interest rate swap as well as other derivatives contracts.”
In order and by assets, Thailand’s biggest banks are Bangkok Bank, Krung Thai Bank, Kasikornbank and Siam Commercial Bank (the country’s oldest).
Back in June Batbayar Balgan, director general of the financial and economic policy department of Mongolia, spoke of the country’s plans to raise $500 million selling bonds in 2010, while the remainder of a planned $1.2 billion program would be sold according to market conditions. Bloomberg notes that the government scaled back its plans for global bond sales after Europe’s debt crisis drove up borrowing costs, and that investment banks have been advising Mongolia to issue debt with maturities of 5 years to 10 years. Per the country’s Finance Minister, Sangajav Bayartsogt, said securities may yield between 8 to 11 percent.
Mongolia is still a fringe play on commodities, and specifically copper, coking coal and uranium, though if the copper industry’s fundamentals in particular indeed shift, and the country’s stock market develops further (currently only 300 listed companies with a total market capitalization of only $1 billion, per the Mad Hedge Fund Trader) it will likely garner increased attention as a steadier play on risk amidst stabilizing cash flows and increased liquidity. This should bode well for its debt. Moreover, the “spillover” effect on GDP is likely to draw further capital stock investment and create a postive feedback loop for future, near-term growth levels. Per the secular demand for copper (driven chiefly by China; see graph inset), analysts with Goldman Sachs recently wrote that “the combination of lower copper-exchange inventories, robust demand largely driven by emerging-market urbanization and a constrained copper-supply outlook will sustain copper deficits large enough to mostly deplete exchange inventories by the end of 2011.” To that end, Barclays Capital agreed, writing to investors this month that it was “reiterating [a] long-held bullish call on copper as supply constraints in the copper industry have intensified due to a variety of issues including declining grades, increasingly difficult geology, and rising geopolitical risk in copper-rich regions of the world.”
Copper dropped for the first time in four days on Friday from a 27-month high, its rise during that time further fueled by the falling dollar. Furthermore, The Macro Man, a London-based money manager, noted that Ivanhoe Mines’ (NYSE: IVN) Deputy Chairman and Director (one of two firms along with Rio Tinto slated to develop the world’s largest undeveloped copper resource, the Oyu Tolgoi mine in Mongolia ) Bob Friedland described Chiquicamata and other mature Chilean mines as “a little old lady in bed, waiting to die” during a recent conference, hinting at the very impending, structural changes in the supply chain explicitly highlighted by the major investment banks. Even the IMF agrees, stating last week that “deteriorating mine productivity (copper and tin) and the impact of policies targeted at reducing the impact of metal smelting on the environment (lead) are among the most important constraints on supply.”
Per the FT’s recent insert on world food, “the prevalence of hunger in developing countries has fallen but is stuck at 16 percent, and there will not be enough time or money, according to many experts, to hit the 10 percent target by 2015.” Solutions are as varied as they are complex, though for certain there is room for “improving agriculatural yields, especially in Africa, where the sector has lacked investment. Only 4 percent of sub-Saharhan African cropland was irrigated in 2002, up from 2 percent in 1962, compared with almost 40 percent in South Asia.” Analysts note that every step of the production process must be targeted–from farming techniques themselves that educate about pesticide use, cutting waste, and improving quality through using best practices such as better seeds, soil testing, and planting and harvesting techniques, to increasing access to customers not only be removing costly intermediaries, but also by improving substandard roads and communication networks that, coupled with increasingly volatile commodity market prices (due in part to climate change as well as protectionism abroad), is particularly devestating to the vert supply chains most abundant in poorer countries that tend also to be more reliant on vulnerable smallholders. To that end, better access to credit and more transparent and credible land rights are crucial to production as well, experts note.
