Major market indexes closed the month of May down sharply, with the Dow losing 7.9% during the month. The loss marked the worst May the Dow has seen since 1940, which included a one day crash on May 6th that took the index down 1,000 points intraday. As we explained in previous posts, we expected for the bull run in stocks to reverse as the Federal Reserve concluded its Quantitative Easing program in April. In late March, we wrote:
“In summary, with equity markets continuing to melt higher, we would currently not be over exposed to equities, but are beginning to look at industries and sectors if and when we get a 20-30% drop in the markets.”
With the S& P 500 beginning to break down, we believe that now is the time to start cautiously building up long positions in stocks or sectors that should do well over the next 3 to 5 years. After the EU’s decision for a Greek bailout, what we know that governments around the world are going to stop at nothing to print their way out of this mess. One of the events that received absolutely no mention over the past month was the release of the Treasury Department’s annual report on public debt. In a nutshell, the report anticipated that US GDP will rise at a laughable 5% average per year for the next five years! Just for comparison, the growth rate during the boom years of 1990-2009 was 4.9% on average. Even more disturbing, is that with that miraculous GDP growth rate, total Debt/GDP will still be over 100% by 2015! If you come to a much more realistic GDP growth rate of 1.5% for the next 4-5 years, total Debt/GDP will actually be 126% in 5 years. Experts agree that when public debt levels reach 90% of GDP, rating downgrades become a reality and the cost of capital will begin to increase raising the risk of sovereign default.
Investors need to realize what Central Banks are doing (ie printing money as far as the eye can see) and come up with a plan to protect and grow their assets. The ramifications of the Treasury’s debt assumptions will have a direct negative impact on the US dollar which, as we have seen, affects everything from oil prices, to stock prices, to food prices. Given all of the above, we have come up with a list of ten investments that we believe every portfolio should include.
Agriculture:
As we have written about for almost a year now, we believe that the agricultural sector will see spectacular gains over the next decade as rising demand from Asia, coupled with falling supply due to less credit available for farmers will create food shortages at a level that hasn’t been seen in decades.
Monsanto (MON) - The Agricultural Chemical Producer has seen its stock price fall from $85 to $50 this year as the rise in the dollar put pressure on agricultural commodities. The company also has increased competition from China which will cut into its margins in its Asia division. Monsanto will most likely end up purchasing one or more of its Chinese competitors to cement its position as the leading agricultural chemical producer in the world.
Potash (POT) - The fertilizer producer out of Saskatoon, Canada has traded in a range from $90 to $120 for over a year and half. The Potash market is improving as China emerges as a substantial importer of corn. In a recent conference call, the company told investors that it believes that global Potash demand is picking up and raised its earnings forecast from $1.30 to $1.50 per share.
Powershares Double Long Agriculture ETF (DAG) - While there are numerous ways to play the coming price inflation in food, Agricultural Exchange Traded Funds may be the simplest way to do it. DAG is a fund that allows investors to take a leveraged position in the actual agricultural commodities. DAG is composed of roughly equal percentages of corn, wheat, soybeans, and sugar contracts.
CHINA:
We continue to be positive on China in spite of increasing talk of a bubble. While we do expect more volatility in the short term, China’s mid-to-long-term outlook is bright. We agree that there is a real estate bubble in some of the coastal areas of China, however there are many industries in China that will continue to grow regardless of the global economic climate as the country transitions to a modern economy.
PetroChina (PTR) - With a market cap of over $200 billion, China’s largest listed oil company will benefit over the coming years from higher crude prices and energy demand. The stock is up over 35% since the March 2009 lows. We expect PetroChina to begin to make acquisitions oversees (BP comes to mind) in the near future.
China Eastern Airlines (CEA) - China’s recent decision to allow greater flexibility in the Yuan exchange rate will be a positive for its domestic airlines as a stronger currency will lower fuels costs and their borrowing costs on foreign currency debt. One of the nation’s leading airlines, China Eastern operates over 80 international and regional routes out of its main hub in Shanghai.
Origin Agritech Limited (Seed) - Keeping with our agriculture theme, Origin Agritech’s business model and strategic direction is most easily equated to a mini- Monsanto. The company currently generates its revenue from the sale of hybrid seed products, but has been heavily investing in the development of a pipeline of genetically modified seeds.
Metals:
With Central Banks around the world continuing to print money, metals will be an obvious beneficiary as people start to lose faith in paper currencies. While we do like gold, we prefer silver or palladium as they are cheaper on a relative basis.
Freeport-McMoran Copper & Gold (FCX) - A one stop shop of mineral resources, Freeport McMoran engages in the exploration, mining and production of copper, gold, silver, molybdenum and cobalt deposits. As of December 31, 2009, its consolidated recoverable proven reserves totaled 104 billion pounds of copper, 37 million ounces of gold, and 270 million ounces of silver. These deposits will only gain value over the coming years as Central Banks devalue their currencies.
Novagold Resources (NG) - Novagold primarily explores for gold, silver, copper, zinc and lead ores. With a market cap of less than $1.6 Billion, Novagold is a more speculative play. Novagold was trading at around $20 a share before the financial crisis, but is only trading at around $7 now even with metal prices higher since the crisis and the company holding essentially the same reserves.
Silver Wheaton Corp (SLW) - Silver Wheaton has quickly positioned itself as the largest metals streaming company in the world. By 2013, annual production is anticipated to increase significantly to approximately 38 million ounces of silver and 59,000 ounces of gold. The company currently has the right to purchase all or a portion of the silver production, at a low fixed cost, from high quality mines located in politically stable regions.
Protecting your Portfolio
Proshares Ultrashort Emerging Markets (EEV) - Given these uncertain times, every portfolio should include some downside protection. Thanks to the proliferation of ETF’s, hedging long market exposure with short positions is easier than ever. EEV trades twice the amount of the inverse of the daily performance of the MSCI Emerging Markets Index. The addition of leverage allows the investor to participate with limited capital and given that we have positioned our portfolio to international companies, specifically in mineral rich, emerging economies, EEV is a great way to hedge our bets and protect the portfolio from extraordinary losses in down markets.
Our near term forecast is that we will see more volatility in the markets over the next 6-12 months. We believe that as the economy and market begin to falter, the US will introduce another stimulus package, whether in the form of income tax cuts, or more bond buying by the Fed. This next round of stimulus will devalue the dollar further and be a big boost for emerging economies. Some key technical levels we are watching are 950 and 840 on the S&P 500. We expect that the next round of stimulus will be announced if and when the market does fall to the 950 level on the S&P 500. However, if the political climate is such that more stimuli are not taken on, then we expect the market to fall to its next support level at 840. If 840 doesn’t hold on the S&P 500, we would sell all or most of our long positions or add short bets because the next stop will be at the March lows of 666 or even lower.
