Taking Stock 25 January 2024

Fraser Hunter writes:

ARTIFICIAL Intelligence (AI) has emerged as a major trend in 2023 and is expected to continue dominating the investment landscape in the coming years. The mega-cap technology firms, revered as the 'Magnificent Seven', have moved swiftly to capitalise on the opportunity, integrating AI into their existing offerings and products.  

The most recent catalyst in the technology world has been the explosion of 'Generative AI', a form of artificial intelligence that can create new content from text to images by learning from vast amounts of data. 

Led by OpenAI with its ChatGPT application, generative AI has shown remarkable capabilities in understanding and generating human-like responses. In just over 12 months, the advancements and applications of this technology have hinted at a potential revolution in how we interact with machine intelligence, promising to significantly reshape our daily digital experiences. 

While there is considerable excitement around its capabilities, it's important to acknowledge that generative AI is still in its infancy. This fast-moving technology, while scarily effective in certain aspects, requires a lot of further fine-tuning and development. It is already being talked about by tech leaders as the next monumental shift in technology, compared to the arrival of the internet, ready to transform our everyday interactions and activities.

The adoption of this technology has been swift and widespread, already becoming prevalent in workforces and education systems across the globe, often without knowledge or approval. This rapid integration into everyday practices underscores a kind of inevitability - it's going to be incredibly challenging, if not impossible, to put the genie back in the bottle.

Scarily, it is the heavy “power users” of the technology that are the most anxious and concerned about its impact on their future career prospects. This worry highlights a broader concern about the balance between technological advancement and job security, an issue that will become more important as AI becomes more involved in various parts of our lives.

Despite the widespread excitement, the path of generative AI isn't without its challenges. Being in its early stages, issues like inaccuracies and the risk of spreading misinformation are real hurdles that need careful navigation. These concerns highlight the necessity for robust safeguards and thoughtful regulation, as the technology is powerful and still evolving.

Economically, the influence of AI is already being felt. The enthusiasm surrounding AI has sparked a surge in stock prices for mature tech giants, with a particularly notable impact on AI-focused companies like Nvidia, which has quickly grown into one of the world's largest corporations. This market reaction reflects the high expectations placed on these companies to deliver on the potential of AI.

Looking forward, the integration of AI across businesses, workforces, educational systems, and daily tasks feels inevitable. The challenge will be balancing the valid concerns and potential threats with the significant opportunities and benefits that AI offers. 

For the NZX-listed (and unlisted) companies, the opportunity spreads far wider than just the large technology firms - there's also immense potential for companies that can successfully use the technology to innovate and enhance their businesses, as well as the infrastructure needed to provide it. 

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THE current advancements in Artificial Intelligence (AI) have not emerged out of the blue but are the result of decades of progress and innovation in computing capabilities. 

The concept of AI, first coined in the 1950s, began with the development of the foundational concepts and basic algorithms. It began with the concept of machines imitating human intelligence, which was famously demonstrated by the Turing Test. This was followed by the creation of neural networks, which try to mirror how the brain works, which would pave the way for machine learning. 

Progress in the field stalled in the '70s and '80s due to a lack of funding and expectations far ahead of the capabilities of the time. The technology still evolved with key developments like expert systems in the 1970s and 1980s, which imitated human decision-making. 

The resurgence of AI in the 1990s was propelled by advancements in machine learning and a significant increase in computational power. In 1997, IBM's Deep Blue defeated chess champion Garry Kasparov in a Man vs Machine battle, showcasing AI's increasing capabilities.

The past decade has ushered in a new era for AI, driven by 'big data' and substantial advancements in deep learning algorithms. These developments have enabled dramatic leaps in fields such as image and speech recognition, underpinned by increasingly sophisticated neural networks.

Today, forms of AI seamlessly integrate into our daily lives, influencing the routes we take on Google Maps, the programmes we watch on Netflix, the music we listen to on Spotify, and even the advertisements or news we engage with on Facebook. 

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IN late November 2022, OpenAI quietly released a version of ChatGPT to the public with little fanfare or expectations. Over the following days, social media exploded with videos of ChatGPT’s capabilities and uses. 

