Wednesday Night #1375 – The Report

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It was a brilliant evening in every respect – and there was not even mention of the G8 meeting. There is no way that a summary can reproduce the articulation and clarity of analysis of the two distinguished guests, nor the many excellent interventions from the other informed and focused participants. What follow are simply highlights of a wide-ranging and intensely interesting discussion.

Chil Heward receives the OWN
Starting the evening on an appropriately convivial path, Chil Heward was awarded membership in the OWN
“In recognition of [his] long-standing support of and contribution to maintaining the quality of information and of dialogue of Wednesday Night through consistently accurate, informative commentary on the global view of the economy, and generous sharing of informed opinions of international experts”. It was noted that two of said experts were present for the first time and thus learned that their opinions had often been shared with Wednesday Nighters.

Chil introduced Robin Griffiths and Maureen Farrow, President of Economap Inc., whose impressive career included two years as President of the C.D. Howe Institute. Rated the Number One independent economist in Canada, Maureen sits on numerous pension fund boards, and has recently joined the McGill Pension Fund.

Water: the final resource
You can go without oil without dying. You cannot go without water.
Water, more particularly fresh water, is the sole commodity essential to continuing human life on this planet. The total amount of accessible fresh water is a tiny fraction of the total and of what is needed. It is a scarce commodity in many parts of the world, but Asia is the most critical region. India will continue to be able to feed itself, but China will not, nor will the desert areas of the Middle East and Africa. As people become wealthier, they tend to eat more meat, exacerbating the water and food crisis. Feeding livestock requires fifteen times as much water as growing the equivalent amount of grain.
Historically, people have migrated from drought areas and without a solution to the scarcity of water and food, there will be large-scale migrations of populations fleeing drought and starvation, leading to social upheavals and inevitably, food and water wars. International efforts will have to focus on orderly removal of populations from the have-not regions.
Investing in water
Bottled water is more costly per litre than gasoline. There are a number of exchanges that trade funds based on the purchase and sale of water. Available investment opportunities through ETFs (Exchange Traded Funds) include: ownership of water rights, water utilities, furnishing infrastructure for its transportation including smart meters that measure not only consumption, but leakage as well, or in semi-permeable membranes for desalination of sea water. However, the performance of most of the companies included in these ETFs is not stellar.
Desalination of water is practical only where solar or another source of inexpensive energy is close at hand to power the desalination process. There could be major opportunities in North Africa, along the Mediterranean coast.
In semi-tropical climates, irrigation is difficult because of rapid evaporation, but there is great promise in the development of water-seeping technology, which makes use of minimal quantities of water, permitting the growth of plants where plant survival would be otherwise impossible.

Canada is blessed – but
Canada’s wealth in natural resources, coupled with its political stability and close proximity to its principal customer make it the top ranking resource-rich nation (with Australia and Russia, – South Africa and sub-Saharan Africa being ruled out because of geopolitical risk). For the region west of the Ontario-Manitoba border, there is 25 years of prosperity ahead. Traditionally, the Canadian dollar has been correlated to the U.S. dollar, but with the changing fortunes of both countries a premium of the Canadian over the U.S. dollar appears very probable.
Ontario
Historically, 40% of Canadian GDP has been created in Ontario, now a have-not province. This year, auto sales in the U.S. will drop significantly. Historically, the single most traded product in the world has been the automobile between the U.S. and Ontario, a trade that has been a victim of the petroleum crisis as well as of foreign competition. This has absolutely devastated Ontario. Our economy has been largely dependent on low energy costs. With higher energy (and consequently, freight rates) and salary costs, production is shifting back to southern U.S. and Mexico thus reversing the fortunes in Ontario where energy costs are higher than in Manitoba or Quebec. The new reality will create political turmoil and difficult questions regarding monetary policy.
These are considerations that neither federal nor provincial governments appear to fully understand, let alone be prepared to deal with. Are we ready for the hollowing out of the Canadian economy? Our natural resource companies are ripe for the picking, but so far the takeovers of such giants as Falconbridge, INCO and Alcan have produced only muted response. Do we have the political will to deal with foreign takeovers of our oil industry? Does our country understand the immense structural shifts that are happening whether in forestry or manufacturing; are we ready to deal with the rise in value of the Canadian dollar? What happens to our labor force with the collapse of manufacturing sector? How to deal with municipal deficits and aging infrastructure?
Despite these issues, Canada looks very good to foreigners. There are indications of renewal in the mining sector, giving hope to northern Ontario and Quebec and several experts believe that there are some excellent values in Canadian stocks in the right sectors and some important investors are bringing money back to Canada from the U.S. and Europe.

