Emerging Financial Markets 11. Raw Materials & Natural Resources Prof. J.P. Mei
Note: Most materials used here are adopted from a research from Naissance. It is to be used for classroom discussion only.
Raw materials - Superior risk vs
Raw Materials
return tradeoff •
Unprecedented consumption (China, India) constrained supply
•
Possible up-tick in Economy will lift prices
•
Pressure on US$ = migration to hard assets
•
Low Correlation to stocks, bonds, property
•
Pension Funds ‘waking up’
Superior Risk / Return Tradeoff 16
Naissance Raw Materials
better value
Annualized Return %
Raw Materials
12 Real Estate
8
Corporate Bonds
Equities (Historical)
worse value
4 US Treasury Bill
0
Equities (last 5 years)
-4 0
5
10
15
20
Risk - Annualized Std. Deviation %
25
Raw Materials
Rising Population = Rising demand
Growth Means Consumption Doubling of GDP per person United Kingdom 1780 - 1888 Unites States 1839 - 1886 Japan 1885 - 1919 Turkey 1857 - 1877 Brazil 1961 - 1979 India 1980 - 1998
Raw Materials
Republic of Korea 1966 - 1977 China 1977 - 1987 0
10
20
30 Years
Source: World Bank
40
50
60
Unprecedented Consumption Estimated Year China, India and Russia GDP surpass developed economies UK Germany Japan
China
USA
Italy France Germany Japan
India
Raw Materials
Russia Italy 2000 Source:Goldman Sachs
2010
France Germany
2020
2030
2040
2050
China: Give vs Take Raw Materials Importer Alumina Borates Copper Iron Ore
Exporter
Lead Salt TiO2 feedstock Zinc
Molybdenum Talc
Tin Thermal Coal
Raw Materials
Processsed Materials Importer Copper Nickel Platinum Source: Rio Tinto
Steel Aluminum Titanium Pigments Lead
Exporter Magnesium Zinc
Example: Iron ore China - iron ore imports 350
Million tonnes
300 250 200 150 100
0
19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10
Raw Materials
50
Source: Financial Times (in orange: forecasts)
Example: Copper Copper - per capita intensity of use in 2000
Raw Materials
Consumption per capita (in kg, log scale)
100
10 China
USA
1 India 0.1 0
5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 GDP per capita in USD
Source: Rio Tinto
Example: Chinese Timber Imports Rising Chinese imports
Raw Materials
Million Cubic Meters
50 40 30 20 10 0 1997 Source: FAO 2003 – 2005 estimates
1998
1999
2000
2001
2002
2003
2004
2005
Raw Materials
Chinese Timber Consumption: Driving Forces •
Privatization of state-owned housing
•
2008 Beijing Olympics: 2nd largest public work i.e. 100 – 130 million square feet of new housing (670,000 units)
•
1998 Logging Ban implemented due to erosion = constraints in forest usage
•
Explosive industrial growth (ie GDP +8,5%)
Timber Investment Returns Performance of Timber Portfolios in different regions over the past 20 years 20%
Pacific Northwest
15% 10% British Columbia
Raw Materials
5%
New Zealand
0% 10.00%
15.00%
Source: Hancock Timber Resource Group
20.00%
25.00%
30.00%
tin Di um a Tr ad mon e Ti ds tan d ir o iu m n or e fe ed sto Tr ck ad ed Th Nic er ke m al l Co al Al um in a Co pp Al e um r Co iniu m ki ng Co al Go ld Zi nc St ee l
Pl a
Raw Materials
Fewer Competitors
Proportion of production controlled by top 5 producers
100%
80%
60%
40%
20%
0%
Source: Cazenove
Raw Materials
Pension Funds ‚Waking Up‘ •
Largest Dutch Pension Fund (ABP) allocating up to 5% of $160 billion
•
Goldman Sachs now recommends allocation of 5% to US institutions
•
AIG established own raw materials index, allocating 3% of own funds ‘Sheep like behavior’ will drive raw material price increases
Raw Materials
