Taking Stock 30 January 2020

ONE of the techniques used by savvy investors to reduce the volatility of portfolio values is to invest in asset classes that are not correlated to other asset classes. They do not all go up or down for the same reason.

Traditionally, as an example, low-risk bonds rose in appeal when higher-risk equities were falling in value.

When inflation was threatening to undermine the future value of cash, gold prices would rise, as might other precious metal prices.

Some of these fundamental relationships have now been cast to the winds.

Property, equities and bonds have been moving together, priced by the deluge of money entrusted to fund managers and pension funds, many of whom have committed to invest robotically, value ignored.

There is no significant ''curve'' in the graph that tracks interest rates. For example, here in New Zealand the overnight cash rate is 1% and the 10-year bond rate is little more. The curve is almost a straight line. Nor do bond yields reward risk, failing to differentiate between quality borrowers (say the power companies) and junk bonds or securities (like the debenture of tiny finance companies).

The one asset class that should never correlate with fiat currencies or paper securities is the precious metal sector.

Indeed the likes of gold and silver ought to be the fallback position for those who believe in their storage value.

Previously there was a cost in holding gold - the opportunity cost of giving up interest on the cash required to hold a metal which cedes no interest.

That cost has disappeared down the drains of Zero Interest Rate Policies, or even negative interest rates.

One might have expected that without the need to assess this cost, investors would look to hedge against market downturns by buying a metal that might be less volatile.

Almost every historically-used signal to buy, for example gold, is now flashing.

- There is no opportunity cost

- Gold usage exceeds supply

- Fiat currencies are being undermined by experimental monetary policy in most major economies

- Gold production is at best static

- Paper securities are priced at multiples that seem absurd

- New risks, including animal/human viruses, may threaten our health

It is true that the gold price has risen in the past three years. I track the price with some sadness.

Along with a few dozen others, I invested in a mine at Waikaia, which in four years produced about 80,000 ounces, beginning in 2014.

When the decision to buy the required gear and mine was made the gold price was around NZ$2000. Prospects, at that price, were promising.

By the time we were actually selling gold weekly, the price was around NZ$1470.

We stopped mining a year or so ago just as the gold price recovered.

The gold price today is NZ$2300.

Had our 80,000 ounces sold at today's prices the additional revenue would have been some $66 million more, turning what was a moderately successful investment into a portfolio star.

I am reminded of the old saying about what might have turned Aunty Effie into an uncle. One has to move on from ''what ifs''.

The gold price has risen but the number of investors now interested in an asset that does not correlate with paper securities has fallen. Investor confidence has fallen dramatically.

The explanation could be in the growing weight of public opinion that regards gold mining as invasive, damaging to the environment, and/or a contributor to the type of pollution that results in climate change.

Right now, a small exploration company in which I have invested has its sights on raising its target to a multi-million-ounce find, in an unmined area that sits beside an operation that has yielded millions of ounces previously.

It will need to spend many millions to prove the size of its discovery but its biggest hurdle might be getting its mining licence granted.

The world has a known mined level of gold since records were kept totalling around 200,000 tonnes, much of it retained in jewellery or in gold bars, stored in bank vaults.

Each year, in electronics and in jewellery, the world consumes about 2300 tonnes, yet it mines less than that figure, and will mine even less in the future.

Does that not imply a distortion to supply while demand is static or growing, and should one not infer from that the gold price will keep growing?

Does anyone believe that investors in fiat currencies (not backed by gold) and paper securities (global equities and bonds) are never likely to suffer from a loss of confidence, such as a major cost of adjusting to climate change might ignite?

In the past two years gold has risen by around 15 percent, in NZ dollar terms.

China and Russia have been stockpiling the metal, allegedly to use as the foundation of a new global currency to replace the US dollar, the latter undermined by Trump's monetary policy, aimed at transferring the cost of encouraging voters to lower consumption today at the expense of tomorrow's voters.

It is fairly obvious that the gold price in recent years has been controlled, allegedly as a part of an American deal with China. Certainly the gold price has not acted logically.

The result is that today, relative to the S&P500 equity index, resources, including gold, are so cheap that their pricing defies explanation.

Only twice in the past 50 years have resource metals been so outperformed by the share index.

There are other matters of fact that are worth noting.

The level of sovereign bonds paying negative interest rates has risen from US$9 trillion to US$15 trillion in the past four years.

Until 2016 there were virtually no corporate bonds ''paying'' negative interest rates. Today the figure is around US$1.3 trillion.

The US Federal Reserve has tripled its balance sheet since 2009. Debt is engulfing most advanced countries.

These are all confirmation of bizarre, unprecedented behaviour, that traditionally might have lifted gold prices.

Perhaps it is time for resource investors to consult a crystal ball.

Oops. Crystal begins with a mining operation.

Make that consultation with tea leaves. Green tea, of course.

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ONE of New Zealand's tiny number of resource share specialists is Craig Robins, who runs the Hayes Gold Fund for clients, and runs a new resources fund for investors.

