Back to ag

Last week I highlighted some inflation stories that were beginning to surface and readers sent me more – everything from gold and silver hitting new highs to anecdotal evidence of Malawi land prices. You are preaching to the choir – there are global imbalances on the one hand, and power-shifting demographic changes on the other that are supporting the underlying strength in certain commodities (not all). One of the areas that we’ve mentioned in the past as a source of stability in volatile periods, a hedge against inflation, and a hedge against worst-case scenarios for those prone to hyberbole is direct investment in agricultural land. I’ve been discussing it for a few years, mentioning the potential and also the difficulty (both in implementation and in management).

We are not alone, as money continues to flow to arable land: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7997910/The-backlash-begins-against-the-world-landgrab.html. This article points out another trend that I’ve been discussing, which is the backlash against globalization as protectionist measures increase globally. In a best case scenario, I expect that countries will move to build up strategic supplies of food-stuffs, and perhaps place loose limits on foreign ownership – troubling, but manageable. In the worst case scenario, I think we could have actual land seizures, elimination of certain property rights – in the name of national security, ideology, or what have you, and nationalizations similar to previous decades in various parts. Egypt, which is enjoying a certain renaissance these days, comes immediately to mind, as do various South American countries.

Given some of the challenges of implementation, I continue to focus on diversified baskets of commodities, commodity-related companies, and second-degree beneficiaries for active investment opportunities. In terms of direct investment in agricultural land, there has been a mad rush to Africa, which I am currently avoiding (at the risk of missing significant returns), and sticking to areas that have ample water supply (north/midwest US and Canada). I don’t expect significant returns there – yields should hover in the 3-6% range unless inflation picks up, but in this environment, that’s not a bad place to wait.

For a succinct article with a few different options mentioned, click here.

Munis – still staying away

Harrisburg’s well-publicised default on $282m in debt on an incinerator project it partially guaranteed already sparked concern. But the far smaller sum of $3.3m, the coupon on its tax-free general obligation (GO) debt, has really spooked the market. Bond-insurer Ambac put its backing behind the issue, the sort of backstop that was criticised as taking money for nothing, since cities’ and states’ power of the purse were thought to make additional guarantees redundant.

To read the full article, click here.

We haven’t visited muni land in a while, but some recent developments made me shudder. Defaulting on a GO bond? That is never supposed to happen. But then again, for those who remember, in 1997 Russia defaulted on ruble denominated bonds, which also wasn’t supposed to happen. The Russia event brought down Long Term Capital Management and supposedly almost brought down the entire financial system, prompting the Fed to step in for a quick save.

In the case of munis, what’s the end game? Well, municipalities will take the long term risk of increased cost of capital for current funding needs and by extension political necessity to appease current voters. Current bond holders, however, tend to be retail investors who need the after-tax income of muni’s, so really, their putting the politicians between a rock and a hard place – on the one hand, voters don’t want to see decreases in municipal services, on the other hand, they face a decrease in the price of their bonds and decreased income from lack of payments. There’s the problem – no one wants to sacrifice on any aspect.

So, politicians will be forced to take the short term beneficial route of rallying the base against corporations, assuring bond holders that their bonds are insured, and putting future town residents on the hook for higher interest payments. In the meantime, the federal government will need to bail out Ambac and the other bond insurers in what will be called a black swan event, but which is so predictable Warren Buffett wanted to stay away from it at any price.

Simultaneously, of course, tax receipts are dropping as real estate values, capital gains, and income taxes get squeezed. Thus, states will not have the ability to backstop the municipalities and local governments. The federal government will be the lender of last resort and with limited ability to increase taxes, will be forced to print. Inflationary? Maybe – certainly on a theoretical level if jobs remain, but could just be desperate if wage inflation doesn’t show up and velocity stays low. If nothing else, it will lead to an increased debt burden and eventually lead to increased rates across the debt markets and all along the curve. While munis won’t be the trigger (I believe lack of foreign buying will be), weak local and municipal positions will certainly contribute.

