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Global Mining Investing is a reference eBook to teach investors how to think and act as investors with a underlying theme of managing risk. The book touches on a huge amount of content which heavily relies on knowledge that can only be obtained through experience...The text was engaging, as I knew the valuable outcome was to be a better thinker and investor.

While some books (such as Coulson’s An Insider’s Guide to the Mining Sector) focus on one particular commodity this book (Global Mining Investing) attempts (and does well) to cover all types of mining and commodities.

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Wednesday, August 31, 2005

Global Economics 101

Introduction
The way information is packaged today its very hard for people to develop or maintain an understanding of global economic activity or its sustainability. These are important issues to us all because we all hold assets, or depend on economic cycles to sustain our livelihoods. The problem is that university studies are lectured ideas detached from reality, novices get analysis of raw data divorced from any global context, or their personal investment objectives. Even the professionals have a hard time coming to terms with all the information, and maintaining a realistic perspective. Its not just a challenge to understand trends, but harden still is determining when trends will change. This is particularly important when markets are subject to sudden moves, ie. stockmarket crashes.

The Circular Flow of Income
The first task in studying the global economy is to focus on what is important. The answer to this in simple terms is to understand what is maintaining current economic activity, and what will sustain it. The answer to this is:
  1. Investment: Fixed capital spending is mostly undertaken by businesses (factories, etc), households (small businesses & homes) and governments. Small businesses are generally less important because of their difficulty raising finance, though there are medium sized companies with an earnings history or assets which have no problem. Governments similarly have no problem raising funds, however most of their expenditure is recurrent expenses, and not of a capital nature. Government (public) spending is generally less productive to the economy, and certainly harder to measure the benefits because they are provided as `public goods`.
  2. Savings: Savings refers to more passive forms of investing retained wealth such as bank deposits, fixed income securities, bonds, etc. These instruments are packed by intermediaries such as exchanges, merchant banks and fund managers.
  3. Final Consumption: This refers to retail consumption of finished goods & services by households. There are 2 types: Non-discretionary spending is the consumption which is less sensitive to changes in wealth or economic activity. eg. Food, utilities are considered inelastic sectors because we always need food, water, power, etc. Discretionary spending tends to be on luxury
Real Wealth and `Money Illusion`
Real wealth is nothing more than a market perception of the capitalised value of an income stream, whether it pertains to vacant land, your job, a car, house or factory. Your wealth is often assessed by market prices because things - whether tangible (physical) things or intangibles (like goodwill or intellectual property) have value in use or exchange.
Real wealth can continue to grow as long as real income in the economic system continues to grow. Growth in incomes sustains more spending, growth in asset prices and higher levels of debt accumulation. Such growth is only undermined by a deterioration in the quality (productivity) of investment such that new investment is unable to sustain growth in final consumption.

Cause of Economic Cycles
The global economy has been in one of the strongest periods in the modern era. Economic cycles tend to be initiated by 2 sources of stimulus:
  1. Government stimulus in the form of public spending, whether debt-financed or funded from tax receipts or printing money.
  2. Lower interest rates: In most western markets short term interest rates on deposits and loans are determined by a country`s central bank. Depending on demand for funds, these rates impact on long term bond rates as well.
  3. Private fixed investment by businesses: Businesses only invest in fixed capital in anticipation of increased consumer demand, because their inventories are low or because investment in technology offers superior returns in the long run.

Generally an economic cycle cannot start until the causes of recession/depression have been overcome, namely a collapse in asset values (property & equities), surplus production capacity or excess inventories. The duration of any recession will depend on the size of the excesses, the industry extent of the over-capacity and surplus inventories. Inventories can clear in months, but with a collapse in consumption, it can take years for excess capacity to clear. Fortunately not all production capacity is equal, thus rationalisation (ie. the closure of high cost factories) can often allow new investment sooner than was permitted when unions and governments gave industry protection. Markets are now much more responsive to market signals, so they recover much more quickly. There are however markets which are slow to clear because of government interference in the economy, eg. Japan has suffered a 13yr recession because of lack of financial disclosure, government propping up failed businesses and lack of reform to such practices. Such practices merely replace productive investment with unproductive types. Poor businesses have to fail to create opportunities for the successes.

Efficient Market Hypothesis
The global economy is only as efficient as human management systems and human nature permit. The limits of human endeavour are not a constant, but a growing sum since our capacity to do more grows with increased sophistication, technology, understanding and cooperation. Management systems are critical. The most important management systems pertain to the way organisations are structured, whether public enterprises or private corporations, and even the way individuals organise their lives to achieve productive goals. As long as a management system is generating more value to themselves or others with fewer resources (money, time or labour), then wealth is being produced. The formal economy recognises such productive endeavour through the money economy, whereas 1000s of years ago it was achieved inefficiently through the barter economy.

In so far as there are still management systems operating under sub-optimal conditions, there will remain a great deal of capacity for the global economy to grow. Consider the opportunities:

  1. Poverty & war: There are countries in which governments don`t have the freedom for outside investors to introduce organisational & financial resources to improve them.
  2. Collectivism: There are countries which continue to operate sub-optimally under tyrannical rule (with fear as the standard) and entrenched social values which seek to preserve the vested interests of those in power at the expense of those who don`t know better. eg. Poor, uneducated people clutching at straws. Sometimes even wealthy ones. Another example of this is protection of industry - where its a virtue to protect the weak, as opposed to defending victims of injustice. eg. Trade tariffs, quotas, subsidies all lead to higher costs in sum. It does however serve narrow vested interests who retain political power.
  3. Knowledge: There are people and organisation executives who don`t have the access or awareness of best management practices. This extends back to childhood education for many people, and it might yet extend to their children. Individuals need formalised systems as much as companies to overcome bad habits, to preserve control.
  4. Sense of life: There is a crisis of confidence in many societies because of entrenched values. Societies have a dominant value system, and experiences reinforce either a positive (proactive) or negative (safe, reactionary) system of values. It takes great leaders to result in either value system dominating - whether Thomas Jefferson (USA) or President Castro (Cuba).
Perspective
The importance of perspective lies in understanding the significance of any factor on the total system. Having recognised that investment, savings and consumption undermine economic activity, its important to appreciate where its happening.

A great deal of focus is given to China`s economic ascension, but consider that its only a processing & assembly plant for western consumers. Still very little consumption occurs in China because the population is still very poor, even with a population of 1.3 billion. It remains a great promise for the future though, but also a great risk. ?? Might China invest abroad.
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Investment Strategy

If you are investing for the long term, you still need an investment strategy. Dont be fooled by the rhetoric of fund managers. The reason they advise you to 'buy & hold' is because they dont want to compete with you in sell-offs. Markets and industrial sectors are cyclical, so they demand trading to get the best returns. Fund managers actually cant hope to match the performance of small investors (if you are half good) because they have to manage huge amounts of funds and charge you a fee besides.
MY ADVICE is (i) look at a range of market indices and decide upon what level of correction would give you the justification you need to get in & out of the market. It might be a 5-10% retracement or a break of trend. (ii) Diversify if you dont have an intimate knowledge of the company or management. More than 30% in one company is aggressive.

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