Raw Material Index Composition Agriculture Wheat Corn Cotton Soybeans Live Cattle Coffee Rice Palm Oil/Soybean Oil Live Hogs Sugar Azuki Beans Cocoa Wool Barley Canola China Net Imports
Σ 9's
9
Orange Juice 2.33% Oats 1.33% Silk 1.00% Flaxseed 1.00% 1.00% Precious Metals 1.00% Gold 1.00% Platinum 1.00% Silver 0.67% Palladium 0.66% 0.66% Energy 0.66% Crude Oil 0.66% Heating Oil/Diesel 0.66% Unleaded Gas 0.66% Natural Gas
9 79.33%
9 9
9 9 9 9
0.66% Forestry 0.50% Timber 0.15% Rubber 0.15% Industrial Metals Copper 15.00% Iron Ore 6.00% Nickel 2.00% Aluminum 1.75% Lead Zinc Tin 20.00% 3.00% 3.00% 3.00% Total
9
10.00% 1.00%
9 9 9
7.00% 6.00% 4.00% 1.20% 0.50% 0.40% 0.40%
100.00%
Performance 1 2 3 4
Raw Materials
5 6 7 8 9 10
Name S. Korean KOSPI Index Naissance Raw Materials Lehman Brothers Treasury Bond Index Barclays CTA Index JP Morgan World Government Bond Index Dow Jones AIG Commodity Index S&P Commodity Index Treasury Bills US S&P 500 NASDAQ Composite Index
* August 1, 1998 till July 31, 2003
Compounded Annual Return YTD 13.7% 15.8% 14.0% 14.7%
Annualized STD 38.1% 18.1%
-3.1% 3.2%
6.9% 6.5%
9.3% 8.7%
4.2%
6.1%
7.3%
5.6% 5.7% 0.6% 13.7%
5.2% 4.3% 3.6% -1.1%
15.3% 17.2% 0.5% 18.8%
29.9%
-1.5%
37.5%
Low Correlation to Stocks/ Bonds
Raw Materials
NRM
EAFE
S&P 500
Naissance Raw Material (NRM)
1.00
MSCI EAFE* (EAFE)
0.18
1.00
S&P 500 JP Morgan Gov't Bond Index (JPMG)
0.13
0.84
1.00
0.19
0.04
-0.11
*MSCI World excluding North America Source: MSCI, Bloomberg
JPMG
1.00
Greenback vs Greenspan
Raw Materials
US Living beyond its means:
US Consumer; Corp. debt at all time highs
Budget Deficit (financing of Iraq)
Unprecedented Trade Deficit and Growing
FED has ‘little rope left’
US borrowing other peoples’ savings (China, Japan) to make ends meet
US$ weakness shifts investor attention to hard assets
Leveraged US Consumer
Raw Materials
in billion 1996 USD
Rising Household Debt 10,000
90%
8,000
80%
6,000
70%
4,000
60%
2,000
50%
0 1974
40% 1981
Household Debt
1988
1995
2002
Household debt as % of GDP
Uncle Sam Borrows too Much !
Raw Materials
in billions 1996 USD
Rising Public Debt 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 1974
70% 60% 50% 40% 30% 1981
Public debt
1988
1995
2002
Public debt as % of GDP
Weaker $ needed to Reverse Trade Deficit
Raw Materials
in billions 1996 USD
Rising Current Acount Deficit 100 0 -100 -200 -300 -400 -500 1974
2.0% 0.0% -2.0% -4.0% -6.0% 1981
1988
1995
2002
Current Account deficit Current account deficit as % of GDP
Investment Strategy: • Highly diversified • Index Approach • Emphasise Commodities China / India need in greatest quantities
Raw Materials
• Prefer Capital intensive commodities, with long lead time to adjust supply (ie 7 yrs to start new Copper mines) • Precious Metals raised to about 25% due to US$ malaise • 18-36 mos view – modest annual adjustments
Raw Materials
AIG Guarantee: An Interesting Product Feature •
Optional – for risk averse investors
•
AAA
•
100% capital guarantee
•
8 years 100% participation in capital appreciation Monthly liquidity
• •
Raw Materials
Terms & Conditions Flat Fee - with guarantee - without guarantee Performance Fee High Water Mark Place of domicile Minimum Investment Currency of denomination Hedging Policy Redemption policy Reporting of NAV Custodian Auditors Lawyers Portfolio Administration
2.00% 1.25% 20.00% Yes Cayman Islands USD 100,000 EUR / USD Currency hedged Monthly Monthly (more frequently on request) UBS PricewaterhouseCoopers Maples & Calder Citco
