Building an ark

[Crip1]

 

A lazy Saturday morning served as a opportune time to catch up on recent postings on this board. One advantage of cramming all of the reading into a single session is that it allows the reader to find parallel themes in what would look to be unrelated topics. The one which stood out to me this morning was the impending inflation in the US and the associated devaluation of the US Dollar. The jury is out on whether or not there will be an interim deflationary period, but there is a high level of agreement that, down the road, we will see significant inflation in the US. Under that assumption it is wise to consider Mr. Buffetts' quote...paraphrasing, “It’s one thing to think that it is going to rain. It’s another to build an ark”. Being a US resident, I need to build me an ark, but would be wise to first develop a blue print.

 

The areas which do make sense to me are investing in non-USD equities where the currency is not expected to be in the same boat as the US Dollar. This eliminates most of Europe, IMHO, as inflation there is likely for the same reasons why it is likely in the US. China and India seem to be the more sexy picks, but without going into details, these areas make me nervous. The three locales which make sense to me are Australia, Brazil and Canada, and I would presume other Asian countries besides China/Japan. The three “ABC” countries are resource rich which will help insulate them from any inflationary pressures and, particularly in the cases of Australia and Canada, have well-developed financial markets. For an American, Canada is obviously a much easier market in which to invest…information is easily accessed, SEDAR, etc. Australia is a little more difficult and Brazil is significantly more difficult for several reasons, language among them. There is a temptation to buy an ETF for these countries but if one assumes that one’s analytical abilities are better than “average”, then one would prefer to buy individual equities versus a market weighted basket. I do have exposure to some of these markets with Suncor, and incrementally with FFH, LUK, JNJ and BRK, each of whom have a portion of their operations generating profits in non-US currencies. Overall, these positions are not hugely significant, though.

 

I would appreciate any other thoughts regarding the blueprint of the US inflationary ark and, if Brazil and Australia make sense as well, any thoughts on how to research companies in those markets.

 

-Crip

 

[Packer16]

I agree with your approach but I don't think that inflation will result because the impact of foreign goods and services (which would be denominated in other currencies) is a small % of US end prices.  I believe the number is something like 13%.  What you may see is deflation in the rest of the world and some small inflation in the US and high real interest rates to pay for the US debt.

 

The only time the US had a large inflation problem was when domestic costs were spiraling upward in the 1970s.  I do not see this as an issue as we have an oversupply of labor and worldwide competition is keeping labor other prices in check.  Although the appreciating currencies of other countries will moderate this check, these countries will also try keep their currencies low and thus keep inflation low.  I think the real losers will be emerging countries trying to keep their currencies low (China, etc.)

 

 

Packer

 

Packer

[SharperDingaan]

 

Keep in mind that you need to make money on the hedge to offset the expected domestic loss

 

The reality is that global indices are now correlated. So an index investment (TIP, ETF, etc.) is a really a bet that the bought index will outperform the US index (DOW, NASDAQ, etc) over time - it is not a diversifier.

 

The basic hedge overlay of long CDN asset, short US liability produces a leveraged return. ie: Assuming parity; if you have USD1 of asset, then add CDN1 of asset and USD1 of liability - you have $2 of assets and $1 of liability. 50% leverage.

 

You need short, medium, & long term strategies.ie: (1) If China (trade) & the Middle East (petro $ recycling) pulled their USD pegs & placed them on some other currency (SDR), the USD would immediately devalue - you'd sell some CDN assets & buy US assets (2) over time global commodity prices would rise as the BRIC starts producing - you'd start taking $CDN profits & moving slowly to USD, & (3) the US economy would eventually settle, the exchange rate would find a 'run-rate' level' - & you'd repatriate the remaining funds.

 

A Cdn chartered bank, oil/gas producer, & a strategic miner would be high on the list; CDN coy's with material US business would be a close 2nd. The intangibles (tighter/enforced regulation, IFRS reporting, transparency, & access to information) also favour Canada.

 

Good hunting

 

SD 

[Guest misterstockwell]

I am in the same boat. I opened an account at Interactive Brokers awhile back. They allow you many choices for a base currency for your account--in my case, I chose AUD. I can buy stocks on 70 exchanges in the native currencies(not Brazil just yet though, and not India since I am not of Indian descent). So I own things like the Fairfax preferred and common bought on the Toronto exchange in CAD, or Lancashire in British Pounds, Nestle and Pargesa in Swiss Francs, etc. I don't think our dollar will be worth squat once Obama is done "redistributing wealth", so I am thinking along the same lines as you. I think some mutual funds might be helpful as well, as long as they don't hedge the currency....i.e Tweedy Brown Global Value is decent, but they hedge, while Matthews Funds do fantastic in Asia, and don't hedge. I try and keep very little in USD money markets, trading in and out of the various foreign currency ETF's(FXA, FXC, BZF, BNZ, SZR, ICN) in my non Interactive Broker accounts.

 

Still an "ark in progress" for me---I'd like to own more individual companies in other countries once I get comfortable with researching them.

[Uccmal]

Correct me if I am wrong:

1) US dollar drops to a lower level vis a vis the commodity markets and Chindia.

2) US loses buying power in international markets including Canada, Brazil, Australia.