Within five days, the application had gained more than one million users. To put this in perspective, Spotify took five months to get to a million users, while Facebook took 10 months. By February 2023, just over two months later, active monthly users had grown to more than 100 million.

By this time, Microsoft confirmed a multi-year investment in OpenAI rumoured to be worth $10 billion. This ensured OpenAI had access to the AI infrastructure and models needed to cope with demand and continue to improve. 

Since then, OpenAI has regularly updated its AI models, introduced premium subscriptions and limited individual use to help manage demand. They have also needed to be quick to refine the outputs, adjust for user feedback and, importantly, address glitches (which tend to quickly be made public). _ _ _ _ _ _ _ _ _ _

THE economic impact of the AI surge is unmistakable, with major tech players experiencing significant market capitalisation growth.

The economic implications of the AI boom have been massive. Since October 2022 - pre-ChatGPT - the Magnificent Seven (Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia and Tesla) have collectively gained more than 117% in market capitalisation between them, outpacing the rest of the S&P500.  

Leading this is chip-maker Nvidia, the pick maker in this AI gold rush, which has gained more than 400% since the October low. Microsoft has gained a more modest 78% over the same period, but as the world's largest stock has added more than $1.3 trillion (!!!) in value. 

The growth should hopefully not be confined to the technology giants. There is growing optimism that generative AI could be a driver of a new wave of productivity.  Its ability to streamline processes, enhance creativity, and open new avenues for innovation is predicted to inject unprecedented efficiency across various sectors, potentially repeating the productivity gains of past technology breakthroughs.

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DESPITE the success, the year also brought attention to challenges and limitations. Generative AI has brought new meaning to the term 'hallucinating' - where a program generates inaccurate or misleading information, without informing the user. This highlights the need for scepticism, caution, and fact-checking, as well as continuous refinement and development. 

These challenges, coupled with ethical considerations around privacy and misinformation, emphasise the importance of responsible AI development and usage.

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AS with all emerging technologies, AI has been and will continue to meet barriers of entry impacting its speed of adoption and potential success. 

The mega-cap technology companies are no stranger to regulatory challenges in the US and across the globe, and AI will heighten this. The European Union has already started its Artificial Intelligence Act (AI Act), which initially focused on the growing need to regulate AI's riskier applications, such as privacy and facial recognition. Similarly, the United States is in the early stages of formulating its AI regulations, reflecting a global trend towards more controlled AI development.

The rapid progression of generative AI has drawn the concerns of leading tech figures such as Tesla’s Elon Musk and Apple’s co-founder Steve Wozniak. They, along with other industry leaders, called for a pause in training AI systems more powerful than GPT-4, citing concerns about the potential for AI to exceed human intelligence. This pause is proposed to assess societal risks and ethical implications, reflecting a growing apprehension about the technology's rapid development and its broader impacts on society. 

The legal aspects, particularly around copyright infringement, have come to the forefront, as seen in the New York Times' lawsuit against OpenAI. This reflects a broader concern about the content and data AI uses for learning and development.

Finally, there is a competition for resources. The speedy rise of Nvidia, the high margins it has been able to achieve and the fact that it too is entering the AI race, has driven the industry to try to find alternate sources of chips, or create them in-house.  This competition extends to developers and more recently electricity, with OpenAI CEO Sam Altman using his recent Davos speech to attract further investment or potential funding for nuclear power. 

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CONCERNS are mounting ahead of the numerous key elections set for 2024, particularly regarding AI's influence on political messaging and voter perception. AI’s capacity to tailor messages to individual preferences could significantly sway voter decisions, further expanding on the influence algorithms have had in past elections.

The ability to quickly create and distribute AI-generated political content is likely to alter interactions between voters, politicians, and journalists, differing from previous election campaigns. A major worry is the potential creation of deepfakes, which produce realistic but fabricated audio and visual content of candidates, potentially deceiving voters. 

Misinformation generated by AI can cause many problems including worsening divisions in society, creating conflicts, and harming fragile economies. Misinformation can also spread biased opinions and false information, which jeopardises the integrity of elections. 

In response, major tech companies and AI developers, including Meta, Alphabet, Microsoft, and OpenAI, have vowed to step up measures such as content moderation and authentication tools, aiming to counteract the detrimental effects of AI on the election process. 

