InvestMacro FX

By MoneyMorning.com.au

If you ever get the chance to hang out with a member of the Fergusson family, you should probably take it.

I’ve been talking to Adam Fergusson, author of When Money Dies, about the hyperinflationary risks inherent in the super-loose monetary policies of the West, for some time now. He’s fascinating. I had a totally different – but just as interesting – conversation with his son James, author of Taliban – The True Story of the World’s Most Fierce Fighting Force, about water.

Water is an oddly undervalued resource, and many big investment houses now have it as one of their long-term investment themes. However, James says that we still aren’t taking water shortages as seriously as we should.

Water and the Lesson of Afghanistan

Consider Afghanistan. In the 1950s, the Americans figured that you could irrigate the south if you canalised the Helmand River. So, in partnership with the Afghan government, that is what they did – and the results were good. Ample irrigation meant that a huge fruit export industry sprung up (Canadian troops in Kandahar recently were billeted in a former fruit canning factory). Then it went bad: the canals were all but obliterated during the Soviet invasion and war of the 1980s. On top of that, the 1990s brought drought. So the supply of fertile arable land plummeted just as the population started to rise rapidly.

What was the result? Huge pressure on the land and a drive to find more profitable crops. Those crops? The poppies that currently finance much of the war in Afghanistan. 90% of the world’s poppy production comes from Afghanistan and 90% of Afghanistan’s poppy production comes from around Helmand. It’s a complicated conflict but, in this particular area at least, the scarcity of water underlies it.

Helmand isn’t the only place where this is the case. The conflict in Darfur can be easily traced to pressure put on grazing rights caused by drought. And what of the epicentre of hydro politics: the Nile, the river that irrigates much of Africa from Egypt to Uganda? There has been bickering over the waters for centuries.

Now, though, the situation appears worse than usual. Ethiopia, which contributes about 80% of the Nile’s flow, is planning four large dams on the Nile – one of which will contain the largest hydroelectric plant in Africa. This project is intended to create a vast reservoir (1,680 square kilometres) to safeguard the country’s future water and power needs. The problem? If it is completed (it won’t come cheap and Ethiopia isn’t rich), it will take something in the region of seven years to fill when built. Ethiopia claims this won’t affect water flow to Egypt, and its agriculture-dependent economy. Others say it could cut it by 25%. How’s that for conflict potential?

Water Shortages Are Dangerous

Another example of the impact of water shortages on seemingly modern life comes from Sanaa, the capital of Yemen. It is soon to have the dubious distinction of being the first global capital city to run out of water. Four times as much water is being removed from the area as is replaced each year. By 2017-20 (depending on whose estimates you believe), it should be all gone. That doesn’t seem to be a problem that will solve itself.

Finally, I can’t mention water without mentioning China – a country where 20% of the global population lives on only 5% of the world’s fresh water supply; where the water table is falling fast; where the price of water is rising; and where President Hu Jintao has noted that water shortages affect “China’s economic security ecological security and national security.”

James Fergusson’s point is that, while we are all aware of the water problem, we aren’t perhaps fully aware of how much trouble it is causing already – and of how fast countries need to move on investing in the water infrastructures needed to keep that trouble contained.

Merryn Somerset Webb

Editor in Chief, MoneyWeek (UK)

Publisher’s Note: This article first appeared MoneyWeek (UK).

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Water – The World’s Most Undervalued Resource

By MoneyMorning.com.au

The following map shows how German forces, in August 1941, encircled and captured over 650,000 Soviet troops in three main attacks during the invasion of the USSR.

Operation Barbarossa was Hitler’s plan to march east and take Moscow by the fall of 1941. The German armies, at Hitler’s instruction, diverted south to begin an encirclement of the Russians. The Russians surrendered by the end of September.

Hitler enjoyed a massive tactical coup at the Battle of the Kiev. But his diversion south of Moscow meant German armies would not arrive there until after the city had been reinforced by troops from Siberia. More importantly, it cost Hitler time. The Russian winter arrived. It froze the Germans. Then it buried them.

Investors in the stock market and government bonds are like the Russians.

The first attack on your portfolio began in 2007 and lasted through 2008 as the banking sector nearly collapsed worldwide. Credit reinforcements from central banks and new lines of stimulus supply from governments prevented a total rout but at great cost.

But the logistics of supporting the failing bank sector took their toll on governments. By 2010, the governments themselves were unable to continue the fight against debt deflation. The noose closed tighter on markets. The army of bears advanced.

The forces of debt deflation now surround us on all sides. Lower house, stock, and bond prices should be the inevitable result, until the last bull is routed. But the central banks are the diehard holdouts in this war. They keep airlifting money into markets (perhaps with helicopters) to keep investors supplied with confidence.

To me, this analogy represents the last stand of the corrupt financial system of the Western world. Central banks in Japan, the US, the UK, and Europe are the only thing standing between you and a big correction in stocks. I don’t think they’ll be able to hold out forever. But keep in mind they have an endless supply of bullets, if bullets are credit and credit can be created with keystrokes.