His Hayes Gold Fund last year delivered 57% against the New York benchmark of 39.7%.

He aspires to create an actively traded PIE fund for retail investors.

Investors interested in resource stocks should email Chris.

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WESTPAC has displayed contrition and wisdom in reaching out to the retired banker, John McFarlane, an excellent CEO of ANZ in the 1990s, and later a respected chairman of other banks.

Westpac has appointed McFarlane to chair its board.

McFarlane was a listener, a down to earth banker, rare for an Australian, well-liked in New Zealand. His efforts to hear strong views even spread to the Kapiti Coast, where he met with a rowdy local sharebroker who wanted to get his views considered by the ANZ board. McFarlane listened and acted.

Westpac has been the worst of the Australian banks present in New Zealand, having had several periods of weak leadership, going right back at least to the 1990s.

Providing Westpac's executive management team is willing to change, McFarlane is likely to alter the culture, reversing the arrogance and the focus on quarterly returns and bonuses.

His selection is to be commended.

The Haynes report in Australia fingered Westpac and the Commonwealth Bank (owner of ASB) as the worst of the banks over the past two decades. Their governance and management was cynical beyond belief.

That report should lead to a large number of additions to the Unfit and Improper list, held by the Reserve Bank of New Zealand, which approves senior appointments in financial markets.

If my views prevailed, an unlikely outcome, the Unfit and Improper list would be published by the market regulators, an action that would probably be to the great advantage of investors for years to come.

McFarlane is a fit and proper person to bring change to Westpac.

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Johnny Lee writes:

GLOBAL developments regarding the Wuhan Coronavirus continue to plague market sentiment, seeing our market drop from its recent highs as the worlds tries to determine the severity of the virus.

Tens of millions of people have now been quarantined, with public transport shut down in major Chinese cities to prevent the spread of the disease. Such quarantines have prompted residents to rush to supermarkets, causing food shortages and localised price inflation.

Some international airports have begun using thermal scanners to scan crowds of people, finding those with elevated body temperatures that may indicate a fever, one of the symptoms of the virus. Once found, people can be isolated for further testing to prevent the spread of the disease.

The largest Chinese stock exchange has been closed during the Lunar New Year holiday period, a closure that has been extended until at least February 3.

The impact on global travel, goods transportation (ports and roading), food prices, retail sales and healthcare are all obvious, but the degree to which these will be impacted is as yet unknown. I would not expect the financial impact of this to be felt in next month's reporting season, but some forecasts and outlooks may be seeing last-minute reviews.

During the SARS outbreak of 2003, airline share prices fell, and retail chains, casinos and tourism operators saw declines.

So far, our market has fallen about 2%, with the likes of Auckland Airport and A2 Milk leading the decline. Air New Zealand and Tourism Holdings have also fallen.

History shows that those panicking to sell inevitably lose in the long term, as crises are resolved and share prices rebound. History, of course, can be proven wrong. Investors would be wise to monitor the situation carefully.

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SHAREHOLDERS of E-Road can feel cautiously optimistic after reading the third quarter update last week.

Although the market response was muted, and E-Road's own description was that it was 'below expectations', the company is still growing strongly and, after announcing a $106,400 half-year loss in November, is almost certainly profitable from this point going forward.

Despite the imminent profitability, E-Road has made no secret that it may be writing to shareholders this year asking for further capital to assist its growth in the near term. One would hope this includes an institutional component, in order to introduce some liquidity to the stock.

E-Road has correctly predicted that its US growth would slow, and it has turned its attention to our large neighbour for its next major source of growth. The Australian market currently makes up a tiny fraction of its business, but E-Road believes several potential enterprise customers could give it a better foothold from which to grow.

E-Road remains a long-term investment, but milestones are slowly being checked off as the company continues to grow.

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AUGUSTA shareholders will be delighted with the news of a takeover offer from Centuria Capital, valuing Augusta shares at $2.00 a share.

The news follows a solid month of share price appreciation, with several large trades early this month sending the share price soaring from $1.50 to $1.65. The buyers will be delighted with the unexpected news of the takeover.

Shareholders have been advised to take no action until further documents are lodged with the Stock Exchange, expected to occur within the next few months.

Assuming both this takeover and the takeover of Metlifecare proceed, the Stock Exchange will have lost another two companies from the bourse. The challenge now will be to replace these with well-managed companies to provide investors with greater choice.

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SHAREHOLDERS of Oceania Healthcare have had a turbulent week, as its half-year result heralded a reasonable improvement in profitability, before an announcement sent its share price back to December levels.

Oceania’s largest shareholder has notified Oceania that it intends to sell its entire holding in the company at a price of $1.20. In the days preceding the announcement, Oceania's share price fell sharply.

The amount sold, representing about 250 million shares, will satisfy a significant amount of demand from around the market and marks the second time a major shareholder has capitalised on rising share prices recently.

