Agcapita Update

December 2010
Agcapita Update

IF YOU CAN KEEP YOUR HEAD WHEN ALL ABOUT YOU

ARE LOSING THEIRS ... YOU DON’T WORK FOR THE
FEDERAL RESERVE

Apologies to Mr. Kipling for using his work to create an

inflammatory headline.  

A considerable amount of ink is being spilled on the topic of

whether there is a recovery underway in the west and if so,
whether that recovery is sustainable. So much ink in fact that
one would have thought that when combined with the mighty
labors of our central banks to single-handedly create an ink
shortage this lowly substance would have been used up long
ago. 

Fortunately, or perhaps unfortunately depending on your view of

my monthly musings, we haven’t run out yet so let me give you
my view on the recovery debate - a recovery in nominal or real
terms?  With the printing presses running full time (ink supplies
notwithstanding) some form of nominal recovery will occur in the
western economies.  Sadly, it’s not going to be anywhere nearly
as satisfying as other post-war recoveries because it largely will
be an illusion in real terms.  Our recovery is not being built on the
sound fundamentals for growth:

–   Favorable demographics;

–    Low national debt levels;
–    High savings rates; and
–    Persistent trade surpluses.

Please take a moment and consider which so-called developed

nation has these characteristics.  Stumped?  None.  Now turn
your gaze to the emerging world - I doubt you are still stumped
as the list is long and obvious.  

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Agcapita Update (continued)
Take Canada as an example of a country suffering
from the western growth malaise.  Canada has:
–  An aging population;
–  Large unfunded liabilities for social benefits;
–  High total debt-to-GDP levels;
–  Low savings rates;
–  Large and increasing government intervention in
the economy;
–  Large fiscal deficits; and
–  An overly accommodative monetary authority.
I’m sorry to be the bearer of bad tidings but these
are not the seeds from which mighty recoveries
are grown.  By insisting on printing over the
systemic solvency issues in the financial sector,
by actively preventing the liquidation of decades
of mal-investment, by subsidizing speculation and
consumption to the detriment of production (and
so on) our valiant central bankers will not create a
recovery.  Unless these problems are addressed they
are creating an inflationary environment with poor
real growth dynamics - i.e. the ideal raw materials for
stagflation in the west. 
What are our investment options?  It should come as
no surprise to anyone who has read one of my letters
that I believe its important to find investments in
politically stable regions of the world that are directly
exposed to emerging economy growth - i.e. regions
that export what the emerging economies need and
are not exposed to emerging economy competitive
advantages - i.e. regions that do not export what the
emerging economies make.
In my funds’ backyard, western Canada, energy
and agriculture are dominant industries. In fact,
western Canada, with only 10 million inhabitants,
is one of the world’s largest net exporters of both
energy and agricultural commodities.  As we know,
energy and food consumption undergo rapid growth
as a developing economy makes the transition to
a middle class standard of living. These markets
already appear to be tightening and demand is still
accelerating.  Here are some quick numbers to
give you an idea of western Canada’s resources
endowment:
Energy
–  Oil (13% of world reserves; 4% of world
production)
–  Uranium (8% of world reserves; 20% of world
production)
Agriculture
–  Potash (60% of world reserves; 30% of world
production)
–  Wheat (21% of the world export market)
–  Oil seeds (10% of the world export market)
–  Farmland (80% of Canadian total)
The Canadian economy appears bifurcated between
the lower growth east and the higher growth west.
Investing in western Canada provides exposure to
emerging market consumption patterns in energy
and agriculture in a politically stable market.  I believe
a good approach is to make direct investments
in commodity production assets - in addition to
providing less volatile exposure to commodity price
trends, production assets are excellent inflation
hedges that, unlike gold, generate cash flow.  
In addition, investors who have a value orientation
have been provided what I believe is an attractive
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Agcapita Update (continued)

entry point into the Western Canadian conventional Let’s take a look at what that vaunted
oil market.  The credit crisis has caused financing to “independence” is costing Canadians using some
become scarce for junior oil & gas companies while Bank of Canada (“BOC”) data.  There is C$1.2
low natural gas prices are reducing their profitability.   trillion on deposit with Canadian chartered banks.  If
They are being forced to sell assets to stay in we assume that BOC actions are keeping interest
business. This has created a buyers’ market for the rates at least 4% below their equilibrium level  then
acquisition of smaller oil production assets - assets Canadian savers are being taxed by the BOC to the
that are highly cash flow positive at current oil prices. tune of $50 billion annually in the form of lost interest
  income. Canadian federal government income tax
Shifting gears for a moment - I want to ask when revenues are approximately $150 billion, so is it not
we gave permission for central banks to take over accurate to say the BOC has unilaterally increased
the tax role of our governments?  Central bankers Canadian income taxes by around 33%? 
now seem to feel free to increase the money supply
by any quantity they deem necessary to keep the Let me leave you with this.  If central banks really
banking sector solvent.  In effect, they are extracting believe that printing money and giving it to the
a massive tax from savers everywhere via the government and the banking sector is solving our
historically low interest rates they have engineered.   problems and is not inflationary why not print much,
When questioned about what they are doing with our much more and be done with the crisis once and for
money they get downright testy and roll out the cliché all?  Perhaps all this money printing will usher in a
of “central bank independence”.  new era of wealth, prosperity and low inflation - what
do you think? 

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