Finally, an underlying issue may not just be sufficient production of quality food, but also sufficient variance in terms of quality of nutrition. Per the UN’s Food and Agricultural Organization (FAO), for instance, ” at a global level, the world already has enough food . . . but if diets are not sufficiently varied, they may lack vitamin A, iron, zinc and iodine, causing infants and young children irreparable harm.” Couple the need for properly diversified nutrition (which in turn is linked not only to fortification of staple foods, but also to sanitation and, most importantly, antenatal care and education of, and perhaps direct transfer-payments to mothers) with Nicholas Kristof’s latest piece in The New York Times on just how crucial the role of the uterine environment is to a given individual and thus, society’s welfare in the aggregate, and it is to easy to argue that the quality and supply of the global food chain is the single most important issue facing developing (and developed?) countries today in terms of their long-term evolution.
That said, I continue to maintain that an even more basic issue–the supply and suitability of water–is even more crucial, in that it lays the groundwork essential to efficiently meeting demand. Admittedly, the topic of usable water goes hand in hand with ‘best practice’ farming techniques and more pointedly, irrigation (agriculture accounts for roughly 70 percent of water consumption). For example the FT cites Daniel Wild, an equity analyst with Sustainable Asset Management in Switzerland, who points out that “with conventional food irrigation, the efficiency level is often well below 50 percent, and important nutrients or corp protection agents are [thus] washed away in the process.” This and other measures, such as horizontal ploughing and preventing farmers from tapping underground sources without limit (if usable water is a scarce commodity, isn’t there a moral hazard to not effectively pricing and treasting it as such?) may in turn boost crop yields by up to 150 percent or more. The FT points out that several emerging market companies–most notably Jain Irrigation Systems in India amd Israel’s Netafim–are experiencing rapid growth in micro irrigation systems (MISs), which include drip systems, sprinklers, valves, water filters and plant tissue products and help to enhance the productivity of seeds and fertilizer while conserving water. Additionally, said firms are exploring solar water pumps, a sort of leapfrog technology in a sense that could be used by farmers even in power-deficit states (of which they are plenty in frontier regions). Ultimately, “[Jain] plans to enhance its distribution by adding new dealers and distributors to penetrate [frontier markets] in Africa and the Middle East,” per Anil Jain, its managing director. Analysts and investors alike, including asset managers and private equity funds, would be wise to keep a watchful eye on this growing sub-sector of agribusiness.
It’s one thing to hear a money manager, whose fund’s thesis rests on African growth, tout the continent’s impending demographic dividend and accelerating consumption habits; it’s quite another when the world’s biggest retailer takes a punt and sinks its own teeth into the game. Last week’s Economist noted, for instance, that Wal-Mart’s recent $4.1bn acquisition of South African-based Massmart (the top wholesaler and low-cost distributor of basic foods and consumer goods, as well as the leading retailer of general merchanise, liquor and home improvement equipment and supplies with 288 stores in 14 countries spread across sub-Saharan Africa) is proof that “Africa is near the top of the agenda for the world’s leading businesses . . . as [its] middle class and urban working class expand rapidly, food consumption is expected to grow strongly, along with sales of other consumer products.” That said, as the article points out by referencing the firm’s travails in Germany, the rewards from such global expansions are never for certain, and hence why the $4bn expenditure should perhaps be thought of more as a cheap call option on the region rather than a definitive, global macro paradigm shift in consumption habits.
Get ready to read a lot of columns in the next decade or so just like this latest one from the FT, whereby asset managers and analysts argue over whether equity valuations in emerging markets are fair (and/or still understated), or whether the acceleration of capital into them has been a bit too fast and furious. This of course begs the real conundrum, which I personally subscribe to: yes to both.
Consider the following: “While emerging economies now account for more than 30 percent of global GDP, U.S., European and Japanese financial institutions have between them only about 2-7 percent of their $50,000bn of assets in the emerging world.” That said, an International Institute of Finance (IIF) report from earlier this week “sharply raised its forecast for capital inflow into emerging economies from an April prediction of $709bn to $825bn. For the IMF, fund managers’ habits are the core of the problem: with a powerful herd instinct, they tend to move together and risk swamping markets with their buckets of money. As the Fund’s report says: ‘Investor flow data suggests emerging markets tend to suffer from herding behaviour.'”
