Taking Stock 19 September 2024

A PENSION fund, or an annuity fund, especially any with a Kiwisaver brief, becomes edgy when it observes the real sages of the world are alarmed about the gap between equity market prices and the underlying threats to equity market values.

Be the cause geopolitics, threats of trade wars, real wars, civil wars or simply threats of tectonic change, alarm bells have sounded for sages.

The likes of George Soros, George Friedman, Neil Howe, Ray Dalio and John Mauldin are all flashing lights about the sustainability of asset values.

Even the lightest weights in our savings industry should pay attention to such people, who have had decades of success in spotting the signals of spiralling asset prices.

The pension funds sector and those running annuities are inured to gluttonous fees from their funds management contracts, especially in New Zealand. So their first response to the threat of lower returns is to switch attention to those sectors which are either opaque (like private equity) or have high short-term returns at the cost of hidden risk (private credit). They will want to protect their mandates and fees if the risk of falling asset prices converts to reality.

Most of a certain generation will recall these scary symptoms from the pre-1987 crash and the pre-2008 crash when alarm bells were deafening.

In the first of these, just in NZ, there were literally scores of “investment” and “property” companies created largely by people who fed off false valuations and hidden fees. Most collapsed.

Just as one reminder, think of Investment Finance Corp, which in 1984 raised $10 million promising to “think about” how it would use the money it had taken from investors. Having raised the money, it owned $10 million cash which the share market valued at $20 million almost the next day, awaiting the implied intervention of the IFC genii.

Of course, IFC collapsed. Various people went to jail. Investors learned to whistle, if somewhat morosely, more like a dirge than a chirp.

In 2006-2008, when the tide was turning, fund managers chased miraculous returns by investing in liar loans created by the likes of Goldman Sachs, who sold the loans while privately placing large bets that the loans would fail.

Pension funds, basing their investment decisions on nonsensical credit ratings, destroyed billions of investors’ money and taxpayers’ money, the latter spent by the likes of the US government to fund managers and investment companies to offset their self-inflicted pain.

One such company, Merrill Lynch, in 2008/9 handed out the US government relief money to their highest paid executives, with bonuses totalling most of the $7 billion (approx.) that Merrill Lynch was given; lovely people.

So here we are in 2024, world sharemarkets priced as though there will be perfect solutions to all issues, share prices at extraordinary multiples of forecast profits.

Soros, Friedman, Howe, Dalio and Mauldin sense a plague of rodents are forming an army.

Various well-respected commentators, watching the inequality grow with these extravagant asset prices, forecast an imminent downturn that would inevitably cause great grief to those least able to absorb the changes.

At least some can see that current debt levels of government (federal and state, and in our case councils) can afford to service EXISTING debt only if interest rates revert to giveaway levels. To bring this to a micro level, the gormless Wellington mayor says she has sold her car to help pay her bills.

The sages sense troubles for corporates, many of whom, as Auckland International Airport revealed this week, can repay existing debt only if they are able to raise more capital or debt.

The US commentariat now place a 40% chance on civil war in the US, due to the unequal wealth transfer of the past decades.

Perhaps that is a topic for another day.

Pension fund and annuity fund managers everywhere always respond first with a switch to the hidden risk of private debt markets and the questionable values of private equity, where values are “declared” rather than visible by daily transactions. Their response may temporarily hide the problem, the equivalent of painting over rust.

Credit delinquency is spreading, like rust. Lowering overnight cash rates will not stop the problem. If there is doubt about it consider this.

There is today US$1.7 trillion in private debt funding for corporates that have wanted lighter covenants or lower margins or longer maturities than the heavily regulated banks would offer.

US$1.7 trillion of private lending is a number that has trebled in recent years.

Some will link this growth to the risk aversion of the fully capitalised commercial banking system, where risk has been offset by the capital demanded by vigilant central banks.

Corporate lending by banks and syndicated lending (where a group of banks share the loan) are being passed over to private lending funds, managed by the likes of Apollo (UK-based) and Goldman Sachs. Small numbers of such faux banks are behaving like banks, without the capital of banks.