Oil and electricity
Oil is politics. Coal miners in England have, at one time, held that country to ransom and if we do not want the same to happen with oil we must decrease our dependence on it. Buildings can be heated in many different ways but without electricity you cannot live a 21^st century life ; it is required to operate telecommunications and the use of fossil fuels to generate electricity is costly and harmful. Nuclear power is slowly being recognized as the logical realistic alternative.

Global economic outlook
We are moving into an Asia-centric universe again (for 1800 of the past 2000 years, the two largest economies have been China and India, with the brief hiccup generated by the Industrial Revolution). This fact will be the defining economic driver of whatever we do.
The U.S. is losing its clout, is in a slow-down and will have to recover from the effects of the current crisis as well as overcome the effects on consumption of aging demographics. However the population won’t shrink (300 million will become 400 million) and the U.S. will not disappear as an economic power. China and India are currently suffering from some cyclical bumps in the road, but before the end of the year should offer some excellent buying opportunities. Both, however, are facing the problem of scarcity and rising food prices among both rural and urban poor. This is expected to have an impact on the congressional vote in India.
While the growth in members of the nuclear club is likely to decrease the risks of nuclear warfare, we can expect continued ‘local’ wars .
The world’s big secular economies are northern hemisphere economies (including Australia) with the same seasonality. Hence the saying “sell in May and go away”. The next buying opportunity comes in September, with the market bottoming in October, although frequently there is a mid-summer rally, particularly in sectors that are oversold. We are massively oversold now and the world is changing.
Historically, the world has only known one economic superpower at a time but we are moving into a period in which three or four might co-exist, most likely the U.S., China, India and Europe.
Commodities are in the beginning of an up-trend which will run for years. The increasing affluence in emerging economies is driving an unprecedented demand for commodities and energy, the supply of which has not increased appreciably in the past two decades.
The oil and food problem is here to stay. No central bank in the world can control their prices which are driven by the fundamental demand and shortage of supply. Inflation is expected to reach four percent. Central banks will attempt to control inflation by controlling wage rates.
For at least the next decade we will live with inflationary pressures coming from costs of commodities food, transportation, freight rate, etc., further exacerbated by the costs of cleaning up the environment.
China is currently suffering the effects of rising wage costs and older (OECD) industrial countries with aging populations are fighting increasing costs for services and health care, exacerbating the inflation problem. Jobs are not being created in the industrial world. The sub-prime problem has destroyed consumer confidence, leading to a financial crisis that historically takes approximately eight years to work through. There is a tendency not to lend money until one’s balance sheet is in order (and not many banks have a good balance sheet). Consumer confidence around the world is declining in tandem. The only motivation to produce products is consumption and when consumers do not buy, the L-shape rapid drop and continuing low characteristic of a recession become evident. In this environment it is necessary to understand the nature of a recession and invest wisely.

Oil money and the U.S. dollar
A lot of money is flowing from oil consumers to oil producers. Unlike the ‘70s, Saudi Arabia is now planning for a future when their oil runs out, and are investing in infrastructure for the entire sub-continent. The countries of the Saudi Arabian peninsula are unlikely to be willing to peg their currency to the U.S. dollar for much longer [“Dropping the peg“], a step that would be very painful for the U.S. Kuwait has already taken this initiative.
The dollar is no longer going to be the world currency. The pound sterling has gone through a similar crisis and has not been devastated by it. It is possible that rather than a single world currency, there might be several, perhaps a euro bloc, an Asian Bloc, as well as a dollar bloc.
At least one Wednesday Nighter holds a contrary view, believing that much of the world would not be keen on a reserve currency that is controlled either by a single-party state (China), a chronically chaotic democracy (India) , or a collectivity of sometimes uneasy, ill-matched partners (Europe).
Another maintains that the world will return to the gold standard.
In the Middle East there is so much liquidity that they earn more money from their investments than they do from petroleum. The Arabs, China and Japan have more dollars than the U.S. and don’t want any more. The good news is that some of these sovereign funds are willing to swap them for real assets – equity-type positions in the western world. They take their own part of the world seriously and know that other people don’t – a situation that they are attempting to change.

Income Trusts
We are only part way through the credit crunch. It will take a long time (a few years) until financial institutions have recovered. We will not see the creation of new investment vehicles but income trusts won’t disappear. When they were introduced, people were slow in buying and so it proved to be a very lucrative investment and when it became popular, everyone wanted in. Different sectors are not always treated in the same manner by the tax regime and so there is a different playback. There does not appear to be a similar replacement vehicle evident for retirees.