Dollar holders beware.
Speaking of dollar holders, we read last week that Saudi Arabia’s inflation rate reached a 27-year high of 8.7%. The riyal’s peg to the U.S. dollar is heating up. How can Saudi inflation outpace American inflation (U.S. core rate excluding food and energy at 2.3%) by so much when the currencies remain pegged?
Inflation rates are the outputs of complicated equations. The devastation at Long-Term Capital Management should have taught us that equations, like humans, are often flawed. That was yesterday. Today, we make the structured products. We use increasingly complex financial instruments whose tangible value often depends on the merits of yet another untested equation. Consequently, we have a “credit crisis.”
If we measured the CPI (consumer price index) by 1970s standards, today’s inflation rate would soar from its current levels. Let’s focus on the fact that inflation benefits debtors at the expense of creditors, since debtors can pay back their borrowing in a less valuable currency. And America has plenty of debtors…the U.S. government and homeowners come to mind.
Faced with debilitating recession or destructive inflation, the Fed foists inflation upon us. So we must brace for crippling effects of loose monetary policy. Beware: They often crop up long after the seeds have been planted. We can’t stress this enough.
According to Nathan Lewis, author of Gold: The Once and Future Money :
“Prices in the devaluing country would eventually adjust to the devalued currency. In other words, something that cost $100 (equivalent in value to one ounce of gold) before the devaluation will tend to cost $200 (equivalent to one ounce of gold) afterward. However, the price adjustment process, in practice, can take a very long time to fully play out. Prices for internationally traded commodities will tend to adjust first, typically within a year or so of devaluation. Other prices (medical expenses, rent, education expenses, etc.) can take up to two or three decades to fully adjust. The slowness of adjustment is due in large part to the existence of long-term contracts.”
This “lag effect” should bear some rather harsh long-term consequences. For now, owners of tangible assets (gold, oil and other natural resources) should continue to prosper. Foreign companies with dollar-denominated debt should benefit as well. Votorantim Cellulose (VCP:NYSE) and Cemex (CX:NYSE) come to mind.
But I want to focus on Lundin Mining (LMC:NYSE) . Last Wednesday’s news of a $491.9 million impairment charge related to recent acquisitions sent the share price plummeting. The rise of the euro on world currency markets certainly isn’t helping matters. I still don't worry so much about this charge after a merger if other fundamentals are firmly in place. This company produces good margins and doesn't carry long-term debt (to me, this is key). It has assets that others would most likely gobble up if sold. If this accounting debacle persists, then that's another story. The Lundin family has a real stake. It threw in another $8 million or so of its own cash last year. So I don't see where anyone's interests would be aligned to a major accounting meltdown.
The absence of LT debt is what really puts me at ease over the long term. We’re long-term holders here. The write-down… it's a hit to assets and a hit to equity, no question. But the fundamental business didn’t change. Barring another write-down, the price-to-book today is 0.75.
Quarterly results should mean little to long-term investors. We’re still believers in this company.
About this time in 2002, the rebirth of the tangible assets sector really began. Much of that growth can be directly attributed to the insatiable demand for raw materials that the developing giants -- China and India -- are now experiencing.
These countries are still in the early stages of development. It takes about 30 years to go from an agrarian to an industrial society. China is only one-third of the way. China will continue to import commodities to sustain this enormous transition. India will do the same.
Furthermore, the golden era of stocks (1982-2000) directed capital in about every investing avenue except natural resources and raw materials. Hence, limited demand caused a decrease in available supply.
Today, the entire world can’t get enough copper, zinc, lumber and oil. But bringing on new production takes time. Supply can’t catch up with demand overnight. In fact, it’s going to take quite some time, especially when you throw the consumption potential of India and China (37% of the world’s population) into the mix. Consequently, commodities, the market for the essentials, will remain tight for the foreseeable future.
That bodes well for commodity producers like Lundin.