I would view these interludes of reflation in the markets as chances for you to exit this system, to slip through the encircling lines and convert your financial wealth to real wealth, or to try to get into another system. I know it’s not easy. But it’s worth trying. The alternative is almost certainly inevitable.

A Market of Stocks, Not a Stock Market

The only ray of sunshine in this otherwise dark forecast is that there is no stock market, just a market of stocks. You are under no obligation to buy “the market”. You buy “the market” when you own an index-tracking fund or a broadly diversified portfolio. If you buy “the market” you will get exactly that: a return that reflects the flow of money into and out of stocks as an asset class.

You’re better off recognising that stocks, as an asset class, are still in a bear market, and perhaps the most dangerous phase of the bear market. That allows you to select individual stocks whose returns are not correlated to “the market”. To find a stock like that, you need a company that has earnings being driven by a business or geopolitical trend that’s more powerful than the debt deflation choking the life out of leveraged markets.

Dan Denning
Editor, Australian Wealth Gameplan

The Stock Market Financial Winter is Coming

By MoneyMorning.com.au

We tell even the most risk-hungry investor to have no more than 15% of their wealth in growth stocks.

Why? Because it’s not a good use of your or your money’s time. It’s wasted time.

And in a volatile market like this, wasted time can be very costly.

In fact, the time your money is wasting in the wrong investment can mean the difference between a plain old moderate retirement and a cruise-around-the-world luxury retirement.

In short: don’t waste your money’s time.

We’ll explain how to avoid that in a moment. But first, let’s show what we mean when we talk about time-wasting growth stocks…

No Growth Since 2007

According to the latest BHP Billiton Ltd [ASX: BHP] annual report, there are 574,229 shareholders with an Australian registered address.

When you think that some of those shareholders are fund managers, investing in BHP for individual investors, you’re looking at a big share of the Aussie population who hold BHP shares.

But how have they done?

As the following chart shows, over the past five years, they haven’t done well at all:

Since at least 2007, buy-and-hold investors have seen no growth.

And even those investors who bought in 2008 during the height of the global financial meltdown have seen their gains wasted away by time.

That’s what we mean by the market wasting your money’s time.

The share price has gone all over place, but what have you gotten from it? If you bought at the average 2007 price of about $35, all you got is about $5 in dividends.

That’s OK. But it’s not great.

After all, you could have put cash in a high interest online account or term deposit and earned about 6% per year.

That would have given you about $11 in income on your $35 investment over the same time… and it would have been a less stressful income too.

Put another way, if you want to get from A to B, would you rather take the straight route or the winding road? And if the return is the same and the straight route is safer, the answer is obvious.

But, the problem with cash is it can take longer to grow your money.

Higher Yield for Less Risk

That’s why you need to look for a higher income yield.

One way of doing that is to invest in dividend paying stocks… companies that pay part of their profits in cash to investors.

The only problem with dividend stocks is they aren’t totally immune from the stock market’s ups and downs.

And while they tend to rise and fall less than growth stocks, even good dividend payers like the banks and retailers fell heavily during the last market rout in 2008.

So, what if there was a way to get better-than-the-bank interest rates, but without taking stock market risks…

Well, good news could be on the way. As yesterday’s Australian Financial Review (AFR) reports, “Investors will be able to buy and sell Australian fixed-income exchange-traded funds within weeks…”

We won’t deny that exchange-traded funds (ETFs) are a lazy way to invest. But there are times when they make a lot of sense.

Right now it’s hard for individual investors to invest in the corporate bond market.

But that’s set to change when a number of bond ETFs are listed on the Australian Securities Exchange (ASX) within the next few weeks.

Amanda Skelly, director of ETFs at fund manager, Russell Investments told the AFR:

“All of the bonds in our corporate bond ETF must be A-rated or above and they must all have a minimum issuance size of $100 million or above. We felt that those types of bonds trade more and are more transparent.”

So, what kind of returns could you make from a corporate bond ETF? Well, without knowing the full details of the ETFs, we can’t say for sure.

But we can look to the returns U.S. investors get from a similar ETF. And how it compares to stock market returns.

Look at this chart:

The blue line is the iShares IBoxx Investment Grade Corporate Bond Fund ETF [NYSE: LQD]. The red line is the U.S. S&P500 index.

Even though the bond ETF fell in 2008, it was nowhere near the price falls seen by growth and dividend-paying stocks (remember the four major Aussie banks more than halved in 2008).

The great thing for U.S. investors is the bond ETF yields 4.21%. That’s not much for Aussie investors. But it’s significantly higher than U.S. bank deposit rates that are around 1%.

Our guess is you can expect to see a similar premium above deposit rates. A yield around 8-9% should be enough to attract investors.

Anything less than that and you’ve got to figure out if the extra risk of investing in a corporate bond is worth it, compared to a risk-free, taxpayer-backed bank deposit.

Of course, nothing is guaranteed yet. And we’ll have to look at the ETFs in more detail. But if the yield is as good as we expect, these corporate bond ETFs could be the one of the best uses of your money’s time…

And the best retirement investment you’ll find.

Cheers.
Kris.

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