Will Mining Stocks Shine Next Decade?

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Mining stocks are not for the fainted hearted. As we have seen in the past few months as the demand for commodities fell, mining stocks were pulled down much more than the overall market indices. However when commodities were hot, mining stocks had an incredible run.

In a recent article titled “After the bubble burst: Where next for mining?” at Trustnet, a unit trust (mutual fund) research site in UK, the author gives some very fascinating stats. The article says that the boom period that lasted “most of the past decade the FTSE Mining Index returned a massive 1,623.22 per cent“.(emphasis added). Mining stocks constitute one of the major sectors of the FTSE Index – the main stock market index of UK. This is type of great returns was possible only because of the demand of commodities worldwide especially the demand from the fast growing economies of China, India and other emerging markets.

FTSE Mining Index Multi-Year Performance Chart:

The chart shows that the mining stocks started climbing around 1999 and that run lasted until the credit-crunch hit the world markets. From the chart we can also observe that the Total Return(TR) since 1986 was 2246.51%.

So what does the future hold for mining stocks?

Mining companies are dependent on the economic growth of countries especially fast-growing countries such as China, India. The government of China and India have promised heavy spending on infrastructure projects such roads,bridges, railroads, airports, etc. as part of their stimulus plans. Here in the US, the Obama administration has promised to invest heavily in upgrading the infrastructure as well. So in a way the demand for commodities might increase as these projects are implemented.However all these government initiated efforts will not start immediately. Hence these stocks will continue to be extremely volatile. Gold will continue to be a favorite for investors in these tough times. But the demand for commodities like coal, silver, iron, copper, tin, etc. are all difficult to predict at this time with any accuracy – other than the infrastructure investment mentioned earlier.

Some of the large foreign mining companies listed in the New York Stock Exchange are:

Companhia Vale do Rio Doce (RIO) – Brazil

BHP Billiton Ltd. (BHP) – Australia

Rio Tinto plc (RTP) – UK

AngloGold Ashanti (AU) – South Africa

Compania de Minas Buenaventura (BVN) – Peru

What Recession? This Company is Growing !

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Most companies based in the USA are in contraction mode laying off people, cutting expenses, postponing projects, etc. to survive this downturn.

On Jan 23, 2009 the Financial Times reported:

“McDonald’s is planning to this year create 12,000 jobs and open 240 new restaurants across Europe, it emerged on Friday, as the fast-food chain shows signs of being one of the few global companies to benefit from the financial crisis.

In stark contrast to the multinational groups announcing record job cuts and losses, McDonald’s plans for expansion in Europe are its biggest in five years.

“We’re certainly not slowing down,” said Denis Hennequin, president of McDonald’s Europe as he outlined to the Financial Times his plans to hire 50 people at each of the 240 new restaurants, mostly in Spain, France, Italy, Russia, and Poland”

The company says the reasons the expansion in Europe the low-priced menus ,improved store designs, new menu choices and food price inflation. While the first three points are understandable the last one is open to argument.

McDonald’s also said that it plans “to add about 400 new McCafes to the 800 it already has in Europe this year.”

Some of the reasons that MCD is flourishing in a downturn economy worldwide are:

1. In many countries McDonald’s is a novelty and consumers want to give it a try.

This is true in emerging market countries and also in some Europe countries.

2. As mentioned by the company, consumers prefer to eat something that is cheap. This is true in Europe as well where local food prices could be high in traditional eating places. Though their food may not be of as good quality as other fast food restaurants they food is comparably cheaper. This is a huge draw among cash-strapped consumers.

3.McDonald’s brand is very popular all over the world and it continues to take advantage of that with effective marketing.

4. The company positions its stores in some of the strategic places around tourist locations, busy thoroughfares, near malls, etc. In countries such as Canada they can be found inside a huge mall right next to high-end fashion or jewelery stores.

McDonald’s (MCD) is a Dow component and is a core holding in many mutual funds. The stock pays a dividend of 3.45% and the market cap is about $65 B. Since going public, the stock has split 9 times.

Are Indian Banks Better than Western Banks?

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Banks in India seem to be faring much the banks in the Western world. In a recent article, The Banker magazine says that though India has been affected by the global downturn its banking system has survived due to the bold actions taken by the Duvvuri Subbarao, the Governor of the Reserve Bank of India.The article says that some of the reasons for the surprising strength of the banks are not having direct exposure to subprime mess, limited derivative exposure and low off-balance sheet activities. These three are the biggest causes of meltdown in many of the large financial institutions in Europe and North America. Another factor that must reviewed when evaluating banks is the “Capital-To-Risk weighted Ratio”. The piece says “The capital-to-risk weighted assets ratio of Indian banks, at 12.6%, is above the regulatory norm of 9% and well above the Basel Accord norm of 8%.” [emphasis added]

ICICI Bank (IBN) and HDFC Bank (HDB) are the two banks that trade in the US. The largest bank in India is the state owned, State Bank of India. However it is not listed as ADR here. ICICI is India’s largest private sector bank.

