The Coming Oil Crisis

What really concerns me at present is not the sub prime induced credit crunch but actually the next oil crisis. There is an interesting debate going on about the future for oil supply between official oil industry sources such as the US Government backed International Energy Agency (IEA) and an independent band of mostly ex-industry professionals, the so called "peak oilers". As their name suggests, peak oilers believe that global crude production has reached it's limit and that supply is about to decline (or indeed that it already has).
This argument is very well presented in a report by the Energy Watch Group (EWG) published in October 2007 which analyses production data in detail by geographic region. The other side to the debate is led by the IEA which largely forecasts demand, where increases will come from China and India and assumes (backed by reserve data) that OPEC countries will increase supply to fill the gap. But the difference in methodology produces vastly different results: EWG predict that by 2030 global oil supply will be down to 39mbpd whilst the IEA forecast 116mbpd (against about 85mbpd for 2007). If the IEA is wrong and EWG is right we are, globally, are in for a serious shock.
The whole issue is far too lengthy for me to repeat in my blog but I will, from time to time, discuss some of the respective arguments. Suffice it to say that a key part of the differential arises in respect of the Middle East, particularly Saudi Arabia.

Royal Bank of Scotland

I had been eagerly awaiting the RBS trading update today and have listened with great interest to the press and analysts conferences (the media conference was much more interesting). The statement was very solid and Sir Fred impressed me as being very clear and straightforward in his presentation. Pragmatic and, as he put it, just delivering what they said they would. RBS (excluding ABN) is expected to produce operating profit and EPS well ahead of consensus whilst ABN is in line with guidance. Integration is going well and the acquisition is expected to produce a better return than originally envisaged. Credit market write downs were significant at £950m but were much less than the had market feared and contained within the overall earnings expectations. Sir Fred refused to be drawn on 2008 but expressed great satisfaction with the greater diversity by business and geography that RBS now had. Overall there was less business to be done but underlying business growth and ABN opportunities remained. Asia was a particular high spot. In the UK as yet there were no tangible signs of increased stress amongst corporates nor consumers and indeed they were seeing very high levels of credit card spending compared to last year which seemed positive for Christmas. An interesting point that leveraged finance is less than 2% of income so the slow down here wouldn't have a great impact. http://www.rbs.com/

Video Tour of Berkshire Hathaway

"Warren Buffett Watch" with Part II of a video tour around the Berskshire Hathaway HQ with Warren Buffett:

http://www.cnbc.com/id/22045978/site/14081545/

On the page this link takes you to is a further link to Part I of the tour.

A Few Thoughts on Buffettology

I have followed Warren Buffett for a number of years now. Whilst I don't think his investment strategy is totally suitable for my own situation I have learnt a lot from him. The following notes summarise the key components of Buffet philosophy which I like to keep by my side. I will add to and edit this from time to time.

1. Buy Businesses not Stocks. When buying highly liquid stocks it is easy to get lazy and think that "if I don't like it I'll just sell". But if you owned the whole company a "greater fool" might be hard to come by. Buffett buys on the basis that he would be happy holding for 10 years even if the market was closed. This is a great way to focus your attention on the underlying business fundamentals rather than the daily share price.


2. Focus on companies with Wide Economic Moats. When I was at ICG we used to talk in terms of "credit" rather than "a moat" but actually we were talking about the same thing. Simply, how well protected is the company against outside influences? Buffett calls it a sustainable commercial advantage and encourages his portfolio companies to invest to widen their moat further.


3. Use Intrinsic Value. This is probably the hardest concept to fully gasp and put into practice. Unlike most analysts I am not at all interested in the relative P/E and try and find some absolute measure based on discounted cashflow which I think is what Buffett bases his valuations on.


4. Always Require a Margin of Safety. In my view the only certainty about any forecast is that in some way it will be wrong. A margin of safety shortens the odds considerably.


5. Think Independently and be Patient. Easily said but a blind contrarian is soon trampled underfoot when the market rushes for the exit. The market is not always wrong (but sometimes can be slow)! Clearly the best performance follows from buying low and selling high but for this to work you have to be sure of the reasons why the market is being irrational. Like Mohnish Pabrai I generally find stocks continue to fall after I have bought and continue to rise after I sell which is one of the joys of not following the herd. Patience: Using a baseball analogy, Buffett also points out that you increase your batting average by only swinging at the best pitches.

Sold out of China

I'm now out of China. Actually that was a couple of weeks ago but since it seems to have been a reasonable move I'm now prepared to write about it! It's been a great couple of years and although I still believe the long term story, valuations seem to have got way out of hand. I've decided a good indicator of market top is when I hear of a really crazy IPO story. In the case of the Dot com boom it was Lastminute.com whilst Blackstone signalled the top of the private equity market. So when I read of an IPO called Alibaba (maybe a clue there in the name) which multiplied 3 times on the first day of dealings to a PE of 306 I couldn't wait to get out. Now a couple of weeks on with the market about 20% off it's peak, the IPO of Sinotruk (which had been 300 times oversubscribed) fell 15% on the first day of dealings.

Contagion

The word we have all just learned is contagion, defined in my dictionary as "the transmission of a disease by contact". When this is all over I hope the bankers will remain humbled by being the origin of this ghastly infection. But how far will it spread? I detect ever increasing gloom in the City where it has rapidly become apparent that the impact on the debt markets is going to be more severe and lasting than first thought. Almost everyone is now saying "there is worse to come" whereas a couple of months ago it seemed only I was saying that .....