Meanwhile, even in the doldrums U.S. 3Q earnings should be positive enough to lift equities past election time and into the shopping season (a coincidence?), at least if you buy into the estimates. Yet one indicator I can’t get past in the seemingly endless ‘buy risk’ phase we’re in is the U.S. 10-year yield, which rose to 2.795% on September 10th, but has since fallen to levels not seen since the beginning of 2009 (2.3353 as I type). Since 10-year yields historically track nominal GDP growth, yields may be lower than they theoretically should be—the latest and final estimate of 2Q10 annualized GDP growth was revised up to 1.7% from the second estimate of 1.6% (and the advance estimate of 2.4%). At the moment, therefore, bond yields indicate either growth and/or inflation will fall. Meanwhile, the continued downtrend of the dollar index indicates that the market is heavily pricing in the probability of further long-term asset purchases by the Fed when it next meets on November 2nd in order to kick-start inflation (core CPI 0.9%, core PCE 1.4% y-o-y). Against this backdrop of further monetary accommodation in both America and possibly the UK as well, precious metals such as gold and silver continue to trend sharply upwards. Along with emerging equities and safe haven bonds.
From this month’s Business Diary Botswana:
Back in late July Bloomberg noted that Botswana, the world’s biggest diamond producer by value and volume, was set to produce 24 million carats of gems in 2010, 36 percent more than last year, as demand recovered following the global recession. Some analysts pointed to the industry’s rapid contraction of output in the face of perceived demand destruction as the root cause underlying the quick turnabout—at the crisis’ peak, for instance, Debswana, the 50/50 joint venture between the government of Botswana and De Beers Group, and then-producer of approximately 33.6 million carats of precious stones per year, said that it would reduce production and reallocate resources accordingly. “The increasing supply shortages forecast for the next decade, coupled with increase in consumer demand, will support industry growth in the long term and enable the diamond industry to bounce back from the short term impact in the global recession,” the company announced in late 2008, though as market value across basically all asset classes sagged in unison worldwide, its fingers were no doubt crossed. Many analysts now maintain, however, that dour predictions surrounding luxury sales were always somewhat exaggerated: what the industry lost to the U.S. turned out to be offset by the rise and relative stickiness of Russian, Chinese and Indian demand, they say. Moreover, this ‘new normal’ in regards to buying habits—a phrase describing the paradigm shift in growth rates and consumption away from developed and towards developing markets put forth by Mohamed El-Erian, CEO and co-CIO of PIMCO, the world’s largest bond investor—is likely to persist going forward, a chief reason why so many industry insiders remained bullish even as prices plummeted. De Beers forecasts that the U.S., which accounted for about half of global diamond consumption pre-crisis (with China and India hovering around 6-7 percent), will fall to 30-35 percent by 2016, while China and India each grow to roughly 16 percent. This shift will translate into overall, annual global jewelry sales growth of 4-5 per cent between now and 2020, according to Freddy J. Hanard, CEO of the Antwerp World Diamond Centre (AWDC), a promoter of Belgium’s diamond industry.
Such upbeat forecasts are certainly reassuring to Botswana’s diamond industry, which began in 1967, the year after Botswana broke away from Britain, upon the discovery of what is still considered one of the world’s largest diamond mines in Orapa, a then-desolate area some 250 miles from Gaborone. It’s also somewhat reassuring to officials startled by this month’s declaration by the IMF that plans to fully balance the country’s deficit (affected in part by falling diamond exports) by 2012-13 were “ambitious.” That said, the indisputable catalyst for Botswana’s economic growth and transformation since its independence (average annual growth rate of 9 percent from 1966-2004) is still the same fuel underpinning its relatively high standard of living and political, social and economic stability across the continent today. In fact, per the Boston Consulting Group’s “African Challengers” research note from June, Botswana was chosen as one of eight “African Lions” (a la the four Asian Tigers—Hong Kong, Singapore, South Korea and Taiwan—all of whom high realized high growth and rapid industrialization between the early 1960s and 1990s) based on a variety socioeconomic factors, but namely GDP per capita rates which as of 2008 exceeded those of any of the BRICs. Yet in Botswana’s case, the sustainability of the accolade may be of more concern than with any of its peers: diamonds currently contribute 50 percent of public revenue, 33 percent of gross domestic product and 70 percent of foreign exchange earnings. And despite persisting rhetoric from government officials insisting that, in the face of various expert opinions that the country’s diamond reserves will be depleted in roughly 20 years and that the economy must therefore diversify away from gems and towards sectors such as mining, tourism, agricultural and even offshore financial services, Botswana remains disproportionately dependent on the precious stones. To that end, the IMF’s recent projection that overall GDP growth will reach 8.4 percent in 2010 is explicitly a function of “the rebound in diamond production” and the overall mining sector’s 16.8 percent y-o-y rebound.
