Where in the World? Best Places for Your Money for 2005

0:00And now for something completely different, as I used to say on a British television program 30 years ago. I'm very honored to be in this august company of academics and thinkers, economists and thinkers. I'm not an economist, although I have been known to think from time to time. What I'm going to do this afternoon is look around the world at different asset classes, different markets, and see which sectors look good to us right now in terms of value. I am, as was discussed earlier, not surprisingly, a value investor and I believe in absolute value. I don't believe in looking for relative value. One can always, of course, find some things that are comparatively less expensive than others.

0:45The trick and the key to successful investing is to find things that represent absolute value. and I have to say that right now from my perspective I don't see an awful lot anywhere in the world in any sector that represents a good value certainly not on a broad on a broad basis. Let's start by taking a very quick look at how I see global economies and I'm not an economist so I'm just going to skim over this but it's pretty clear that over the last few years we had a had a coordinated economic recovery around the world where pretty much every part of the world was in some kind of economic up move. But these recoveries have started to lose momentum recently.

1:33We've seen that with the leading economic indicators, not just in the US, but global leading economic indicators are all showing a decline in momentum. In the US, of course, the consumer remains very strong, but largely, in my view, based on credit. Europe, in continental Europe, when I talk about Europe, I'm not talking about England, of course. Continental Europe, we're seeing the recovery stall in many parts, particularly in Germany. And then Japan, of course, has now entered its fourth recession in the last ten years. so the economic outlook does not look particularly positive certainly not compared with the last couple of years and at the same time there are some significant risks so we're going to touch on later the risk of a hard landing in China and of course the risk to Saudi Arabia at the same time there's another factor I won't call it a risk there's another factor and that is the US dollar We've had some comments already on the dollar, we had an excellent talk from Dr. Mueller on the dollar, I agree with everything he said, and I think we're all familiar with the basic problem, the deficits, the twin deficits in the US now represent almost 6% of GDP, which is considered by most economists a danger point and a crisis point, if it weren't for the fact that the US economy, in my view, if it weren't for the fact that the US economy was in fact the leading economy,

3:07economy in the world and the dollar the reserve currency in effect it's clear that the dollar would already be a lot a lot cheaper than it is and of course the other factor that we know about is the tremendous foreign buying and foreign holding of dollars that we've seen over the last 10-15 years I've got lots of lots of the graphs and tables on this in the handout I hope you all have the handout you can look at these at your leisure later but I would just like to I'd like to point out to one of them, which is on the top of page 3. And this is the one that shows the US required share of net export world capital. The point was made earlier and I think is a very, very important point. Foreigners do not need to sell a single US dollar for the US dollar to go down.

3:59All that is needed at this point is for foreigners to stop putting quite so much of their new money into the US economy, into dollars. They don't need to sell at all. Right now, the US is taking up almost 80% of net export world capital. That is clearly, clearly unsustainable. So that all we need going forward is for foreign investors, foreign banks, foreign private investors at the margin to put less of their new money to work in the U.S. And in fact, we saw that last year with both Russia and China. China was, the amount of new money that China was putting into the U.S. economy last year fell dramatically. And that's one of the reasons that the dollar was so weak last year.

4:49Now, I manage money for a living, and so I'm concerned not just with, I'm concerned not just with the long term, but I'm also, I have to be concerned with a fairly shorter term horizon as well when I'm placing money. And it seems to me that the dollar, as we know, the dollar has had a rally in recent months. I think it's a short term rally based primarily on market factors. Sentiment was overwhelmingly negative, the dollar, and it was well above its trend line. And when you see this, it's not unexpected that you should get a counter-trend rally and that I think is what we've seen. Going forward, whether the dollar rally has finished or not is unclear and nobody knows, of course.

