25 May 2021
Based on our ongoing commitment to providing insight and thus (hopefully) appreciation for our somewhat unique approach to investing, we are taking advantage of some of the questions we’ve received about our current fund positioning to offer further insight into our investment process. This Op-Ed piece focuses on some of our primary Investment Principles, namely 1) our Primary and Secondary (Bull/Bear, Buy/Sell indicators), 2) the relevance of commodity prices, and 3) keeping emotions out of our investment decisions.
Over the longer-term, South African equities remain the asset class of choice for any local investor wanting their investments to generate inflation-beating returns. Gryphon’s rules-based approach to investing relies on two primary indicators; one gets us into equities and the other one gets us out.
Explaining these indicators and our application of them has resulted in some stimulating conversations in which we endeavour to inspire the mind-shift required to grasp this approach. A useful analogy may be that of language translation. Translation tends to sound easier than it is. People often think that it’s just a matter of replacing each source word with the corresponding translated word, and then you’re done. Unfortunately, translation is much more complicated than that. There can be multiple ways — sometimes dozens — of saying the same thing in another language. Add to that things like syntax, grammar, colloquialisms, and any other number of examples of linguistic nuance, and the potential for mistakes is huge.
We’ve all chuckled at examples of poor translation such as on car rental brochure, Tokyo: “When passenger of foot heave in sight, tootle the horn. Trumpet him melodiously at first, but if he still obstacles your passage then tootle him with vigour”, or in a hotel lobby, Bucharest, “The lift is being fixed for the next day. During that time we regret that you will be unbearable.” But, while these instances are simply entertaining, it does help to comprehend the importance of testing understanding and ensuring that the intention of the words and ideas are landing and understood in the way that they were intended.
Realistically, it would be neither sensible nor wise to rely on a single indicator for these very important decisions. While we trust our indicators, we also know that the four most expensive words in investing are, “this time is different”. Thus, to ensure the integrity of our primary indicators, we employ a number of supplementary indicators that inform our ultimate decisions.
We have been out of equities since August 2018 and, while many of our peers are of the view that a ‘secular bull market in commodities’ has begun, our supplementary indicators, particularly those related to commodities, do not support this; they are, in fact, flashing red.
We are concerned that those four words could again turn out to be pretty expensive for investors for the following reasons:
- Over the long-term the Rand has performed in-line with the relative performance of Developed Markets over Emerging Markets. The chart below plots the Rand (on the left hand axis) against the MSCI World Index divided by the MSCI Emerging Market Index (on the right hand axis).
While there have been deviations in the past, the current differential is quite stark.
The chart below reflects our view that the Rand is overbought and no longer offers value for investors. We would advise investors to take some of their wealth offshore and would recommend currencies like the Swiss Franc over the traditional safe-haven of the U.S. dollar.
- Increasingly we believe that the U.S. Federal Reserve has become overly attached to quantitative easing and that this may result in the U.S. dollar losing some of its safe-haven status.
- Looking at it slightly differently and, we believe, confirming our thesis on commodity prices, below you’ll see the MSCI Emerging Market Index divided by the MSCI World Index (on the left hand axis) and the Goldman Sachs Commodity Index (on the right hand axis). Emerging Market equities generally start pricing in a commodity bull market ahead of the underlying pick up in commodity prices, as was the case in early 1999 and then again in late 2001. This time Developed Markets remain firmly in control and, despite the pick-up in commodity prices, the outperformance of Emerging Markets is not yet evident.
- One possible explanation is that Emerging Markets are still mired in the bog of COVID19 and lag Developed Markets when it comes to rolling out vaccines. While this is a possibility, we believe that there is a more simple explanation; simply that supply-side issues are placing pressure on the efficient delivery of commodities to where they are required.
These supply side issues are clearly reflected in the results of the Maersk Shipping Company for the quarter ended 31 March 2021. The company’s largest operating segment “Ocean” is, as one would expect, involved in the logistics of moving goods around the world and its revenue is contingent on freight charges earned. On a quarter-on-quarter basis, freight revenue was up 36%.
While this may appear to support the “all’s-well-in-the-global-economy-scenario”, a look at the granular detail reveals the following:
As can be seen from a closer look at the results, while average freight rates have risen more than 35%, the increase in volumes is less stellar.
We would therefore contend that much of the pricing pressure is a function of supply issues in the shipping industry, i.e. the required ships and containers not being at the ports they are needed, etc.
So it is that we believe that emotions should be kept out of decision-making. This prevents us getting caught up in the “excitement and heady euphoria” of a phantom boom but means that we wait, clear-headed and sober, for sustainable opportunities. Data presents a cold, hard, clinical perspective, and currently the numbers inform us that the next commodity super-cycle is not yet upon us. But we remain vigilant and alert; we are ready for it…