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COULD this be a bubble? Of course. The whirlwind of hype and capital investment in AI has prompted comparisons to the dot-com era. Also, any tangible returns in the form of revenue and profitability are still years away. 

Yet it is also very believable that a bubble has yet to begin. The prospect of a major AI player such as OpenAI, Anthropic, Databricks, or Midjourney entering the public market via IPO would get an absurd amount of investor interest and could spark the beginning of an even bigger wave.

Also of comfort is the level of investment and commitment coming from the established leaders in the tech sector. Microsoft has committed substantially via its partnership with OpenAI, and Google's subsequent heavy investments to keep up, offers reassurance. 

These developments, along with the more modest stock valuations and investor sentiments appear a lot more grounded compared to the dot-com era. The move to date has come from established companies in the technology space, using their vast cash reserves for development rather than new capital raising, indicating a more measured and sustainable growth trajectory.

The upcoming quarterly reports from the tech giants should provide an updated view of how they view the sector's future, potential revenue growth, and investment strategies. To date, the narrative has been largely about infrastructure spending rather than revenue or earnings growth. 

Across the S&P 500 the shift in corporate focus is probably best represented by the references to AI in corporate communications. Prior to Chat GPT, there were just over 800 mentions across 500 companies. By Q3 last year there were more than 8,000, with Nvidia and Facebook dedicating more than 100 mentions each. 

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IT’S still early days, but the implications and potential of Artificial Intelligence seem immeasurable. In the near term, market volatility is expected to persist, influenced by ongoing uncertainties around inflation, interest rate fluctuations, geopolitical tensions, and looming recessions. 

While it's premature to determine the winners and losers, the long-term outlook for the technology sector, as well as companies able to leverage this next wave of technology, remains highly positive.

For clients interested in AI investments, there are opportunities to invest through various ETFs that provide access to these companies. If you would like to learn more about which funds, please feel free to contact us.

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Travel Dates

Our advisors will be in the following locations, on the dates below:

7 February – Christchurch – Chris

8/9 February – Ashburton/Timaru – Chris

7 February - Blenheim – Edward

8 February - Nelson (PM) – Edward

9 February - Nelson – Edward

12 February – Tauranga (PM) – Chris

13 February – Tauranga (AM) – Chris

14 February – Auckland (North Shore) – Chris

15 February – The Wairarapa - Fraser

15 February – Auckland (Ellerslie) – Chris

21 February – Christchurch (Russley) – Fraser

29 February – Kerikeri –David

1 March – Whangarei – David

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee & Partners Ltd

Taking Stock 18 January 2024

IN THEIR surge to produce ever more (revolting) earnings and bonuses, America’s investment banks, private equity funds, and financial advisors are embracing ever more risk.

Many New Zealand KiwiSaver and fund managers, but not all, will be caught up by the illogical, I would say frenetic, American charge to deliver theoretically high returns in order to justify vulgar bonuses.

I have previously recorded how fund managers everywhere put ever-increasing sums into unlisted assets that have no visible daily value and are therefore of hidden value until a “valuer” records his opinion.

It is not the equivalent of stretching a 36 inch tape into a ten yard tape to suggest that valuers get more support, and therefore more assignments, if their “valuations” are welcomed by the fund manager. Valuations are, shall we say, high in elasticity.

We are already witnessing this switch to assets with subjective, not market, valuations.

So we are accepting that we are inundated with more, and different, risk.

Now the US is driving for an even greater level of risk.

Investors need to be alert. Their fund managers will not have to discuss it.

The US investment banks for years have encouraged wealthy investors to invest in high-return, high-risk, private equity funds before this latest trend. The banks lent their wealthy investors hundreds of billions to speculate into private equity funds.

By one measurement I have seen there is $7 trillion now invested in these funds, which are essentially speculative by definition.

Meanwhile the likes of Goldman Sachs is no longer achieving “enough” fees through arranging new listings or by collecting handsome brokerage on listed exchange transactions, so it wants new revenue streams.