1. ICICI Bank (IBN)
Current Yield: 3.48%

Today ICICI reported earnings for the last quarter of 2008. Profits after tax went up 25% over 3Q, 2008 at $261 M. NPA stood at 1.95% which is much less than many large global banks.

As of December 31, 2008 ICICI’s total capital adequacy was 15.6% and Tier-1 capital adequacy was 12.1%.

ICICI is gaining more customers and increasing its deposit base in UK and Canada. The main reason for the growth in these two countries is higher interest rate offered by the bank in comparison to many domestic banks.

ICICI has a rating of BBB-, which is just above junk status, given by Fitch back in November last year. Last year there was a run on some of its branches as rumors spread that the bank was about to collapse. However that rumor turned out to be false. S&P; seems to think that the bank would survive any eventuality. It said in October last year ” the bank had a strong credit profile, but a relatively low credit rating as it is rated on a stand-alone basis. But given its importance to the Indian economy, the agency believes it would ‘receive extraordinary systemic support in the event of any financial distress’, and is therefore unlikely to fail.”

2.HDFC Bank Ltd (HDB)
Current Yield: 1.05%

HDFC has been affected by the economic downturn in India. Asset growth has slowed.In order to increase loan sales the bank has started to cut interest rates especially on mortgage loans. However customer default is a concern due to many job losses and complete freeze in the real estate market. HDB’s current capital adequacy ratio is 13.7%. Unlike ICICI, HDFC does not operate retail outlets in UK and Canada.

It remains to be seen whether the policy changes put in by the central bank will prevent further downturn in the Indian economy.

Update:
Bloomberg: State Bank of India, ICICI Profits Advance on Bond Investments

US Economy: Is New Growth Economics the Cure?

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There are three major economic growth theories: Classical economic theory, Neo-Classical theory and New-Growth Economics.

Classical theory states that the output of a country depends on the capital available per worker. If capital per worker increased output would increase. The problem with this theory is that it does not account for important factors like technological change and the stock of knowledge. There are many African countries where capital per worker has increased in recent years due to the discovery of natural resources such as diamonds and oil. Nigeria and Sierra Leone are examples of such countries. Though oil was discovered in Nigeria in 1956, in 1998 Nigeria ranked 151 of 174 countries assessed under the United Nations Development Program’s Human Development Index. The majority of the population has the lowest living standards in Africa. Similarly diamonds were discovered in Sierra Leone in 1930; however, the United Nations listed the country among the World’s Poorest Countries of 2003. Thus when we apply the Old Classical theory to these countries, it is proved incorrect (i.e. though the capital per worker increased the output did not increase). This is because even though the capital per workers increased, there were no technological innovations in these countries. Moreover the capital fled abroad to escape instability at home

The Neo Classical theory tries to address some of the problems with the original classical theory. It states that economic growth is dependent not only on capital and labor but also on technology. Robert Solow isolated the sources of economic growth using a growth accounting equation. His contribution is to explain the sources of long-term economic growth. One problem with Solow’s theory is that it does not explain the reasons for the difference in economic growth rates between countries. Solow predicted that there would be convergence in the standard of living of all the countries of the world. This is because the growth in developed countries would stagnate because of the diminishing return to capital per worker and capital would flow to developing countries where there would be higher rates of return. Invested capital would in turn, lead to convergence between the developed, underdeveloped and undeveloped countries. However, in practice, the convergence predicted by Solow has not happened because growth in advanced countries continues to increase due to technical progress and also the capital does not flow to underdeveloped and undeveloped countries because of factors such as political instability and lack of institutional reforms. Conditional convergence occurs among countries with similar economies and cultures but not among dissimilar economies. Hence we find that both the classical and neoclassical growth theories do not adequately explain the differences in growth between various countries. The theories do not consider the fact that the wealthy and developed countries can improve upon their existing knowledge base and maintain the lead over the other countries due to technological innovation.

The New Growth Economics proposed by Paul Romer and Robert Lucas provides an explanation for the persistence of long run inter-country growth differences. These two economists from the University of Chicago proposed the theory in the 1980s. According to this theory, technology is endogenous (i.e. produced from within) and economic growth occurs from innovations that result from new ideas. New ideas come from many economic agents. These economic agents can be either privately or publicly funded. Some examples of the economic agents are the R&D department of a big corporation or a government funded entity such as NASA. These agents create new ideas from the pool of knowledge. The New Growth Economics can be represented as Y = f (K, L, H, A) where K is physical capital, L is labor, H is human capital, A is technological change and Y is output. The old classical theory concentrated on capital available for a country’s economic growth. Solow emphasized the importance of technical innovation for long-term growth, but his work did not account for the causes of technical change. Romer and Lucas, on the other hand, identified the causes of technological change in their New Growth Economics theory.