EBOS shares took a small hit when a large shareholder sold shares to market, before recovering to a point roughly in line with previous highs.

As share prices climb, these large-scale transactions will become more common, as businesses look to diversify their risk, and pursue other ventures. As usual, the market will be the arbiter of company value, not an individual shareholder.

Shareholders of Oceania should not be overly concerned that a single shareholder is choosing to sell. The share price was at record highs, perhaps boosted by acquisition activity within the industry. On almost every metric, its half-year result was an improvement on the prior period, including its dividend payout.

The increased liquidity arising from this transaction is a good outcome for the company, as it welcomes thousands of new shareholders to its register.

An article on Oceania Healthcare is available to our advised clients that have access to the Private Client Area of our website.

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RECENT market speculation surrounding consolidation within the banking sector should be viewed carefully, with a generous supply of sodium chloride on stand-by.

Speculation of an announcement in March that Heartland would acquire ANZ-owned UDC has some logic and should not shock Heartland shareholders. Heartland has been consistent in its desire to grow, and sees UDC as a vehicle to grow via acquisition.

Heartland has previously balked at the price demanded by ANZ, and attempts by ANZ to find another buyer stalled when the Overseas Investment Office rejected an offer from a Chinese conglomerate in 2017.

Suggestions that the ANZ is also considering offers from three American-based private equity firms seem like a desire to introduce price tension. ANZ will be careful to select a credible long-term buyer to protect its brand, after a difficult year reputationally for the banking sector.

Other speculation regarding Kiwibank purchasing the Bank of New Zealand would represent an enormous change in our financial landscape.

Kiwibank was established almost 20 years ago, with the stated goal of encouraging competition within the banking sector of New Zealand. Such an objective is difficult to measure, and opinions will differ as to whether this objective has been achieved.

It is not the first occasion that such bold changes have been put forward by media, and I suspect it will not be the last. Investors should wait for more formal confirmation, and acknowledge that January is generally the quietest month in financial markets, especially for journalists.

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TRAVEL

Kevin will be in Christchurch on Wednesday 12 February. Afternoon appointments only.

Chris will be in Christchurch on February 18 (pm) and February 19 (am).

David Colman will be in Lower Hutt on 19 February, Palmerston North on 26 February, New Plymouth on 27 February and in Kerikeri on 6 March.

Mike will be in Auckland (CBD) on 25 February, Hamilton on 26 February and Tauranga on 5 March.

Edward will be in Nelson on 4 March, in Auckland (Albany) on 11 March and Auckland (Mt Wellington) on 12 March.

Johnny will be in Christchurch on 25 March.

Anyone wishing to make appointment is welcome to contact our office.

Chris Lee

Managing Director

Chris Lee & Partners Ltd


Taking Stock 23 January 2020

Chris Lee writes

IF the Wellington author Ron Asher ever plans a holiday in Asia, I suggest he avoids its biggest country, China.

In fact, he might want to skip Asia completely, if he is even half right about the influence of China and its danger to New Zealand.

His book, In The Jaws of The Dragon, published and now updated and republished in Wellington, is as aggressive and outspoken as any New Zealand book I have encountered.

A pedant would begin by noting that Asher's command of English is only average, and his writing style (four exclamation marks at the end of any strong sentences) is closer to Donald Trump’s than Ernest Hemmingway.

However his content, quite well documented, is fully enriched nuclear fodder, excoriating our politicians, Australian politicians, and fingering China as the imminent threat to New Zealand’s comfortable existence.

It would be easy to dismiss the book as being of the Ian Wishart genre, claiming that Martians live in Browns Bay, and that jets excrete plumes comprising chemicals aimed at making Americans vote for Trump, and encouraging children to eat McDonalds stuff.

Yet the book haunts me, unlike the piffle of so many conspiracy theorists.

As Asher documents, China has indeed made purchases of key items in our food chain, and in Australia's.

It bought the Crafar farms, inexplicably encouraged by Key's government, and China now has several potentially powerful banks in NZ lining up to compete for rural lending should the Australian banks want to reduce their exposure to this sector.

It has made inexplicable links with politicians of no obvious commercial relevance, like Shipley and Richardson, and its recently arrived business people are genuinely major donors to our political parties, or at least one of them.

I have attended functions where Chinese business people have filled up the coffers of political parties by buying donated items, such as an amateur drawing of Key, for $50,000; proceeds to the party.

For decades the Chinese were our most wonderful, hard-working immigrants, often overtly critical of communism, and embracing NZ as their adopted country.

Today the range of immigrants is much wider and not so easy to pigeon-hole. Asher implies that many recent immigrants are communist stooges.

China, as Asher documents, does have a menacing presence in the South China Sea, does make strategic decisions in the Pacific, has bought Australian and New Zealand food chain assets, and has rapidly become our most important trading partner, all the while growing its navy at immense cost.

None of this is necessarily sinister but these ''facts'' are the basis of Asher's contention that by 2040 NZ might be a puppet state of communist China.