To achieve more income, GS, for years, has been lending money to its wealthy clients for the clients to put into private equity funds i.e. we lend, you borrow, you speculate. (Its security is the clients’ other assets.) This type of lending sank Credit Suisse.

After years of stagnant activity in the private equity fund transactions, those punters who pay higher interest for the GS loan (wealthy clients) now want some cash flow from their private equity fund investment, if for no other reason than to service their GS loans, where interest rates have increased.

So they are pressuring the private equity funds to repay them. (“Sell assets, pay us back.”)

The private equity funds have no money with which to repay and cannot sell assets, or do not want to sell assets at current prices.

Ah ha! GS has the solution. It will now lend to the private equity funds so they can repay the investors who in turn can repay GS.

The brilliant GS solution is to lend to the private equity fund managers, taking as security the future (fat) fees that private equity charges, usually 2% per annum with a 20% share of any generated profits (but no share of losses).

These new loans relieve the private equity firms of the frightening prospect of being forced to sell possibly over-valued assets into an illiquid market that might discount those assets to a bargain price.

So GS, and others, including JP Morgan and very possibly the likes of HSBC, are lending ever more to help preserve the appearance of orderly equity markets in the home of capitalism.

At the same time the magnificent seven (Amazon, Alphabet, Tesla, Microsoft, Nvidia, Apple, and Meta) have been underpinning the Dow Jones, the Nasdaq and the S&P500, by using their claimed surpluses to buy back their own shares.

This underwrites buying pressure on their own shares, lifting the price, and thus underpinning the US indices.

Hmmm, the word hydraulicking comes to mind.

Implicit is the willingness of the shareholders of the magnificent seven to forego dividends in favour of capital gains that in the USA usually, and in my opinion quite rightly, are taxable, as they should be here in NZ.

Of course, when those shareholders need cash they can always ask GS to sell some of the investors’ magnificent shares, at the hydraulicked price.

I do not expect GS to forego brokerage on such sales!

Does not all this sound somewhat circular? Does it sound like compressed air creating a balloon?

To me, the combination of share-buybacks, lifting share prices and thus lifting bonuses, are creating a bubble.

Lending to private equity funds, which buy shares in companies thus lifting their share prices, is simply lending to speculate.

The lending, taking security over future fees and bonuses, enables private equity funds to hold their assets and to avoid testing the true value of the companies they have bought.

I guess I will one day learn how all this circularity can be sustainable.

In my 50th year in capital markets I have yet to reach that acclaimed stage of learning.

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ANOTHER mystery to me is the willingness of global bond funds to overweight their holdings in the flimsy sovereign bonds issued by the likes of Argentina, Turkey, and Zimbabwe, all of which pay extreme interest and are bought at an astonishing discount.

For example, Argentina, where inflation is now 211% per annum, pays extreme rates by borrowing from the International Monetary Fund (IMF). That is, Argentina borrows to pay huge levels of interest on its excessive borrowings.

As long as the IMF lends to Argentina then bond funds keep collecting on their high-risk bonds and can present to the bond fund investors that the fund managers are henceforth to be regarded at genius level, based on the returns they get from bonds.

Just this week Bloomberg recorded the triumphs of bond funds that overweight these bonds.

Last year the bonds, credit rated CCC, returned 100% per annum to the fund managers whereas AA bonds returned 4%. Call this return for risk if you wish.

A credit rating of CCC is a pip above a default rating: Bridgecorp stuff.

Credit ratings do matter, at least a little.

All of this is relevant to NZ investors as the Reserve Bank grapples with the challenge of establishing a fair fee for the marketing favour it will offer the tiny finance companies when the Crown introduces a guarantee for those who deposit money.

In logic the Reserve Bank would charge a high rate to the likes of General Finance, now owned by ex-Dorchester Finance owner, Brent King. General Finance has a credit rating from a second-tier credit rater of BB, below an investment grade.

I submit that if the AA banks have to pay 25 basis points for a Crown guarantee, then a finance company would pay something more like 5%, unless it has a credible, investment grade rating as, say, UDC Finance would have.

In other words, a Crown guarantee would cost what a private sector insurer would charge, if I were the insurer who was guaranteeing non-bank loans for a guarantee fee. Non-investment grade finance companies would almost be uninsurable, in my parlance.