5:36But going forward, it seems to me that with new money that we put into foreign currencies, We want to emphasize the euro a little less, and we want to emphasize Asia and Asian currencies a little more. But there is a risk in the near term, it seems to me, particularly if the dollar continues to rally, and particularly if China does have a slowdown, I'm going to touch on this a little bit later, because both of those factors combined would have a significant impact in the short term on gold and other commodities. Let's just sum up before I get to markets by looking at the global economic environment. Clearly we still have economic growth around the world, albeit growth whose rate of improvement is slowing.

6:23We have low interest rates around the world, albeit rates that in many parts of the world are moving up, but on a historical basis as we all know, interest rates are at very, very low levels right now. We have an inflation risk again, albeit inflation is low. We have a very vulnerable dollar in the long term and of course we have geopolitical risk as well. This kind of environment is obviously weak for the US dollar, it's weak for bonds, not just US bonds but global bonds and it's weak for many stocks and stock markets and stock sectors but it's positive for commodities, real assets and particularly emerging markets, It's particularly emerging markets in Asia and we'll talk about that a little bit later.

7:11What I'd like to do is look at some of the main sectors and markets around the world and just see where the value is or is not. If we look at the U.S. stock market first of all, the U.S. stock market of course being the largest stock market in the world by far, the U.S. market right now is selling at valuations And those that are above their averages, it's more expensive than it is cheap. And it seems to me the continued earnings growth is already priced in. Now we had very strong earnings growth last year, but a lot of that earnings growth was based on lower interest rates, reducing the net interest cost of many corporations. If you take that out, then the earnings growth in U.S. corporate sector was actually very, very modest last year.

7:58but the market is already priced in continued earnings growth which I don't think we're going to see. As an investor I look at risk and potential. Every investment you ever make has some kind of potential, some kind of risk and it's their job to look at both and to try to balance the risk with the potential. So one of the things I always do is look at what the risk in the US market is. This is This is a very, very simplistic table. I'll warrant all of the things that are wrong with it, but it's a very simple measure of what the risk in the market is. All I do is look at what the today's multiples, fundamental multiples in the market are today.

8:43Then I look at the long-term historical average multiples, and then I simply calculate how far would the market have to fall or rise, in this case fall, in order for the market to be trading at those long-term historic average multiples. It assumes, of course, a static economy, which we all know is not so. And what you see here is that on an earnings basis, the market would have to fall 13%, not a lot. But on a price-to-book and on a dividend basis, it would have to fall 30% to over 40%. That is a lot. So from a risk-reward basis, it seems to me whatever kind of potential is in the market right now, depending on a lower oil price, a stronger U.S. economy, continued corporate earnings growth, a calm geopolitical situation.

9:31All of those things could happen, but in my view they're unlikely to happen, at the same time there's significant risk in the market. If we look at global economies, we see much the same thing, most markets around the world, indeed I would say all markets around the world are expensive based on their own historical parameters. And what do I mean by that? When you look at Hong Kong, for example, Hong Kong at 18 times earnings yielding a little over 3% is relative value, perhaps. But it is not relative to the rest of the world. But it is by no means absolute value, and it is by no means good value compared with the Hong Kong market's own historical parameters. It's traditionally yielded around 4.5% to even 5% and traded around 12 times earnings multiple.

10:21So I don't see a lot of value in global stock markets around the world and not cheap by historical standards. Earnings momentum is slowing and then of course the potential for a big decline in the dollar is very real. I do see some values though. I think one can look for value in global blue chips. I'll mention a couple of names in a second. Global blue chips are good prices. companies, high-yielding companies with sustainable yields, European stocks are traded at discount. These are often holding companies or family-controlled companies. As a value investor, if I can buy a dollar's worth of assets for 50 cents, I generally don't mind how long I have to wait to realize the full value.

11:06So I don't mind if it's controlled by a family because typically over time, these values do get realized. Asian emerging markets have value, but obviously it's a little more speculative for many investors. And lastly, commodities, particularly oils and the metals. But most markets have been bid up over the last 6-12 months. And again, I don't think you need to be particularly aggressive in buying because we're not seeing overwhelming value at the moment. We're simply seeing some good value, some reasonable value. Here are some stocks that I think are good buys, but they're by no means great buys. Hong Kong Bank, for example, trading at about 17 times earnings, yielding a little over 3%. It is a great company in my mind. It's a great kind of company, but you want to own and you want to own it almost permanently.

