When looking for a dominant investment theme the approach I take involves looking at global or big picture conditions. I study trends, read the news, basically watch and listen to what’s going on in the world. What I’m looking for is something so powerful, so dominant, it’s going to be my guide to where I invest – I focus on the factors that I think will drive headlines going forward.
If you had used this approach almost a decade ago (and were to use it today) to try and identify major long term trends within which you can see long term opportunities you would have to come to the conclusion that the resource sector looks especially attractive/lucrative.
In the resource sector there were, and still are, considerable opportunities presenting themselves - investable themes always blossom from these major trends.
Three examples:
- Obama’s electrification of America’s transportation system
- Growing human population climbing the protein ladder
- High oil prices,
After identifying the major themes you need to study the different sectors in order to select the one that you think is going to match up well and outperform the rest.
- Obama’s electrification of America’s transportation system – Lithium
- Growing world human population climbing the protein ladder – Potash
- High oil prices, reduction of carbon footprint – Nuclear power/Uranium
The next step would be to find individual Lithium, Potash and Uranium company’s – based on the quality of their management teams – and make an early, well timed ahead of the herd investment.
After you’ve made your investment, you need to show some patience and let your chosen management team, and the trend, go to work for you. Watch and wait. If you’ve made the correct decisions, management conducts successful programs, does a creditable promotion job and the trend continues, you will reap considerable rewards.
This is “Top Down” investing and in this author’s opinion is the most rewarding way to invest.
Most people do not seem to realize that today there are two easily identifiable, and easy to follow over riding dominant global factors from which all of today’s investable themes are blossoming from.
Each and every one of us, as investors, has to be aware of what is going on - we need to know the influencing factors on the economy and what is going to be influencing investor sentiment by driving headlines. Knowing what these dominant themes are, and understanding their effects, will help every investor decide where to place their money and see the inevitable corrections along the way as either a buying opportunity or perhaps that the end of that particular investment theme is near and it’s time to head for the exits.
Urbanization
Migration is defined as: the long-term relocation of an individual, household or group to a new location outside the community of origin. Today the movement of people from rural to urban areas is most significant.
Migration cause can be explained two ways:
Push factors – conditions in the place of origin which are perceived by migrants as detrimental to their well being or economic security.
Pull factors – the circumstances in new places that attract individuals to move there.
Unemployed, poor and hungry (push factor) people from rural areas are attracted to cities because cities are perceived to be places where they could make more money and have a better life (pull factor).
During the 19th and early 20th centuries urbanization heavily contributed to industrialization. Job opportunities in the cities caused the mass movement of people from the country to the city. These rural to urban migrants provided cheap and plentiful labor for emerging factories.
Urbanization is a macro-trend, in 1800 two percent of the global population was urban, by 1950 it was 30%. Today half of all the people in the world live in cities. This is an economic migration - historically poverty rates are 4 times higher in rural than urban areas. The UN projects that by the year 2030 there will be 1.5 billion more people living in cities.
Nowhere is this rural to urban migration - and a higher degree of industrialization - more evident today than in China and India.
Chinese urbanization
China has set a goal of 65 percent of urbanization rate in 2050. Over the coming 40 years that means 20 percentage points of urban growth per year. This translates into 300 million rural residents becoming urban residents over this time period.
- At the end of 2009 mainland China's total population was 1.334 billion. 712 million people or 53.4 percent of the population were residing in rural areas while 622 million or 46.6 percent were residing in urban areas.
- City's Blue Book: China's Urban Development Report No. 3 said China's urban population is twice that of the population of the United States, one quarter more than the total population of 27 countries of the European Union and that the urban economy would continue to drive domestic demand
- The UN has forecast that China's population will have about an equal number of people, the 50-percent point phenomenon, living in the rural and urban areas by 2015
- By 2025 China's urban population is expected to rise to 926 million. By 2030 that number will increase to a billion
- China's current urbanization rate of 46 percent is much lower than the average level of 85 percent in developed countries and is lower than the world average of 55 percent
- In 2010 the disposable income of the urban population stood at 17,175 yuan per capita - the net income of the rural population was 5,153 yuan per person
- Over the next two decades China will build 20,000 to 50,000 new skyscrapers
- By 2025, 40 billion square meters of floor space will have been built
- 221 Chinese cities will, by 2025, have one million people
- More than 170 cities will need mass transit systems by 2025
"The growth potential of the vast middle and western regions, together with the rapid development of small cities and towns, could keep the economy on the fast track for at least 15 to 20 years." Wei Houkai, director of the center for China's regional development at the Chinese Academy of Social Sciences (CASS)
China's economy expanded at 9.8% in the quarter ended December 31st 2010.