If the likes of General Finance ever acquired an investment grade credit rating then a guarantee might cost less.

But as displayed earlier in this item, global fund managers have been gorging on Marque Vue and Chinese whitebait as a result of their investment in junk Argentinian bonds.

The IMF funds these refreshments with its ongoing loans to avoid an Argentinian default.

As you can see, I still have much to contemplate about the logic of financial market guarantees.

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IN LAST week’s Taking Stock, the first in 2024, written from a sun-soaked Waiheke Island, I recorded the extraordinary failure of the NZ business media to notice the unarguable progress of the Bendigo gold exploration project, now owned by Santana Minerals.

For three years I have regularly recorded its progress, which became turbo-charged after discovering in 2022 an offshoot of the long-lost Bendigo quartz reef.

That reef had fed thousands of mouths in the 19th century, miners operating with a shovel and a pick. Eventually the reef broke off and was never rediscovered, despite the likes of BHP having spent time looking for the missing body of ore.

Two years ago, Santana’s brilliant, highly experienced geologists, Kim Bunting and Warren Batt, sniffed out the lost reef, which has now produced occasional drilling results way way way beyond bonanza ratings, in an area Santana names “the jewellery box”, at its Rise and Shine tenement.

Ever since, Santana has confidently been forecasting that it has discovered a multi-million-ounce resource. Its intensive drilling, costing tens of millions, implies an average grade of 2.3 grams per ton, on a very substantial resource.

It has been easy to extrapolate that a potential resource of millions of ounces, able to be mined at low cost, would produce at today’s value nearly NZ$10 billion of gold, in a 10-15 year period.

Taxes and royalties due to the Crown would make this a generous contributor to any government’s coffers. (The Crown’s “royalty” is 10% of the nett profit before tax, each year.)

Yet the project has remained under the media radar, unaccountably. Those who might have wanted to risk a punt on the project received zero information from our media. As a foundation investor, I was able to discuss it with our clients. That has had a nice outcome for our clients but the general public has been left uninformed.

Ironically the day last week that I recorded this media error, New Zealand’s decorated business journalist Pattrick Smellie wrote a careful piece in the NZ Herald, noting the potential of the project. He had studied Santana presentation notes, circulated last week.

Within 24 hours several other publications had copied and pasted Smellie’s article. The “secret” was out.

What happened next?

Suddenly aware of this three year-old story, Australia and New Zealand investors sought to punt on the project, generating a turnover of nearly 10 million shares within a few days. Prior to that, share turnover was less than one million in a week.

The price lifted by around 30%, generating an Australian Stock Exchange request for an explanation from Santana.

The ASX could have spared itself by ringing me.

The answer lay in our new Minister for Resources, Shane Jones, having loudly supported the project, and having eliminated one of the more illogical steps in the resource consent process.

Simultaneously, the media had headlined stories about the significance of the gold discovery at Bendigo, though few made much of Jones’ supportive attitude.

So some serious investors began buying from a small pool of willing sellers.

As well, there were very large numbers of orders from Sharesies’ clients, literally hundreds buying the shares for sums ranging from $40 to $1000. Good on them, for being alert.

It would be a surprise if Australian institutions do not begin to request field visits to Bendigo and meetings with geologists.

(A cynic, like me, might also be guessing their visit to Bendigo would include a round of golf at The Hills, a tasting of pinot noir at Bendigo’s various vineyards and a great steak at the Botswana Butchery in Queenstown.)

The project is now clearly no longer under the radar of our business media.

If the next independent Mineral Resource Estimate (MRE) in coming weeks confirms a seven-figure amount of “indicated” gold and an even larger figure of additional “inferred” gold then all the current excitement would seem tiny, compared with the potential of the project.

Of course there are some “ifs” including that as yet uncalculated, unpublished MRE, the future of the gold price, and the challenge of a consent, though the Government seems supportive of a sensible pathway to consent.

As well, Santana investors have to hope there is no pod of dinosaurs playing underground rugby under the privately-owned land Santana would need to dig up, though on reflection such a game would produce enormous gate office receipts.

Full marks to Smellie for announcing the project and communicating its potential. The project is no longer a secret, here or in Australia.