The book lashes the complicity in these developments of our recent politicians, Clark, Key, English and Ardern, portrayed as being more interested in attracting political donations and votes than in safeguarding our sovereignty.

Indeed, by my definition Asher defames various people.

I cannot imagine any publisher or distributor being game to be part of the book's production and marketing chain. Yet I read it, in full, and feature it here because it is a book many investors would read with interest, even if the book is distinctly uncomfortable.

It is one step ahead of simple social media junk, being documented and not anonymous, and it does make you check under your bed for red slippers.

Paper Plus in Wanaka, one of the country’s best book shops, has copies.

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WHEN one reads of supposedly wealthy people filing to liquidate their companies, usually with the ultimate outcome of personal bankruptcy, one may be excused for wondering what they did with their supposed fortune.

Let me call that supposed fortune their ''loot''.

How could someone who claims his wealth is a billion dollars, or hundreds of millions, be so inept and unwise as to lose it all? Do they not ring fence real wealth as they take ever greater risks?

Perhaps one easy explanation is that when one's assets fall into the hands of a receiver or liquidator those assets almost immediately are discounted in value by a frightening level. Three pound notes are sold for half a crown.

Usually that loss in value is caused by the secured creditors having no motive other than to have returned to themselves as much of their loans as possible. They allow liquidators to ignore all other creditors.

The unsecured creditors and the owners of the original assets simply are irrelevant to the secured creditor. The receiver or liquidator can protest, arguing they tried their best and ''met international standards of recovery'' but only politicians, lawyers, bankers and perhaps valuers and investment bankers, believe that protest.

The victims know the truth. They are not in the Old Boys Network. They get rorted, royally, nearly every time.

Often, they see their two-year-old truck, or their livestock, or nearly funded property developments, being given away by those with the power.

The victims describe this as the ''punishment'' they endure because of a business failure.

So often the ''wealthy'' guy who failed is left with nothing because of our unconscionable insolvency practitioner laws. As he will end up bankrupted he has no resources to contest in court the ''system'' that is therefore unaccountable, as well as being rapacious and virtually psychopathic.

There is a second explanation for the major discrepancies between ''boasted'' or ''declared'' wealth, and reality. Far too few people understand this second pathway to a deceitful claim of extreme wealth.

It rests on gross over-valuation of assets, often as a result of market manipulation, or on dishonest transactions designed to fool creditors and tax gatherers.

Consider these two examples:

Property guru X buys a building in a city for $10 million, two million cash, borrowing $4 million from the bank and getting the vendor to leave in $4 million, subject to a second mortgage, or perhaps he arranges a settlement that defers the part of his payment to the vendor, for a year or two.

He then buys the building next door, which we will describe as similar, for $15 million, again with vendor debt arrangements that are induced by this flash price, and then he buys another up the road for $20 million.

A valuer, who likes the mandates, values all three buildings at $20 million, that figure ''clearly being the latest price achieved by a similar building''.

Suddenly property guru is worth $60 million gross and has maybe ''wealth'' of a few million of his own capital, plus $15 million of new ''wealth'', in the opinion of the well-paid, perhaps over-paid, perhaps less-than-independent valuer.

When the cycle turns, the guru’s game is exposed, he loses control, and a creditor appoints a receiver who finds buyers for all three buildings at $10 million each. There was only ever one mug buying at $20 million.

Bankruptcy follows. Unsecured creditors, perhaps including the vendors, are left unsatisfied. Wealth, created from thin air and claimed, is now wealth destroyed.

There is a second version of deception:

Now imagine a privately owned business shifts its headquarters to Fiji. The owner then ''sells'' to the Fijian-based company his ''brand name'' or his ''intellectual property'' or his ''licensing rights'' at a price calculated by a valuer who likes the mandate.

In another world ''mastheads'' once performed the same function, though today the media would struggle to justify any fancy price for such an intangible asset.

Let us say the self-acclaimed billionaire sells his ''brand'' or his ''IP'' for tens of millions to his Fijian division.

The Fijian brand cannot pay cash, so the sum is shown as a ''secured debt'' to the owner, placing him at the head of the queue, when the business fails.

The business collapses probably because an airhead owned it.

The ''secured creditor'' (the owner) might or might not be repaid but either way the unsecured creditors will have been cheated by a balance sheet they may not have ever understood, or even read.

The businessman would have spent years boasting of his wealth, based largely on imaginary assets worth nothing when a business fails.

So we see the guru, displayed on vulgar rich lists as being worth a billion or some such fanciful figure, might actually be worth nothing.

You would hope bankers would never be fooled, those people supposedly wise in the ways of the back streets and balance sheets. Yet bankers are regularly victims of such chicanery, as are fund managers. The media perpetuate the myths.

The failure of CBL and Intueri may well highlight the shallow levels of real research, or the extent of the misrepresentations.