One notable source of potential revenue going forward that, until the past few years, has largely been underdeveloped and overlooked is coal mining , as well as the comparatively environmentally friendly production and use of coal-bed methane (CBM)—a naturally occurring methane gas trapped inside coal that once was considered a dangerous hazard. Admittedly, given that Botswana currently imports 80 percent of its 550 MW power demand, with the majority coming from South Africa—which is dealing with its own shortages and will stop supplying its neighbours by 2012—the matter touches as much on security and sovereignty as it does budgetary concerns. Yet there are roughly 200 billion metric tons of coal reserves (largely located in the eastern Kalahari Karoo Basin, an extension of South Africa’s Waterberg Coal Basin), that theoretically could be a vital source of internal power generating capacity, according to the Ministry of Minerals, Energy and Water Resources, as well as help reduce the country’s dependence on imported power and also be transported for sale not only to South Africa, where Eskom, the government-run utility, still faces a coal shortage due to an inability to meet demand with domestic output—but to an export terminal on Namibia’s Atlantic coast, where ocean-going vessels could be loaded quickly. Until recently, though, the problem has centered on transportation, and at least one analyst (who asked for anonymity) blames the lack of capital stock squarely on the state. “The problem is that Botswana and its coal resources are landlocked. There is no easy way to transport these resources to ports for exports as the country does not yet have adequate infrastructure, and building such infrastructure is associated with great expenses,” he wrote.
But that lack of investment may be a thing of the past, per the Southern Times, which reported in late September that “both Namibia and Botswana are in the midst of courting private companies to build the envisaged Trans-Kalahari Railway line stretching from Mmamabula coal deposits in Botswana’s hinterland to Namibia’s deep water port of Walvis Bay.” Ultimately, proponents say, Botswana coal could be marketed internationally, across Europe, China and India. To date, four private companies have been actively exploring eastern Botswana’s coalfields, including CIC Energy, Kalahari Energy, Aviva, and Saber Energy, part of the Tau Capital group that owns CIC Energy, while a fifth, Australian-listed Earth Heat Resources, will soon join the fray. The companies will be engaged in projects, per a report, “ranging from coal mining, coal to hydrocarbons, a coal-fired power station, CBM production, a CBM-fired power station and the various fuel [spin-off] industries.” Moreover, the government seems keen on attracting further investors, revising its Mines and Minerals Act of 1999 that, while continuing to vest all mineral rights in the State, introduces a new retention license which gives it an option to acquire up to a 15% interest in new ventures on commercial terms, thus abolishing its free equity participation, which previously meant that, for significant minerals operations, it would tend to exercise a legal right to acquire an equity interest of 15% to 25% without compensation.
Finally, the CBM market in particular seems to be drawing a growing contingent of advocates, though its commercial uses is less clear. “Research [has] demonstrated that capturing methane and harnessing it into a productive energy source has the ability to dramatically decrease the detrimental effects on the environment. It has been proven that burnt or used CBM is twenty two times less detrimental to the environment than when it is left to escape un-burnt. It also has twenty one times greater heat trapping value when released into the atmosphere than carbon dioxide. Based on its environmental footprint it is clear that every opportunity should be taken to remove CBM from the atmosphere and one of the best ways to do this is to use it in energy production,” wrote Megan Rodgers of Bowman Gilfillan, a Johannesburg and Cape Town-based law firm. That said, China’s CBM experience—involving convoluted access for suppliers to the pipeline network, and the necessity of subsidies—leaves question marks on the industry’s future feasibility. Such concerns aside, however, Botswana’s energy and diversification push seem on the right track, another step away from diamond dependence.
JGW
Frontier Markets 