Typically, private lending funds are loaded up with money handed over by pension/annuity fund managers, as well as by very high nett worth individuals.

The private loans are dished out by the likes of Apollo, largely to companies whose risk profile does not suit the regulated banks. Some of these loans ae then sold off to annuity fund managers.

The real issue is capital, or the lack thereof, though banking knowledge may be another important factor in the decision-making loan committee room.

The banks must cover risk with their own capital.

The private lending managers usually have no, or little, capital and a database far inferior to that of the major banks. There is no government guarantee for depositors, as there is for banks.

Private credit managers are loan brokers, in essence.

Some such managers then gear up the money taken off pension funds by borrowing from banks, granting priority to the banks, aiming to bulk up their lending capacity.

Imagine a private lending manager collecting a billion from pension funds and then borrowing another billion from banks. The banks will see their billion-dollar loan as well-secured, as their exposure is reduced by the subordination of the pension fund contributions, effectively the capital, as far as the banks would judge.

The sages watch this pursuit of high short-term returns with often light covenants (rules applied to the corporate borrowers).

The sages would be well within their commonsense boundaries if they pondered how the corporate world can continue to borrow ever greater sums at a time when, to say the least, the globe is balanced on a fragile axis. A few big private credit funders now are like magic banks, barely within regulators’ radar.

Observe these figures.

Share of loans held by a handful of private credit lenders:

2014     10%

2018     20%

2023     32%

2024     50%

Should this be attracting regulator attention? Who is protecting the real owner of the money handed over by pension managers? The real owner is the pensioner!

Note that in recent weeks NZ pension funds have been spruiking the claim that more, not less, of the money they manage should be heading into private equity/debt managers. The public is being conditioned to more risk. The same phenomenon is occurring in Britain as it, too, like New Zealand, observes its listed equity board beginning to shrink.

The NZ Superannuation Fund was a high performer when first Adrian Orr, then Matt Whineray, was in charge. Indeed, Britain is now urging the NZSF to open a branch in London, where private lending is the boom sector. The NZSF, I suspect, will be more cautious than others, though it risks being seduced by the high returns it has had in recent years, but is unlikely to repeat in the foreseeable future.

What can NZ investors do if they do not like the lack of transparency and the hiding of risk by their Kiwisaver managers?

Not much, might be the real answer. At least some of the power is in the hands of the wide boys.

So pester your fund manager. Ask about the amount of funds in private equity and in private lending.

Monitor returns over the coming years, not just on recent months.

Maybe dial back expectations of long-term returns.

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NOT all future returns require a miracle. Some such potential stars rely just on mathematics.

When next Monday, September 23, arrives, a milestone will have occurred for what is undeniably one of New Zealand’s post-Covid success stories.

On that day, the gold discoverer Santana Minerals will be admitted by Standard & Poor’s to the NZX Small Caps Index, acknowledging Santana Mineral’s financial progress.

At the time of writing its market capitalisation is quoted by the NZX as being $468 million.

Almost exactly four years ago Santana Minerals, a small Australian mining company, took over Matakanui Gold’s licence to explore for gold at Bendigo, near Cromwell.

Santana swapped Matakanui’s licence for about 35 million shares in Santana, along with a commitment to fund more exploration.

At that time Santana’s market capitalisation was around $10 million, the share price around A$0.10.

The difference between today's market cap $468m and the 2020 market cap $10m, is almost entirely attributable to the skills, experience, and energy of two of New Zealand’s greatest exploration geologists, Warren Batt and Kim Bunting.

It was these two men who lived in the barren valleys of the Dunstan ranges, pursuing old tailings that signified historical gold discoveries, testing the soil for anomalies that indicated gold, digging, bagging up rock samples, and engaging drilling rigs in their quest for what they hoped they could prove was “another Macraes”, still New Zealand’s largest-ever gold discovery.

 It was Batt who headed the team that discovered Macraes in the 1980s, when he was a young man in his 30s. He has managed many exploration, discovery, and mining companies since that date, including one company that over time grew from a market cap of around $10m to a cap of a billion.