Inflation stories starting to surface

Deflation has been all the rage the past few month as bond prices continue to astound bringing yields down, and analysts like David Rosenberg at Gluskin Scheff turn out to have been right. And, I admit, I too have been in the deflation camp, arguing that a global slowdown, and a Chinese slowdown especially, will cap any upward price pressures. I’m still in that camp, but not as adamant as I used to be. There are a few major trends on the horizon that are starting to tilt me to the other camp.

The first is structural. Globally, governments are all in stimulative mode, trying to outdo each other on the easing fronts. Japan is the classic story of the government continually being thwarted with higher yen, but if there’s one thing a government can do effectively is devalue the currency, so I expect the government to eventually win. But Japan is not alone. Ireland is issuing debt to itself, in an apparent twist on the ponzi scheme – in the Irish version, they’re actually pyramid-ing themselves, without bringing in new investors. Hmmm. Probably not going to work out well for them. The US too is in easing mode, which will eventually mean yields will rise. So, while I’m not in the inflation scare camp yet, global easing continues to make me fear fiat currencies.

Then, there are the stories, apparently unrelated, but sounding incredibly similar. Coffee prices up by a third in the past few months as reported by the WSJ. How about Russia banning exports of wheat, sending the prices higher? What about gold hitting new highs? Check out the corn ETF:

True, energy hasn’t skyrocketed, but it also hasn’t broken down in the face of global slowdown. How about POT getting Chinese interest? Or the increase in rare earth materials? For now, a lot of these prices moves are supply disruptions and not being driven by demand, but could they lead to an increase in consumer prices and a flight to “needs” in the near future? Very possibly and it’s something to keep an eye on. For now, economic slowdown and consumer retrenchment are the orders of the day, as is debt deflation (coming soon) on the corporate and sovereign sides, and depressed equity valuations. But at least on a relative basis, if not on an absolute basis, the recent moves in the above mentioned markets might give us insight into where to invest.

Energy – by the time you read about it…

When the BP spill occurred, I wasn’t able to blink without energy being mentioned. Every article, every economist, and every politician wanted a piece of the PR feeding frenzy. The problem was that the focus was completely misplaced; I said it then and I’ll say it now – a spill was not surprising!

Given our energy dependence, the fact that oil is getting harder to find and extract, and the lax government regulations, it was only a matter of time before some major spill happened somewhere. So it happened to be BP and it happened to be in the gulf. Immediately, everyone wanted a piece of BP’s massive cash hoard. I get it and I’m happy to fine them, but there are bigger issues at stake. No effort has been made to analyze the underlying issues of energy – but a bigger issue is looming and the rest of the world is aware of it more than the US.

Iran is going nuclear, and whether we like it or not, energy dependence will once again take a front row seat, with no one to pay any fines, as we face a massive squeeze in oil prices.The front page of The Atlantic Monthly brings to light one (of numerous) scenarios that might drive this squeeze:

The rest of the world is more aware of it that the US, and is taking the appropriate actions – investing in domestic energy supply through alternatives and nuclear. By far, nuclear energy offers the best option to gain long term energy independence. Even Finland, with its strong environmental and bureaucratic structure has found a way of burying nuclear waste, so how come we can’t?

The geopolitics of energy are about to trump the global slowdown.

I go away for 2 weeks

In the span of two weeks, there has been a lot of noise, but not a lot of movement. The S&P is roughly where we left it, 10 year yields are where we left them, and most currencies haven’t moved – except one.

The yen is at 15 year highs and any attempt to short it has been met with continued strength. There are a lot of theories out there, but one thing is for sure – the deflationary pressure continues for now as stocks and bonds no longer offer investors any haven.

I usually like taking the other side of government traders. They tend to be driven by institutional considerations more than any market or profit signals, so they have a good record as contra-indicators. That being said, we are facing the one time I do not want to be on the other side of a CB. CB’s are incredibly effective at devaluing a currency. While deflation might be the order of the day for the yen, eventually, the BoJ will win and inflation will hit as even local investors and citizens begin to fear the government campaign. I think we might be in the last throws of deflationary pressure in Japan. I’ve been wrong on the timing for the past year, so there’s a chance I’m still wrong. However, once the tides change, I believe the downdraft in the yen will be swift and painful for anyone caught long the currency.