CBL and Intueri were public companies, based on what I might politely call ''misleading'' practices.

Private companies are not required to disclose.

Few public or private companies display the conditional contracts, with clauses designed to protect the few at the cost of the many (absurd management contracts, phony assumptions, etc).

Published estimates of extreme wealth may, or may not, mean anything at all.

However it is certain that when cheats fail, as they usually do, the assets are never worth what they were said to be worth, either because the assets were falsely valued or because random passers-by have negotiated the purchase of the assets from inept receivers/ liquidators who themselves have no conscience, exposing creditors who have no meaningful protection from the law.

The Ministry of Business Innovation and Employment needs new people, and a smarter Minister, to put teeth into the law, but no one seems to care.

One key objective of law should be to establish accountability, so the villains with their shonky processes are made to return their loot to those who become the victims.

Lazy, inept insolvency practitioners must be made accountable for failing to maximise returns to creditors and shareholders.

We need better law. We need new law-makers. We need people who care about fairness.

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Johnny Lee writes:

FINANCIAL markets very rarely stand still.

2020 is now in full swing, with stories of bushfires, rockets and Brexit crowding the airwaves. Those hoping for a quiet and calm summer did not have to wait long for that hope to be dashed.

The Australian bushfire crisis will have far-reaching effects, both for the environment and the economy. Farmers, apiarists and orchardists alike will be counting the cost of the devastation over the coming months.

At the same time, the headline ''Stock market reaches record high'' has appeared on several occasions already, an eye-catching but ultimately less than meaningful statistic to most market observers. Traders celebrate volatility for the opportunities it brings. Investors prefer sustainability and predictability.

Whether the gains in share price have been fuelled by strong, sustainable underlying performance, or simply a flood of money, will be answered in February when the majority of our listed companies begin to report their half-year or full-year results to market. The likes of Heartland Bank, Fletcher Building, EBOS and Sky TV will be among the more interesting, for differing reasons.

By the end of March, we expect to have a clearer picture on the Tiwai Point issue, one way or the other. I remain of the view that a closure is the less likely outcome, however it remains a possibility and investors should consider it as such.

For those who took a break from markets over the holiday period, 2020 has started strongly, with several companies posting large gains over the past month. The likes of Summerset are up almost 15%, while Mercury is up 11%, Napier Port is up 10% and Infratil is up 9%.

There are two points I want to highlight regarding this. Firstly, the impressive gains are worth monitoring, especially with regards to the retirement village operators and Infratil. Shareholders should ensure that their holdings have not ballooned to a proportion of their portfolio that is unreasonable. A year ago, Infratil was trading at $3.66. It is now trading at almost $5.50. The likes of Ryman and Summerset may be seeing some benefit from the Metlifecare takeover.

The second point is specific to Napier Port.

Napier Port listed in August of last year, after being part-sold at a price of $2.60 a share. Today, it trades at about $3.90, after reaching $4.25 during the holiday period. In a period of five months, investors have made gains of about 50%, while collecting a modest dividend.

It would be nonsensical to suggest that this has been justified by an increase in revenue or profit. Ports are very defensive assets, servicing our need as a country to export and import goods. As a reference, over the same time period, Port of Tauranga saw climbs of about 25%. The market at large rose about 12%.

Those few who managed to participate in the Initial Public Offering, mostly Port staff and residents of the Hawke's Bay region, will be sitting on gains that have far outpaced the gains seen from the rest of the market - gains that are unlikely to be replicated in the year ahead. Indeed, I suspect 2019 will be remembered as a year of unusually high share price growth, as the market adjusted to a world where interest rates plumbed new depths.

Share price movements are determined by supply and demand – that is, people and institutions buying and selling the shares on the open market. When an Initial Public Offering like Napier Port is so heavily oversubscribed, it creates an imbalance which almost always leads to share price rises, as the likes of index funds purchase shares to ensure their performance remains aligned to the benchmarks they track.

Such stimulus is not permanent. Eventually, sellers will be willing to part with their shares, and buyers will have their fill.

Napier Port shareholders should be pleased with the performance of its share price. However, they should not anticipate such gains to continue at the magnitude they have witnessed so far.

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TRAVEL

 

Chris will be in Auckland (Waipuna Lodge) on February 5, available from 9.30am till 5pm and in Christchurch on Feb 18 (pm) and Feb 19 (am) at the Airport Gateway Motor Lodge.

Kevin will be in Christchurch on Wednesday, 12 February. Afternoon appointments only.

David Colman will be in Lower Hutt on the 19 February, available from 10am to 4pm.

Mike will head to Hamilton, Tauranga and Auckland over late February and early March, dates to be confirmed.

Edward Lee will be in Nelson on March 4, Auckland (Albany) on March 11 & Mt Wellington on March 12.

Chris Lee

Managing Director

Chris Lee & Partners Limited


Taking Stock 16 January 2020

IN the days before year-end calculations were made by fund managers (of investment returns and bonuses), the high octane they had injected into the NZ share market led to a platform for 2020 set at a dizzy height.