“China’s GDP growth continued at a blistering pace during the first quarter of 2011, rising 9.7% from the previous year, according to economic data released by the People’s Bank of China. Once again this outpaced many forecasts – even that of the Chinese government – and reignited the discussion of China’s overheating economy. While its robust growth may raise a few eyebrows, the economy isn’t in danger of red-lining.” Will China’s Economy Overheat? Frank Holmes, CEO and chief investment officer US Global Investors,
India’s Urbanization
“Every major industrialized country in the world has experienced a shift over time from a largely rural agrarian-dwelling population to one that lives in urban, nonagricultural centers. India will be no different. However India’s urbanization will be on a scale, that outside of China, is unprecedented.” McKinsey Global Institute’s report India’s Urban Awakening
India has 1.2 billion people and the second largest urban system in the world - currently 340 million people.
Less than 60 percent of the households in India’s cities have sanitation facilities, and less than half have tap water on their premises.
The share of the urban population in India is expected to reach 40% by 2021, and by 2011, urban areas could contribute around 65% of GDP.
A report done by the McKinsey Global Institute called India Urban Awakening predicts that 590 million people or 40% of the population will live in cities by 2030 up from 340 million today. By that time, Asia’s third largest economy would have 68 cities with populations over 1 million, up from 42 today.
With less than 1/3 of the population India’s urban areas generate over 2/3 of the country’s GDP and account for 90% of government revenues.
India's economy expanded at 8.9% in the quarter ended September 30th 2010.
Out of Control Spending
The federal deficit this year is a record $1.6 trillion — a number that requires the government to borrow 43 cents out of every dollar it spends. The US government's total debt will mushroom from $14.2 trillion now to almost $21 trillion by 2016.
Obama’s projected $1.6 trillion deficit for the current year would be the highest dollar amount ever. It represents 10.8 percent of the total economy, the highest level since 1945 when the deficit was 21.5 percent of GDP and reflected heavy borrowing to fight the Second World War.
The president's 2012 budget projects that the deficits total $7.2 trillion over the next 10 years with the shortfalls never coming in below $607 billion.
Professor Peter Bernholz, from the University of Basel, examined 12 of the 29 hyperinflationary episodes where significant data exists.
“Hyperinflations are always caused by public budget deficits which are largely financed by money creation…The figures demonstrate clearly that deficits amounting to 40 percent or more of expenditures cannot be maintained. They lead to high inflation and hyperinflations.”
Most analysts quote government deficits as a percentage of GDP:
“The president's projected $1.6 trillion deficit for the current year…would also represent 10.8 percent of the total economy.”
This reporting is misrepresenting the true size of the problem because it doesn’t say how big the deficit is relative to expenditures.
On February 14, 2011, President Obama released his 2012 Federal Budget. The report updated the projected 2011 deficit to $1.645 trillion. This is based on estimated revenues of $2.173 trillion and expenditures of $3.818 trillion.
He then unveiled a $3.73 trillion budget for 2012 with a projected deficit of $1.1 trillion – a lot of savings/cuts and revenue assumptions in the 2012 budget appeared to this author, to put it politely, to be pie in the sky. The savings and revenue projections have more to do with the 2012 election than reality – Obama is trying to appear fiscally responsible to the voters. It also doesn’t look like either party can agree to any cuts except to those in someone else’s (that somebody being from the other party) back yard.
The US government cannot sell enough of its debt to its own citizens and foreigners to finance its deficit and pay the interest on its existing debt.
“Yes, we are monetizing debt. You buy bonds and you monetize debt. Right now, a lot of that is going into excess reserves so it is not having an immediate effect on inflation. It will initiate inflationary impulses. It takes time.” Thomas Hoenig, President,Federal Reserve Bank of Kansas City, early March 2011
The US government is already buying its own debt - this is the most inflationary thing a country can do - and it looks like we can expect this trend to continue and probably increase.
On April 27th 2011 the Federal Reserve Open Market Committee (FOMC) announced it will continue to purchase government securities - including reinvesting principal payments from its holdings – and confirmed its accommodating policies may continue for quite a while.
FOMC downgraded their economic growth forecast, acknowledged inflationary pressures have moved from commodity inflation to core inflation and said inflation remains too low.
It should not be a surprise if the U.S. dollar weakens further - when a central bank wants higher inflation they’ll get what they wish for.
Conclusion
It’s quite obvious urbanization is the driving force behind global commodities demand and inflationary pressures have moved from commodity inflation to core inflation. Both urbanization and inflation look set to continue for the foreseeable future. Of course there will be corrections but the dominate themes are set, the trend is clear. And there are other factors influencing the supply side of the equation.
PDAC curse, sell in May and go away, unusual amount of financings done late last year and investors are chewing through a wall of paper – pick your reason – A, B, C or D all of the above - the fact is junior resource companies – the owners of the worlds future mines - are on sale a little earlier than normal this year. If you like their management team, and their plans for 2011, than perhaps now is the time to be slowly acquiring a position for this summer’s work programs in anticipation of fall results.
Two factors – developing countries urbanization and US$ weakness - are so overwhelming driving the global economy and their effects are so in-sync with each other that investments in two sectors - commodities and precious metals – should be on every investors radar screen. Is it on yours?
If not, maybe it should be.