Disclosure: My family and our staff own shares in Santana Minerals.

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Travel Dates

Our advisors will be in the following locations, on the dates below:

31 January – Auckland (Ellerslie) – Edward

1 February – Auckland (Albany) – Edward

2 February - Auckland (CBD) AM only – Edward

7 February – Christchurch – Chris

8/9 February – Ashburton/Timaru - Chris

7 February - Blenheim - Edward

8 February - Nelson (PM) - Edward

9 February - Nelson - Edward 

29 February – Kerikeri –David

1 March – Whangarei – David

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee

Chris Lee and Partners Ltd

Taking Stock 11 January 2024

IN the short weeks of Yuletide investors had some merry news.

Interest rates fell by nearly a full percent, though I caution that in 2023 interest rates had several days when with euphoria they fell, only to rise again when the excitement was seen to be caused by traders’ noise rather than central bank behaviour.

Yet we enter 2024 with a legitimate hope that base rates – 90-day bill rates, swap rates, overnight cash rates, 10-year bond rates – might all have fallen, allowing prime lending rates to slip back towards the five-to-seven percent band that one hopes becomes locked in for many years, enabling us all to plan.

The cause of this latest batch of rate falls is the American belief that inflation has been squashed, consumerism capped.

If the world were prepared to lend the American Government long-term money at 4% then there would be a fair show that less indebted countries would be lent money at similar rates.

The US, by the way, expects its national debt to rise from $34 trillion now to $50 trillion by 2035, and $60 trillion by 2040. Let us not talk about such realities.

However, I point out to readers that in 2001 the US debt level was less than $1 trillion, a reminder that unimaginable debt increases have already occurred, and even at today’s levels provide steeper steps than at Machu Picchu for future generations to climb.

Heaven knows how greater longevity (more pension demand) and greater debt servicing can be funded without the sort of tax revolutions that historically have banished the wealth creators to distant tax havens and led to hotheads fuelling the fires of revolution.

But these are issues that will have to be addressed tomorrow afternoon.

We all know that voters in democracies vote for the best deal for today without any real focus on tomorrow.

So a fair guess is that rather than accept a bonfire of today’s wish lists, our country will load up on debt to maintain some version of the status quo, regardless of whether that is sustainable.

Most likely, interest rates will fall in 2024. The fall will be sufficient to impact positively on corporate profitability, and should mean that properties, as an example, are valued on higher multiples of rent than is now the case.

It follows that the better property trusts (Goodman, Kiwi, Precinct, Property for Industry, Argosy) will find more buying support.

Indeed, those trusts with in-house management might be pursued as takeover targets if funding costs allow bidders to find a nett margin between yields and debt cost.

The same is certain to apply to retirement villages, whose share prices have mostly been crushed by the irrational fear that their long-term essential assets might be funded by unaffordable debt.

Arvida has already deflected a takeover bid pitched at a huge premium to its current share price, Arvida effectively arguing that its true value is more than twice what the fund managers calculate.

Other sectors that are sensitive to interest rates, and/or excessively discounted by investors, might also prompt takeover interest.

One hopes that sound companies are developing strategies to ward off opportunistic takeovers.

About the vilest corporate offence these days is to fall for a takeover bid, funded by debt, that allows some exploitative private equity fund to buy at bargain prices, providing the fund with time to prove the actual value of its target, then re-listing it to investors at a vulgar premium, effectively having devoured other people’s Christmas dinners.

This outcome is as hideous as its complete opposite, such as occurs when a new company (My Food Bag, anybody?) sells at an extreme valuation and is bought back by the original vendors when the much lower true value is revealed.

Will anyone ever forget the likes of Reeves Moses Hudig or Mowbray Collectables, which were sold for a highly improbable price to the public, then bought back by the original vendor for a price that was a few cents in the dollar of the public listing price.

Reeves Moses sold to Holdcorp, one of those 1980 bulldust companies, for $5 million. When Holdcorp collapsed under a mound of debt, the late Roger Moses reacquired his old company for an amount of coin easily accommodated by a shallow fob pocket. The investors in Holdcorp had made him a wealthy fellow.

No investor in today’s market should allow a repeat.