In December our sharemarket usually soars. The skilled investors position themselves for this, closing out of any short positions and leaking out shares to those buyers who want to see prices rise for year-end calculations.

Meanwhile, computer-driven index funds (exchange traded funds - ETFs) rush in to head off those who audit the index fund promise to replicate indices at specific dates.

Real investors, who care little about day traders and seek income and/or ownership of companies they choose, scratched their heads in wonderment as the share prices of companies like Summerset, Arvida, Oceania Healthcare and Port Of Napier rose by at least 10 per cent in the days around Christmas.

The retirement village price rises might be explained by the Swedish bid for all the Metlifecare shares. Metlife has been the poorest of our retirement villages, going right back to its inception in the 1990s when an eclectic bunch of private rest homes were given a lick of acrylic paint and cobbled together for an NZX listing at a share price that was fanciful.

The share price slumped, the Securities Commission conducted an enquiry into a very poorly described listing and eventually short-term positions in the shares were taken by opportunists like Todd Corporation and later Infratil, both of which organisations came, made a fast shilling, and fled, leaving Metlife to confront leaky buildings with a potential repair bill of $70 million.

The Swedish fund is so enamoured with our business model for the retired that it has bid for all the shares at $7.00. No doubt someone will pay the ferryman one day. Users will accept higher tariffs.

The subsequent price rise of better operators might have been caused by the fund managers switching to others after making the decision to sell Metlife or it might have had its origin in the thought that if someone will pay $7 for a rusty old bike then someone else might be in the wings, willing to pay extravagantly for a shiny bike with a bell and a saddlebag.

The other remarkable price rises, like Napier Port, will have had more to do with ETFs which seem unfussed by the regular gaming to which they are subjected when they are forced to buy shares to match their promises to replicate indices. The concept of signalling one’s buying plans (declared in the promises to investors) is a concept that is easily exploited. No one ever said that ETFs needed intellect, judgement or discretion.

So, 2019 ended with a predictable flurry of repricing, enabling some active fund managers to gloss up their year but leaving conscientious investment advisers with a number of conflicting thoughts.

The NZX index rose 31 per cent in 2019, largely because of falling interest rates, causing income investors to switch bank deposits into dividend-paying shares, and because of the international ETFs reweighting of allocations to NZ shares.

Those investors who pay real advisers would have had ample warning of the inevitable price rises that follow huge dollops of cash chasing a finite number of shares.

The obvious conundrum now is whether 2020 will be as benign, with no catastrophies to offset the deluge of ETF and Kiwisaver money which continues to chase NZ shares without consideration of value and to buy NZ bonds without heed to risk and return.

On the latter subject it is worth observing that ETFs that buy US corporate bonds are forced to accept lower returns and heightened risk. Some US analysts believe US corporate bond failure in 2020 could be a mind-altering 70 percent. My own view is that foreign bond ETFs comprising any corporate bonds are for lemmings.

The ETF spokesman for NZ seems to be Sam Stubbs, a likeable salesman whose tiny Kiwisaver fund, Simplicity, has about one per cent of the market, and like all ETFs employs no knowledgeable, experienced staff, because its computer-driven formula dictates which securities to buy, irrespective of price. Such funds do not claim to add value but rightly claim to run on low-cost diesel fuel and thus seek a following because of the Warehouse-like fees.

Stubbs, disarmingly self-described as a bush economist, forecasts that our economy and equity market will continue to grow at an impressive rate, fed by the rising levels of Kiwisaver money and the high level of funds arriving from offshore.

None of us will be confused by that claim but genuinely experienced and knowledgeable commentary would point out that all markets rely on one key input that is even more important than liquidity. Markets are underpinned by confidence.

If confidence is shattered, investors withdraw from ETFs at a frantic rate and may even withdraw from investing in Kiwisaver, the latter an unwise decision if the weekly input is matched by employer subsidy. There is no impediment to withdrawal from ETFs. They can deflate as fast as they inflated. They have been described as a weapon of mass destruction, at least potentially.

In recent years there have been no sustained withdrawals so many investors, too young to recall 1987 or even 2007 and 2008, will be tested when the next collapse of confidence occurs.

Stubbs, in his mid-50s, will recall those events but he will be obliged to do what his covenants promised and will be powerless to intervene or use any discretion. The computer cannot be reprogrammed.

Investors will need to be paying attention if they want to beat any rush-hour traffic in 2020.

We all must hope that confidence continues and that the various people in charge of governments and economies, here and elsewhere, are not revealed as being weak, selfish, out of their depth, and increasingly reliant on public servants no longer focussed on long term objectives.

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ONE signal of imminent danger would be a significant change in the lending policies of our big banks, particularly with lending to the rural sector.

The banks are already discounting rural loans, securitising packets of loans and on-selling them to other institutions and funds with an appetite for the rural sector. It may have been this activity that duped some amateur commentary that Kiwibank was soon to receive billions of new capital so that it could buy out the NZ division of an Australian bank.