In addition to putting emphasis on technical change, New Growth Economics also proposed public policies supportive of economic growth. The public policies are listed in below:

  • Free Markets
  • Intellectual Property (IP) Laws and Enforcement
  • Support of R&D (due to knowledge Spillover)
  • Human capital
  • Rule of Law
  • Need for Openness (free flow of ideas, people)
  • Democracy
  • Political Stability
  • Government Spending (productive spending)
  • Concentration on Technical Innovation like IT

Source: Applied MacroEconomics – Olivier Blanchard

In order for innovations to flourish, Lucas and Romer state that a free market form of government is essential. The US economy is a perfect example of their theory, where free market capitalism generates the majority of the technical inventions and hence higher economic growth. Every major business cycle in the US economy has been made possible by new innovations. Examples of this include the dynamo, railroad, microprocessor, computer, Internet, etc.

Are we following the public policies of New Growth Economics?

1. Free Markets – While the core of the free market principles are still followed some of the recent actions by the government such as the bailouts have prompted some folks to question if we are moving away from free market principles. In fact, there are some folks who say that things such as Social Security should not exist in an ideal free market. However I do believe that compared to most other countries the USA still has the best free market system in the world.

2. Intellectual Property (IP) Laws and Enforcement – The IP laws and their enforcement in this country are no doubt the best anywhere. For example, copying and distribution of music, movies, etc. are illegal and violators are taken to court by the IP owners. Similar rules are applied to companies for patents.

3.Support of R&D (due to knowledge Spillover) – The government and the private sector spend huge amount of their budgets each year on Research and Development. However it must be stated that some countries such as China are investing heavily in R&D to catch with the advanced countries. Knowledge Spillover occurs when a company files a patent. When other companies come to know of the patent they try to create better ideas.

4. Human capital – Some of the best and brightest minds in many fields live in our country. We continue to attract the best talent in the world.

5.Rule of Law – This is a country built on law and most of us follow the laws.

6.Need for Openness (free flow of ideas, people) – We encourage free thinking, free flow of ideas and we accept people from around the world no matter what their belief systems are.

7.Democracy – For a young nation, we have a highly successful democratic political system.

8.Political Stability – Compared to many other countries, political stability is not an issue in our country. For example in many emerging market countries such as India, Brazil, Chile political stability may not exist.

9.Government Spending (productive spending) – This public policy suggests that government spend its funds on productive projects. But what exactly does productive spending mean in modern times? Some may say even investments in infrastructure such as roads is not productive spending since it does not generate any additional return to the government.

10.Concentration on Technical Innovation like IT – Innovation can be one of the engines for growth. A few weeks ago Business Week had a cover story on how innovation is important for companies even when economy is in recession.

Questions to readers:

1. Should we follow all the public policies of New Growth Economic Theory to pull us out of the current mess?

2. Will New Growth Economics lead us out of this downturn?

3. Instead of encouraging bailing out banks and encouraging them to lend should the government increase its spending ?

4. Do we need to invest more in R&D and develop new products that we can export to other countries?

5. If we emphasize technical innovation as suggested by New Growth Economics or concentrate more on manufacturing and other high labor intensive industries?

Feel free to leave your answers in the comments section.

Three Australian Banks Offer Yields over 10%

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After the crash of the banking sector, the three Australian bank ADRs offer yields that are well above 10%. Just like any other bank that is cutting dividends or outright suspending them non one can be sure that these yields are sustainable.

However each bank is different and Australia is normal times is a stable country with a strong domestic economy. Australia is a regional powerhouse whose companies are heavily involved in many Asian countries. The country is heavily dependent on the commodity markets since it is a resource-rich country similar to Canada. These two countries are unique in a sense that they are both western style democracies, have developed economies and have stable political systems with an abundance of many natural resources.

The following are the three Australian Bank ADRs:

1.Australia & New Zealand Banking Group Ltd (OTC: ANZBY)
Current Yield: 12.67%

Many lawsuits have been filed against the bank recently due to not disclosing heavy losses sustained by the bank in its involvement with a failed brokerage outfit in Australia. One of the lawsuit says:

“The Company and its top executives violated the federal securities laws. The complaint charges that ANZ failed to adequately disclose the range of risks arising from its loans to Opes Prime Group Limited, an Australian stock brokerage firm that lent money to customers on margin. ANZ had lent hundreds of millions of dollars to this failed brokerage house, but without adequate disclosure of the risks the loans posed to ANZ. The day before the Company announced its losses stemming from exposure to Opes Prime, its stock (ADRs) closed at a high of $17.24. The following day, after ANZ’s announcement, ANZ’s stock price dropped to $14.57. ANZ’s stock is currently trading at $9.90.”

2. National Australia Bank Ltd (OTC:NABZY)
Current Yield: 11.83%

3.Westpac Banking Corp (WBK)
Current Yield: 10.26%

Westpac is Australia’s second largest bank.

Recently it emerged that Westpac and ANZBY plan to issue samurai bonds backed by the Australian government. Samurai bonds are yen-denominated bonds issued by foreign institutions in Japan. Since the bonds are to be backed by the government, they would have the same sovereign debt ratings which would lower the financing costs for the issuers.

Multi-Year Chart:

As the economic crisis continues to unfold and commodity prices remain volatile investors can keep an eye on the Australian banks. If the Asian economies of China, Indonesia, Singapore, Thailand, Malaysia and other countries gets worse then Australian companies could be hurt more.