As an aside, it is for that reason that I applauded ERoad’s board for absorbing media drivel and rejecting a takeover bid that would have cut the investors’ torso off at about pectoral level.

The Christmas break has provided us with an expectation that interest rates can begin to fall (but never again to Covid’s absurd levels).

We know that consumption is falling and that growth in our economy is not going to be based on productivity or wealth creation.

Growth will be based on immigration, house trading and ever more debt. Luxon does not have the numbers to reverse this.

Will lower interest rates drive slightly better corporate profits?

Or will the insatiable demand for ever more debt mean that our interest rates are more or less stable meaning our currency remains over-valued while debt servicing is painful?

Investors need to think through this conundrum.

My guess is that only a tiny number of companies are planning to generate a significant new source of wealth.

Our clients will know of our view of one such company.

We have to hope there will be more than one listed company that makes wealth generation in 2024 their hallmark.

We think we know of at least two that might make a difference!

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THE attempt to take over Arvida at an unusually large premium posed some questions that the media might like to ask of itself in the interest of more mature public debate.

Arvida is a retirement village operator. It began as a mixed bag of owner-operated villages in small towns, many in the South Island.

A group of All Blacks had been sold the potential growth story and must have been elated when Arvida listed on the NZX, as the most humble of our retirement village operators.

It then exploited the low cost of debt, took over villages in bigger centres, and was a huge beneficiary of a change in law that enabled such operators to reduce the losses of care facilities.

The law was changed enabling the likes of Arvida to charge more for its care rooms if the rooms could be classified as “premium” rooms. Hitherto, every room was sold at a standard price set by the government.

That price had been unreasonably low because the government had to fund a high percentage of the people living in the more humble villages, such as Arvida manages.

With the freedom to charge more – maybe $20,000 a year more – Arvida and others overnight became less dependent on development margins and property turnover.

Arvida began to obtain a real return for the risks it took in providing low-margin services to its residents.

The “premium” pricing option was a great bonus.

Yet here we are now with the excellent villages struggling to attract investors, their share price in tatters, dividends cancelled or unnoticeably modest.

A really great business model has been disrupted, profits deferred.


The central reason is the cost of new, debt-fuelled, village developments to prepare for the huge numbers of people expected to want a care-based retirement in the next 10 years.

The numbers do not lie. Those who own homes will be easily able to afford a unit in a retirement village where hospital-standard geriatric care will be available as people reach an extreme old age.

They sure as heck will not get geriatric care from the Crown.

Societal changes have meant only a small number of Pakeha families will accommodate their folks when they need significant age-related help. They will need private sector care.

The problem is that to prepare for the extreme numbers soon lining up for a unit, the villages need to find land, hold it, borrow, and find construction teams to develop dwellings on the land, in preparation for the incoming elderly.

One could argue that more of the funding should come from capital, meaning less of the funding is reliant on debt.

Huge new development work messes up cash flows.

Yet investors want dividends. Debt is a logical funder of long-term assets.

But should a village operator borrow to pay dividends?

In summary, we have developers of excellent facilities finding real demand from cash-rich prospective residents, all springing from a business model from which everyone, including the government, wins.

The government wins because it does not have to fund geriatric care facilities.

The government is not even scratching the surface of solving the decaying state of public housing, let alone geriatric care.

Then along come some airheads in the public sector, with no demonstrable business sense or common sense as far as I can see. Capital market people somewhat cruelly describe these people as muppets. I can see why.

Typically, they have had their bugles in the public trough for all of their lives and acquired little wisdom.

They have listened to the minority voice alleging that the retirement village business model heavily favours the developer (or the village operator).

This tiny minority want to change the model. They know not what they are doing.

They imply the retirement village profits are excessive.

Well, clearly investors must also be muppets for they have been sellers, not buyers, of retirement village shares, not receiving dividends, losing the patience to wait for the capital gains that would offset the lack of dividends, once supply and demand is nearer equilibrium.

The public sector and the naysayers argue the operators are creaming the residents.

Yet the majority of the residents say they are completely satisfied with their decision to buy into a village.

The investors say the model is not providing fair returns.

They are selling shares at prices barely half of their asset backing.