11:58It's the very first stock I ever bought in 1978, but it is not, by its own historical parameters, inexpensive. So I think it's the kind of thing you want to look for, look for a correction and move into slowly. And we could go through all of these with the same kind of discussion. Commodities are attractive to me right now, although again, I don't think one needs to be overly aggressive. But painting with a very broad brush, we've seen a lack of new projects in many of the commodities. and we're seeing, that's been true for many years of course, supply has not kept up with demand for a long time but there's been high inventories in many of these commodities for many years. Those inventories have generally, and again painting with a broad brush, been run down over the last couple of years which is why prices have moved up.

12:49The macroeconomic climate is also positive for commodities. The big question in the near term perhaps is China. Seems to me that, you know, six months ago or a year ago A year ago, I thought China was almost certain to have a hard landing of some type or at least a significant slowdown but it seems to be that conditions have got a lot stronger in China recently, we see this in inventories being run down in China, we see that in the shipping rates, the Baltic shipping index on Europe to Asia, the US to Asia, prices moving up, so that's all a sign of a stronger economy. I think there's still some risk in China though is still an open question we have to watch. The risk is not so much at the government level or even at the corporate level.

13:35The risk is now at the consumer level. A lot of bad consumer credit, the banking system, as we know, is in pretty bad shape and largely because of this bad consumer credit. So I think it's still an open question in the near term whether China is going to escape a hard landing. Certainly in the longer term, and we don't have time to go into it now, Now, but certainly in the longer term, I'm very, very bullish on China, in longer terms, 10, 15, 20 years, but even in the next five years or so, when Beijing is holding the next Olympics, there'll be a lot of infrastructure building. I think that's going to be very good for China and very good for the commodities. The ones I would stick with would be oil and gas and gold primarily.

14:21How long do I have, Mark? Seven minutes. Okay, wonderful. If we look at oil, I think a lot of us will know the story, but it's important to look at the long-term fundamentals. Long-term, the big major fields around the world, which contributed to the growth in oil demand over the last half century, have all peaked and are all mature and are all in decline. Now, I'm not a doomsday saying the world's running out of oil. We're not running out of oil. It's a matter of the price it takes to get it out. But it is true that the big fields that contributed to the growth in the oil supply have all peaked and are all mature and are all on the way down. I'm talking about the North Sea, the Alaska slopes, continental U.S. before that, of course.

15:07And what we're seeing instead is a lot of smaller fields in much more unstable situations like Nigeria, offshore West Africa, Indonesia, the Stans, Russia. I think our next speaker may have something to say about Russia. But clearly these are more unstable. And despite this, we're only seeing 75% reserve replacement by the major companies. So we have a very, very delicate supply demand situation in oil at the moment, and the oil market is always vulnerable to a supply disruption. That's why there's a geopolitical premium in the price of oil right now. But in my mind, a justifiable geopolitical premium, Because that risk of disruption is very, very real and given the precarious balance between supply and demand with low inventories, then a disruption has an immediate impact on price.

16:05If we look at gas, the situation is much the same, although, of course, it's confined to one geographic area. Supply is declining, the big, big, mature fields, I mean the big fields in North America are mature fields. And exploration success, and this is a key point, exploration success has been very, very limited. Despite the huge increase in the price of gas over the last few years and the enormous pickup in drilling activity, both in the US and in Canada, to the point where we now have record drill activity in Canada, Almost record-drill activity in the continental United States, as you would expect when the price goes up. The plain fact is that we are not replacing the gas that we are consuming. What we are finding, despite all this activity, we're finding very short-lived fields with high decline rates.