As an aside, would you believe, I heard that Foodstuffs has been in a royal muddle after a corner dairy notified commentators that it was eyeing up a takeover of the food giant.

You might hear this in a public bar during a conversation about Kiwibank’s plans.

Lending policy changes to the business and property sectors might also occur. I expect a number of property lending funds are gearing up to capture market share at much better margins than the banks required before the recent changes to the models used by the Australian banks to self-assess risk, and to tone their capital to take account of that self-assessment.

One signal of imminent stress would be Reserve Bank lowering of the overnight cash rate, displaying concern about the economy. My view is that falling rates would do much less for the economy than mature government leadership in areas like infrastructure.

If we want tourism to keep growing we need better and safer roads, as an example. It is outrageous that successive governments have wanted the GST from tourists but left a coat of paint to be the safety barrier between fast-moving traffic. As long as infrastructure has a financial return it is okay to borrow and will add to our nett wealth.

The most worrying signal would be rising unemployment, perhaps triggered by the quantum leap in minimum wages, by mortgage defaults, or by the banks paring back their lending rather than raising retail deposit rates.

Almost as worrying would be forced sales of productive land, painfully accompanied by farmer depression. Our farmers remain at the helm of our journey to global selling of our dairy products, meat, fruit, crops, vegetables, wine, fish and lumber. Our living standards depend on these productive people.

Any revenue falls lead to lower tax receipts, lower consumer spending and result in the opposite of a virtuous circle.

How will investors spot the signals? 

It is facile to assert that the media will alert us. The likes of Stubbs provide soft commentary from their sales roles but it is not obvious who will provide research-based information, filtered by experience and meaningful participation in capital markets. Those who run computer-based asset allocation companies are seagulls looking for a feed, and have little or no access to boardrooms.

For years investors have had real help from Brian Gaynor, who runs a research-based funds management operation employing a few skilled staff who do have access to boardrooms, and whose opinions do influence corporate behaviour, and are respected in capital markets.

Now in his 70s, Gaynor was an important research analyst well before the 1987 sharemarket crash. He has a sharp memory.

For many years he has written a weekly business column in the Auckland daily newspaper. It has been of genuine help to investors and has also underwritten the paper’s credibility in the business and finance sector.

However for the past several months his column has not been available to digital readers unless they paid some sort of subscription, so his audience has fallen to newspaper readers and perhaps the thousand or two subscribing to the digital service.

For Gaynor this has been unhelpful, decimating his audience numbers. Without the scale provided by the previously free digital users, he has less motivation to share his knowledge. Previously he was able to use the platform to display the wares of his business. Any monetary payment for his work was in shekels and of no relevance to Gaynor.

To put this in perspective, consider how Carmel Fisher was able to promote her much lesser business and eventually sell it for more than a hundred million. Shekels do not rate to the owners of funds management businesses.

Unable to maintain his total audience, Gaynor has now bought a significant share of Business Desk, which employs some hard-working business journalists like Pattrick Smellie and Jenny Ruth.

Gaynor’s words will henceforth appear for those who subscribe to the Business Desk service.

One wonders who will have the insight, the skills, the energy, the motivation and the credibility to help newspaper readers by contesting the marketing stuff from those looking to create sales and to acquire a market presence?

Will the Auckland paper (The Herald) get any takers for paid business news without finding a genuine replacement for Gaynor’s insightful and opinionated comment?

Who will be the unofficial policeman to frighten those in the corporate sector, like Eric Watson, whose lower extremities seem to have been created by a potter?

Dross might continue to fill space and add noise to public bar debates but will such dross (endless discussion on Kiwisaver rules, as an example) do anything to help investors, attract buyers for digital services or be of even remote relevance to the necessary role of providing intelligent analysis of business behaviour? Capital markets ignore dross. Indeed, they mock it.

If the Herald abandons that role will Business Desk be the provider?

Until we know that, investors will need to watch carefully the behaviour of the banks, ironically lashed with a warm Wettex by Stubbs for at least the past few months.

Bank behaviour will be the portent on which real investors should focus. Such investors will not be helped by the sort of shallow guff that has previously spilled from bank chairmen and chief executives as they endeavoured to deflect attention from their self-focussed activities.

Reserve Bank Governor Adrian Orr might be a big help, given he has seen through the Teflon cover displayed by phoney people. Quite rightly, he has been lining up banks for errors that came either from inadequate investment in technology (as the banks want us to believe) or through very poor governance and leadership, as Sam Stubbs alleges.

Banks will be raising several billion in capital and quasi-capital in 2020 and will know that their regulator, the Reserve Bank, sees through the sort of guff that John Key put up after the ANZ had to confront its previous chief executive.

Rigidly controlled from Australia, the New Zealand branch of ANZ, our biggest bank, has no relevant input on the appointment of its chief executive, does not determine her pay, and has meaningless input on bank asset sales, such as we will soon see when UDC Finance is sold. 