A small number of meaningless commentators make banal comments, failing to see that growth and development produces fair returns, only after the development is sold.

Are we stymied by developers who are logically able to respond by stopping a development and allowing demand to far exceed supply, over time?

The latter result would be much happier prices.

I guess the other result could be the government of tomorrow could rebuild a hundred versions of Silverstream Hospital, that relic of the 1960s.

My advice to the dopes who think they can further squeeze the operators is to consider the possibility that no more facilities with geriatric care are built in advance of demand.

So look for opportunistic bids for the retirement villages in 2024, long-term money seeking to exploit the discounted prices of today.

The share prices of all the operators endure a huge discount to value.

The public outcriers should be encouraged to retire – in fact instructed to retire, rather than fuelling a stupid debate.

The likes of the Retirement Commission should be at the top of Nicola Willis’ and David Seymour’s lists, an absolute frontrunner for closure.

We have a Human Rights Commission, with an amply resourced team.

We have a Commerce Commission and a Financial Markets Authority, and our Stock Exchange has various regulatory powers.

One wonders how much we spend on empire-building usually based on the latest measurement of success – clickbait.

Seymour is probably the man to call out these aspiring emperors.

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THE project I have followed with great admiration – the Bendigo-Ophir gold exploration, headed by Kim Bunting and Warren Batt – has now moved to its penultimate stage.

Before it becomes a wealth-creating mine it must move through the consent process, proving that it will respect matters like flora, fauna, visual pollution, air pollution, waterway welfare, local people, environmental standards, and cultural expectations.

The new government has in recent days loudly announced its support of gold mining to generate wealth (within sane rules).

Santana, having proved it has a major find of high-grade gold, now faces a year of aggregating technical reports, and maybe several further months of responding to the questions of the relevant authority, before it can establish a fully-fledged, highly-productive, modern mine that will greatly enrich the local area and the Crown.

In coming weeks it will release the independently calculated scale of its find, as it seeks to shift the status of its gold discovery from “inferred” to “indicated”.

Gold discovery that is “indicated”, in market terms, is worth twice that of a discovery that is “inferred”.

The explanation is mathematical.

Gold that is “indicated” relies on intense drilling results, seeking to reduce the odds that each drilling hole may have been “lucky”, and not representative of the defined area.

A hole drilled every 25 metres is less likely to produce a fluke result than holes drilled every 100 metres.

The Australian market rewards the more certain data by valuing the find at twice the value of “inferred” gold.

Santana will release the latest data in coming weeks.

The confidence in its future is displayed by the recent addition of a senior mining executive with expertise in the consenting process.

Its CEO is an engineer experienced in building and managing mines.

The company has now ticked off the riskier stages that begin with first finding gold, then raising money to prove the find is commercial, then attracting a funding base to provide financial credibility, then attracting high-quality executives to lead the project. These boxes are ticked.

Throughout this lengthy process, early investors watched the gold price with hopes that the metal would not lose its relative value. It has not lost. Its value has grown.

The next stages are consent, designing and building the open pit mine, and recruiting a work force, before producing gold.

By 2026, it expects to be selling gold, paying royalties, paying tax, and formulating its dividend plan.

Though Santana is an Australian company, nearly half the company is owned by New Zealanders. Two New Zealanders are on the board.

Great excitement will build as Santana confidently moves towards production.

The share price gains in the past weeks will be inconsequential if the company achieves the profits implied by the grade of gold (high) that it has discovered, and if the gold price stays at or near today’s price.

I expect the value of this project to filter through to the markets, and even to the business media, here and in Australia, providing no “unknown” factor arises.

To date, Santana has escaped unwanted attention.

A successful, high-performing mining company in central Otago, generating real wealth, might provide a rare tonic for the current government. At that point it will get all the attention it deserves.

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Travel Dates

Our advisors will be in the following locations, on the dates below:

31 January – Auckland (Ellerslie) – Edward

1 February – Auckland (Albany) – Edward

2 February - Auckland (CBD) AM only - Edward7 February - Blenheim - Edward8 February - Nelson (PM) - Edward9 February - Nelson - Edward 

29 February – Kerikeri –David

1 March – Whangarei – David

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

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