Bunting, a West Coaster, also in his 70s, has had similarly broad successful experiences in other countries. I see him as the real old-timer, boots, shorts and singlet, living in a caravan (this time in the Dunstan ranges) heating up frozen meals for weeks on end as he explores.

Both these men may soon be judged to be in the same category as Woolf Fisher, Jim Wattie, or Rod Drury, in terms of their contribution to NZ wealth.

Of course it is now well chronicled that Batt’s extensive contacts led to Santana Minerals, a minor explorer in Perth, buying out Matakanui Gold’s licence and providing the tens of millions needed to drill hundreds of holes into rock where Batt end Bunting had sniffed out gold.

Remarkably the seventh Santana drill at hole number 007 (James Bond, as they nicknamed it) converted the project from “interesting” to “exciting”, the independent laboratory results from 007 confirming a bonanza find, capturing worldwide attention, if not, for unknown reasons, the attention of NZ brokers or media. At that point, every newspaper should have been focussed on the discovery.

Continued drilling over the past three years has led to the probability that Santana has made NZ’s largest discovery since Macraes, with a modelled value, at the current high price of gold, of a figure in billions of dollars.

The NZ government stands to make from royalties and taxes a figure of around $100 million every year for at least a decade.

It would be a surprise to me if the Santana project at Bendigo is not named as the “poster child” for the fast-track legislation that the government introduces on October 18.

In part this is because of the quantum and high grade of the discovery, which differentiates it from any discoveries for many years.

Perhaps, just as importantly, the find is on private land, in a valley of the Dunstan ranges well away from local housing, visible by binoculars from the opposite distant hills around Hawea. The land is hardly pristine. It comprises loose rock, infertile soil, heather, gorse, thorny bushes, rabbits and very little pasture.

If consent is forthcoming, the next steps, final feasibility, mine pit design and funding, may seem linear events.

Of course, the modelled extraction success needs to be proven.

And nobody knows the future price of gold.

One must ignore the forecasts of the world's mineral users, some of whom have an expectation of even higher gold prices.

Does all of this explain the rise in market cap of an explorer/discoverer of a high quantum/high grade crop of mineralised rock? From $10m to $468m in three years is a rare source of excitement on the NZX scoreboard.

The $468m is a figure that acknowledges the discovery but discounts the value were Bendigo to be a producing mine in two years.

Disclosure: Various members of my family are shareholders in Santana Minerals.

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FOR comparative purposes here are the market capitalisation values of various companies last week.

Delegats 585m, Scales 531, Tower 474, Restaurant Brands 469, Santana 468, Tourism Holdings 453, NZX 430, Warehouse 423, Hallensteins 379, Sky TV 367, Sanford 363, Colonial Motors 228, Michael Hill 215, Scott Technology 173, Steel & Tube 154, Marsden Marine 138, NZ King Salmon 137, PGG Wrightson 136, Seeka 116, Comvita 82.

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Contact Energy – Green Capital Bond Offer

Contact Energy (CEN) has announced it is considering an offer of up to $200 million of unsecured, subordinated, green capital bonds.

More details, including an indicative margin and tenor, are expected to be announced next week. At this stage, our expectation is for a coupon around 5.25% to 5.50%, and a likely term of five years.

Please contact our office if you would like to be added to the list for further information.

Travel

20 September – Christchurch – Fraser Hunter

27 September - New Plymouth – David Colman

02 October – Tauranga – Johnny Lee

04 October – Hamilton – Johnny Lee

04 October – Wairarapa – Fraser Hunter

7 October – Christchurch – Chris Lee

8 October – Ashburton – Chris Lee

9 October – Timaru – Chris Lee

16 October – Albany - Edward Lee

18 October – Ellerslie – Edward Lee

29 October – Takapuna – Chris Lee

30 October – Ellerslie – Chris Lee

Please contact us if you would like to make an appointment to see any of our advisers.

Chris Lee and Partners Limited