I don't believe China is uncoupled and think the country will soon start to export inflation. Consumer confidence has been shaken both here and in the US and the housing market has stalled. Add in a near record oil price and sky high commodities and the economic outlook is decidedly cloudy.

Meanwhile on the Stock market for many companies, particularly financials, there has already been a big pricing correction and despite the uncertainty, I don't forsee another crash (the particularly overstretched structured finance markets have already been decimated). Overall the market has further to fall but for the long term equity investor there are a few value opportunities emerging so for me cautious and very, very selective buying.

Intermediate but not Boring

Today Intermediate Capital Group reported their half year figures. Given the current investment climate results were outstanding with continuing strong capital gains, 24% increase in core income and 33% growth in PBT assisted by a significant write back of provisions. It should be pointed out that the trading period covered mostly relates to the period before the contraction in the debt markets which happened in September and the outlook is less robust, but unsurprisingly the market reaction was very positive. ICG has for some time been wary of the credit bubble and avoided expanding too aggressively other than by geography. Now with plenty of funding, ICG is well placed to take advantage of the current conditions leading to more creditor friendly structures, prices and terms. However long term growth is very dependent upon the overall growth in the private equity market and that is currently constrained by availability of debt. Sources tell me LBOs are being put together but there is no bank underwriting and banks will only sign up to their final take appetite, if necessary as part of a "club". Apart from a nominal holding I sold out of ICG earlier this year near the all time high. This is a good business with a very thorough long term investment process and deeply embedded credit culture but there are risks and I see less upside. http://www.icgplc.com/

The Need for Data Security

The most shocking thing about the data loss just reported at HMRC is not so much that a couple of disks have been lost in transit as the apparent ease with which a huge amount of sensitive data could be accessed and downloaded to CD. Clearly HMRC culture does not recognise the importance of data security and there is a total and systematic lack of the proper procedures which should be in place. The good news (if it is fair to call it that) is to bring to the fore IT Security, another investment theme of mine and specifically a company based near Cambridge called nCipher. nCipher produce hardware modules for data encryption and the software to control who has the keys needed to unlock it. Although small nCipher is already a world leading business in this field with many blue chip clients and I expect is now receiving a lot of calls. http://www.ncipher.com/

Sub-Prime for Laughs

A great take on the sub prime crisis. From the South Bank Show

http://www.youtube.com/watch?v=SJ_qK4g6ntM

Renold Renewed

Today I attended the Renold Plc interim results presentation to analysts. There were only three of us there but nobody minded me as a small shareholder. The company has been through a period of significant change with new management, disposal of loss making businesses, relocation of significant capacity to China and Poland and other operational enhancements. Greater sales growth is now in prospect. I was expecting the market to react positively to the news that everything was on track, but instead the share price fell over 10%. The full impact of the so called PACE (Profit and Cash Enhancement) plan is yet to show in the numbers and so a great buying opportunity has presented itself.

Update Thursday 22nd November 2007: I caught the falling knife! My buy order went through at a rock bottom price today and seems to have stopped the slide. I will count my fingers again in a couple of days....http://www.renold.com/

Property Supply Limitations Are Key

Longer term house prices will go up in line with real wealth - as we get richer we all want a bigger, better house and then second home. Hence there will always be strong demand for the best properties, particularly well located family houses in London and the South East where new supply is severely limited. That said some of the froth will get blown off in the near term. City bonuses might drive house prices in Fulham but not everywhere else! Around the country during 2008 I expect some falls and stagnation as mortgages are harder to come by and confidence declines. But no immediate crash unless we fall into a recession. But I would steer well clear of City centre new build B2L flats.

Giles Hargreave

On the lookout for the next Anthony Bolton I've recently been following the progress of the top performing Marlborough Special Situations Fund run by Giles Hargreave. In this interview he sets out the investment process followed by the fund.
http://www.marlboroughfunds.com/priv/MarlboroughTV_SpecialSits.htm
Key points I took away were:
Average up and not down (i.e. build on good performance)
With small companies "things can happen" hence the need for a diverse portfolio (this is a small cap fund with about 50% AIM)

Between a Northern Rock and a Hard Place

The solution to this crisis depends upon whether any bid for the company is structured in the best interests of the shareholders or merely to get the Bank of England off the hook. Without Bank of England support Northern Rock is bankrupt so clearly the Bank of England and UK Government hold all the cards. Most likely they want a quick solution and don't care about the shareholders so that is why the hedge funds whom bought in recently want to stop the sale process. When British Energy got into a similar situation the Shareholders came out with very little. I see no reason why the same shouldn't happen here.

How to Live Longer

Always on the look out for new investment "themes" I read a very interesting article in the FT yesterday about longevity. It seems we are starting to live a lot longer and, more significantly, longevity is increasing at quite a rapid rate. Apparently in 1990 the life expectancy of a then 65 year old male was 17 years (i.e. 82 years in total). It is now 24 years (i.e. 89). The ONS has published statistics showing a 90 fold increase in the number of people making it to 100. Quite a big jump and good news which means my life expectancy is a few years more than I thought it was yesterday. But I wonder if all this is factored into actuarial mortality tables with allowance for probable further increases in life expectancy.
Update 26th November 2007: Further small FT article refers to study by David Blake of Pensions Institute at Cass Business School. He uses the same data as ONS but comes up with a range of outcomes. Believes a man who reaches 65 in 2050 (22 now) would live to 91. Government forecasts for longevity are underestimated by up to 12 years.