16:58High decline rates means the first year might have a lot of gas, but then it drops off very quickly. One of the things a lot of people have thought is that over the next couple of years, Liquid Liquefied Natural Gas will come to the rescue of the North American market. First of all, LNG is at least four or five years away from having any significant impact on the North American market. But more significantly than that, and we heard about this earlier from one of the speakers, is that a lot of the Asian countries, China, Korea, Taiwan, India now, are making long-term contracts with suppliers in Mexico, Venezuela, Nigeria, even Trinidad to lock up the LNG that we previously thought was coming to the North American market.

17:45So I don't think LNG is going to be a solution. If you look at the next two tables, graphs are on the top of page seven, they're on page seven on your handout. This shows U.S. natural gas production. We now have 11 quarters, there's one missing from the graph. The latest quarter was down. We have 11 consecutive quarters of declining production. That is phenomenally significant and is staggering when you consider what the price of gas has done. And the activity, looking for gas, 11 consecutive quarters. This shows you Western Canada. Western Canada, of course, is the biggest part of Canada for gas. Record drilling activity. So here are some oil and gas stocks. I'd be happy to talk about them later. And then lastly, gold, I know we've got a speaker tomorrow on gold, so I'm just going to touch very, very quickly on this, I think it's a very positive macroeconomic environment, it's also a very positive industry environment.

18:43Same sort of factors in gold that we've seen in other commodities, a lack of exploration, and even though anybody who follows the gold market is constantly hearing about new discoveries, what you don't hear about are, A, the number of discoveries that ever actually produce gold. The number of the produced gold is a lot less than the discoveries that are made. And the other thing you don't hear a lot about, of course, are the older mines that go out of business or produce less than they used to. So, in aggregate, we saw a decline of 5% in gold production last year, which again, given the price of gold, is pretty amazing when you think about it. And that follows about four or five years of either stagnant or slight declines in global production of gold. of Gold. Most recently of course gold has moved in inverse relationship to the dollar. It's been an almost entirely anti-dollar move and when the dollar rallied at the end of last year beginning of this year gold fell from

19:40455 down to 412 or something and that was also compounded by this new threat of sales of gold by the IMF. It's quite interesting that every time gold hits a peak and starts to come off there's always some government somewhere that announces they're going to sell off all their gold just to spook holders. That IMF threat of selling gold seems to have retreated. I don't think it would pass Congress. I'd be interested in what Dr. Paul has to say tomorrow. But I think that threat has retreated, and gold has rallied a little bit. So now we're looking basically at the dollar. The other question people ask is after the huge increase in the price of the gold and gold stocks in the last year, are the gold stocks expensive?

20:28Well, from a purely fundamental value point of view, yes, the gold stocks are expensive today, but then they are always expensive. I challenge anybody to ever tell me a time when gold stocks have been value stocks, except in retrospect. I think the important point is that gold stocks carry a premium and they carry a premium for very valid reasons. So when we look at the valuations of the gold stocks today, we see in fact that they are trading at below average valuations on a historical basis relative to reserves, production, price earnings, yes some gold stocks do actually have earnings and cash flow. So if gold goes up today, if gold rallies today, the gold stocks are cheap enough that they also have a significant potential to move up.

21:17This is just two examples of that, and the charts are on page 10 of your handout. These are graphs of valuations of the North American producers over a 20-year period. And as you can see, they are not at all-time historical lows in terms of valuation at this point. But they're not far off, particularly in terms of price earnings, and then this is the NAV. So in conclusion, I think this is a time for cautious investors, for conservative investors, for investors to be pretty cautious and conservative. I think you want to hold a lot in cash right now. And when I say cash, I'm including foreign currencies. I don't think there's any rush or any urgency to be aggressive at investing your money. But you certainly want to be holding a position in gold and good quality gold stocks.

22:08In oil and gas, you need to be looking for global blue chips. and then also I think is a good time to be in good quality dividend paying stocks as long as those dividends are sustainable and with that thank you very much.