It seems the ANZ board is there for figurehead reasons only, and in Australia is seen as a flower vase on the board table, rather than a vital voice on local strategy and policy.

So we must not expect too much of Key. As its NZ figurehead he has about as much control as a rugby club president has over the All Black selectors. In my view this is fortuitous as I see no evidence that Key has the relevant background to recalibrate strategy and culture. His gravitas is more like that of a cheerleader than a team coach.

I guess most in capital markets and most investors would wish the Australians gave their NZ division much more control rather than resort to tokenism.

Investors must watch the Australians who will dictate how the bank treats the rural sector.

If it becomes clear that the big banks are shortening the terms of loans, demanding higher margins, declining to roll over loans, enforcing obscure covenants of loan terms or flogging off securitised loans at a handsome discount then one of two things will happen.

Rabobank or some other international bank, perhaps a Chinese bank, will take a less shallow view and will replace the Australian banks. 

There might alternatively be a series of retail bond issues bundling up loans to sectors in which the Australians are over exposed.

Or there might be a growing list of mortgage defaults, hopefully not correlating with farmer depression or, worse, suicides, as farmer equity diminishes.

China, keen to secure a bigger share of our food chain, is a strategic investor, with long term goals. It might become a huge player. Anyone interested in this possibility might want to contact Paper Plus in Wanaka and buy the book In The Jaws of the Dragon, which has some fairly controversial views on the Chinese interest in NZ and Australia.

Nothing shatters investor confidence more thoroughly than the spreading of bad news in a NZ sector that is generally admired as hard working, productive and the basis of our wealth, its intellectual property of a gold standard.

I do want to see the Australian banks rid themselves of guileless governors, greedy executives and behaviour that exploits clients. I do not see any advantage in banks leaping from one short term tactic to another, undermining consumer and investor confidence, not to mention the effect on national wealth. I would prefer the banks to focus on aspirational, long term goals, rather than regarding the quarterly results and their political relationships as being of prime importance.

Real investors will be paying attention and will have to rely on someone other than Gaynor to keep the relevant information in front of the general public. I guess their alternative is to subscribe to Gaynor’s Business Desk.

I expect the behaviour of the banks will have great influence on investment returns in 2020. Confidence is a key ingredient in financial markets.

We have long handed over our banking sector to the Australians, who have generally had benign views of NZ.

Will they be staunch and take long term views or will they behave in the way the Haynes Commission of Enquiry discovered?

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THE encouraging news in all of these deliberations is that NZ, despite its weak laws, its inept public sector and its feeble political leadership over many years, does now have two strong regulators, the Reserve Bank and the Financial Markets Authority, which are committed to face down any further poor banking behaviour, penetrating the glossy PR fed to us via the media releases.

The regulators’ biceps are bulging, following the Haynes’ report which highlighted the cost of weak, complicit regulators. Our regulators now need a whopping new financial budget to do the job that in the past neither politicians nor the Securities Commission regarded as important.

I guess the mission to improve corporate behaviour is also enhanced by the relatively new power of litigation funders.

To improve the country’s nett financial wellbeing, and to maintain investor confidence here and abroad, NZ needs rising productivity, rising wages, stable employment, a reversion of banking leadership to adult standards, low stable interest rates, unwavering regulatory supervision and enforcement and new politicians with the relevant experience, guts and empathy to install black and white standards, whatever the cost to Old Boys Networks, like our insolvency practitioners.

Society blossoms when the old Rotary adage of being fair to all is enforced.

I have some hope, though we would first need a new breed of political leadership. My observations over the past few decades have been of political party leaders like Clark, Cullen, Key, English, Joyce, Ardern and Robertson. None seemed to have any focus on capital market standards, an extraordinary attitude given the power of those markets in a capitalistic society. Ironically, Peters has probably had a better insight than any of the above, but his power to act has been limited.

New law producing binary outcomes for those weak people who cheat would help to stabilise investor confidence.

May I start 2020 by offering the current group of politicians this brief thought.

If someone in a capital market leadership position ‘’takes’’ because he ‘’can’’, then what he takes, no matter how he hides his loot, must be regathered and returned to those he cheated.

If the cheat loses that money, loses his freedom, and has his pathway to re-entering capital markets cut off indefinitely, then only the biggest idiots will fail to see the cost of their treachery.

Taking, because he can, be it through nauseating behaviour of so-called men towards young female interns or be it through appalling contracts that unduly enrich individuals, or through corporate decisions made to transfer wealth without conscience, is behaviour of cowards and cheats.

May some politician in 2020 get their head around this and stop the clock!

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Travel

 

In February I will be in Christchurch on Tuesday 18 and Wednesday 19, and in Auckland, dates to be advised. Please contact our office to arrange any required appointments.

Chris Lee

Managing Director

Chris Lee & Partners Limited


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