Resources March Has Just Begun

The best strategy for investors over the next few weeks is to buy quality stocks, particularly resource stocks, while there is a dip in the market. Don’t just take my word for it. Earlier this week, the chairman of BHP, Don Argus, said he was optimistic about the sustainability of the drivers of the commodity cycle; and on Tuesday night the world's largest nickel company, Inco, confirmed its view on the cycle with a bid for Falconbridge. Xstrata was left the bridesmaid again.
Clearly, BHP's bid for WMC Resources was an indication of how it views the cycle; while Inco used just the slightest trading dip in resource sector sentiment to launch its bid for Falconbridge.

What are these events trying to tell me? It is that if investors won't price the resource sector appropriately, then corporates will. Global resources companies continue to take advantage of the fact that investors are pricing stocks as though they are already at the peak of the commodity cycle. It is abundantly clear that the world's leading resource companies believe no such thing.

It's as simple as that: you have to make a choice on where you stand; there can be no sitting on the fence. You either need to believe the cycle has peaked and bale out of the resource sector or, like me, believe that we are only a third of the way into the long commodity march, and keep your portfolio double-weight in high-quality resources.

I believe reports of the resource sector's death are very premature, and the current trading weakness will be your last genuine buying opportunity before an upbeat AGM season and some earnings surprises when the 2005-06 interim results are announced in February. You must increase weightings into this weakness, and be ready for more merger and acquisition activity.

It is interesting that commodity stocks have fallen in recent days, even though commodity prices have not. The profit-taking we have seen has been driven by concerns over interest rates and inflation yet, ironically, those inflationary concerns are partly driven by the pricing power the global resource sector now commands.

There has been no "seasonal weakness" in commodities as such; all we are seeing is leveraged money quit the listed commodity sector as the price of money, as measured by l

TRADER TO TRADER TO TRADER

From a trading perspective, this has occurred two to three times a year for the past two-and-a-half years, and every time was a genuine buying opportunity in quality. I can't stress enough how these events usually occur when there is a complete lack of stock-specific news around, and the market is being dominated by traders acting on macroeconomic influences. I also believe they tend to occur around school and religious holidays, when there are generally few investors around to take advantage of traders’ profit-taking. In other words, traders can force the issue harder on the downside as few portfolio managers are around to take them on.

It would be unwise to underestimate the amount of leveraged money out there. I suspect that 85% of the current ASX turnover is coming from "non-traditional" sources, particularly brokers trading as principal. If you look at the net turnover figures in leading stocks, most of the activity is brokers’ day-trading in decent volumes.

You can also see this unprecedented leverage on the registers of leading stocks.

I did read the Macquarie Office Trust (MOF) annual report this week (yes, it was another big night in the Aitken house). I was stunned to see when I got to the top 20 shareholders that UBS Prime Broking a/c held 21.2 million shares, or 1.26% of the company, at 31 August.

UBS registers 21.2 million MOF shares on behalf of its hedge fund clients. I just couldn't believe hedge funds would play in such a "low beta" stock. If UBS registers 21.2 million, I couldn't help but wonder about how much of this register is held by the hedge fund community.

The point is that we are playing on a completely new investing field, where even the dynamics of low beta registers are changing. Don't underestimate the amount of leverage out there; yet don't be alarmed when it all moves together. Nowadays, instead of a one-month correction where the market loses 20 points each day for 15 days, the market now loses 300 points in three days! Corrections have become much shorter and sharper, and can be "over before they begun".

THE POWER OF COMPULSORY SUPER

I was reading the Macquarie Office Trust annual report in an attempt to increase my knowledge on property trusts '” and to help induce sleep. Both goals were achieved, but this Macquarie Office Trust is a classic example of Australian compulsory superannuation flow finding its way into the ownership of high-quality global and local property assets. I'll bet that very few employees of the Wachovia Financial Centre in Miami, Florida, know their building belongs to a property trust offshoot of an Australian investment bank.

This global model, funded by local superannuation flow, is working. For 2004-05, distributions to unit holders increased 5% to 10.75¢ (an unfranked yield of 8%); total assets under management rose by 86% to $3.6 billion; and the stock was the best-performing Australian listed office trust, with a total return of 22%. It also has 95% occupancy rates across its portfolio, with lengthening lease terms. It is a good example of domestic superannuation harnessing for a global model.

There are also some detailed remuneration figures in the MOF report. I was more interested in the figures related to Macquarie Bank (MBL) itself. William Moss, who is the head of MBL Property, is also a director of MOF. There's no doubt that Bill Moss has added genuine long-term value to MBL shareholders via his creation and cultivation of the MBL Property Division, which now has $23 billion in assets. However, did he personally create enough value for MBL shareholders to warrant a package of $15,144,258 in 2004-05? He also seems to have 145,206 more MBL options than the previous period.

I don't know the answer to that. Perhaps he did. But what I do know is that it is an extraordinary amount of money for someone who did not take much physical, personal, or capital risk. I believe reward should partly be a function of capital risk taken personally, not for risking shareholders’ capital.

Anyway, good luck to him. At least we are seeing an "entrepreneurial culture" developing in Australia, which is making university students who see the rewards available at listed companies strive that much harder. I suspect that in the greater scheme of advancing corporate Australia, having remuneration reach globally comparable levels will help the nation retain its most promising business talent.

That's a good thing, because that talent is one of the corporate sector’s most precious assets.

ENRON’S SMART GUYS

You know my view remains that we Australians sell ourselves short on this topic of management skill. We don't quite believe in our own ability yet, but I suspect that's good thing considering what occurs in the US where they generally overrate their management ability. Over-confidence leads to shareholder wealth destruction, and to see what can happen I recommend investors go and see the movie Enron, the smartest guys in the room.

There are actually some good investing lessons in this reconstructive documentary-style film. Its key point of the film is: "If you don't understand it, sell it". Enron had the analyst community convinced that it was a unique company, which had to report earnings in a completely different style. Everyone took those comments on face value, and Enron became the seventh-biggest company in the US. It received award after award for "innovation", and numerous awards as "America's most admired company".

I may be naive, but I just don't believe this scale of fraud can or will occur in a top 50 Australian company. If anything, as a corporate culture we are almost "too honest" '” if that's possible. The entire US market fell for this Enron card trick, and fell hard. This film really did reaffirm to me that the best thing to do if you don't truly understand how a company makes its money or how to value it, is to sell it.