3) Commodity prices crash, Canadian exports crash, Canadian goes into a severe recession and our dollar does the nose dive.  Same for China, India etc. 

4) US dollar rises relative to other currencies. 

 

From my perspective the best place to invest right now is probably the US.  US based multinationals should do really well in this climate.  You can see this theme in WEBs investing and FFHs investing. 

[Crip1]

All,

Thanks for the comments.

 

Al,

A couple of thoughts.

 

Assuming that you are right (more on that in a moment), buying commodity-based assets and then moving into US assets during the step 2 to step 3 transition would presumably work out well. One would only need to be approximately right in terms of this transition to profit handsomly.

 

Can you elaborate on how you got from #2 to #3? While there will be invariable fluctuations in commodity pricing, I don't forsee the drop of US buying power triggering a crash, especially considering that a much higher percentage of worldwide commodity usage will be in the developing countries. I am not necessarily disagreeing with you, but I would like to understand the circumstances which bring about the crash in commodity pricing a little better.

 

-Crip

[SharperDingaan]

 

To get a commodities crash we essentially need 2 things

1) An end to stockpiling. There are various 'reports' that Chinese coys have been using their stimulus to buy up stocks of key commodities; when the stimulus stops, the buying will stop & inventories will run down - leaving an extended period of low demand & a price crash.

2) Reduced global demand > new BRIC demand. Make anything & you use up a commodity, & the more you can sell the more of the commodity you will use. In the short-term the demand shortfall may well be true, but over the long-term the positive wealth effect on that growing BRIC population is likely to be overwhelming; a lot of cheap goods made by, & sold to, the BRIC adds up to a lot of commodity.

 

Then keep in mind that the price risk is actually beneficial as it slows the ascent of the CAD, & dissaudes the BoC from acting.

 

Cheers

SD

 

[Uccmal]

Hi Crip, Obviously oversimplified.  Should the US dollar get too low relative to the Cdn dollar then the US will import less goods from Canada.  Aside from oil everything else we produce can likely be found in the US.  At a certain point it becomes cheaper to buy there.  At a certain price it becomes cheaper for the US to use homegrown energy as well - natural gas where it can be used.

 

Canada's currency is being driven up by higher prices on a few commodities which each have their tipping points.  An adjustment back down could easily happen any time. 

 

There are so many moving parts to this that I honestly think no one can reasonably predict the future of the US currency or any others.  All I know from my perspective is that every time the Canadian dollar reaches parity it becomes cheaper for me to buy US multinationals that just happen to sell around the world.  20% cheaper than a few months ago in fact.

[woodstove]

Currencies are too abstract for me to make money directly taking currency positions.  Rather two approaches make sense to me...

 

- Tangibles are a form of alternative currency, useful for diversification.  Imperial Oil, for instance, was selected for its reserves, and because the company has proven adept at slowly converting those reserves to cash, profitably, over long duration.

 

- Firms that provide a business process, converting from one material form to another, or from one location to another (distribution), and that have shown the ability to adjust pricing as input costs change (up or down), while still maintaining profitability.  For instance, Richelieu Hardware, and Winpak, are two.

 

All three firms have no debt and no shennigans (that I've noticed) going on re financial structure, so they are reasonably likely to be robust in turbulent times (ark weather).

 

Disclosure: positions in all three (and Berkshire and Fairfax).  Though have downsized Richelieu recently, waiting for price fluctuation.

 

Actually, rather than "making money" as a criterion of merit, Richard Russell's comment may be relevant for ark weather:  He who loses the least, wins.

[beerbaron]

 

- Firms that provide a business process, converting from one material form to another, or from one location to another (distribution), and that have shown the ability to adjust pricing as input costs change (up or down), while still maintaining profitability.  For instance, Richelieu Hardware, and Winpak, are two.

 

 

I own Richelieu as well I think it has even more value then what people think. The management is great and has proved that it is focused and risk averse. It is determined to add new SKUs every year, they have 55 000 SKUs right now. I see that as their moat, no other supplier could come up with 55 000 SKUs in a short period and not being a drag on inventories and operations. They can just buy other distributors for their client base, implement their software and increase the returns almost immediately with all the new SKUs added. The bonus...as said in the last conference call, they can change their pricing overnight (except with special accounts). At one point RCH represented 25% of my portfolio, I would not sell those shares for a short term profit, this is no cigar butts.

 

I have never looked at WinPak before but I will take a peak thanks woodstove.

[woodstove]

You're welcome!  Richelieu is probably the superior business, considering its return on capital.  With Winpak, I'm looking for a re-assessment as the next few quarterlies come out -- commodity price changes, and also some efficiencies resulting from getting recent capital expansion projects into smooth production.  But I would anticipate selling some non-core WPK sometime to move back to RCH or something else.  WPK is sort of a hunting expedition setting out from a stable base.  It's a question of what style makes a person feel comfortable.  I like to deploy capital in excess of what is a reasonable long term allocation, wait for a good news event, and then sell back to a core position and retrieve the original capital.  If everything goes very well, might get the core position "free" on a cash flow basis.  I know it's irrational and anchoring, but it definitely makes me feel better.  Sort of psychological hedging.

 

Still, if buying for a five-year hold, no trading, I think RCH would be superior to WPK, even given the Price-to-Value ratios of the two securities.