UK Value Investor

The UK and US economies are still heading for recession caused by the credit bust and high food and energy prices. The rest of the world is affected to greater or lesser degrees. So mainstream equities are a bad idea and today they went into bear market territory with 20% drops from the peak last October.

Oil is $146 so oil related stocks are still looking like the place to be. I don't see how that's going to change for the next few years, if not a decade. China and India are still growing, non OPEC supplies are still falling and demand still equals supply. If OPEC starts to decline in the next decade we're in for a hell of a rough time.

This only makes 'climate change' stocks and funds look more attractive since most of the responses are the same for peak oil and climate change. Fuel efficiency, renewable energy, electric cars, lightweight materials, insulation, energy efficiency, etc.

As things stand I might up the climate/renewable % of the fund to 20% from the current 10%.

Just to remind myself, the breakdown is currently:
cash 10%
renewables 10%
oil/gas related 30%
industrial mining 30%
gold miners 20%

I saw a nice chart that illustrated the point of following the long term trends. This ties in with Long Valuation Waves where the p/e of a mature market tends to ride up and down over a time scale of one or two decades. Last time I wrote about this I mentioned the roughly inverse correlation between energy consuming and producing companies. The 1965-1983 period was good to energy producers and inflation bets (gold), the 1983-2000 period was good for energy consumers since energy was cheap.

Another way to view these long cycles is that there is always a decade long bull in something. If you invested $35 in gold in 1970 it was worth $627 in 1980. Put that into the Nikkei until 1990 and it was worth $3,548. Put that into the nasdaq until 2000 and it would be worth $35,105. Finally stick that in oil and it's now worth $159,591.

Those weren't insanely hard trends to spot. Of course, you'd probably be hedged to some extent on a couple of major plays, but in general I still love this strategy. Currently I think the trend for the 2000-2010 period is oil/gold, although emerging markets have been a pretty handy place to be. I think the trend for the 2010-2020 period is likely to be renewable energy and energy efficiency, but again China could be useful. For 2020-2030 the trend may be back to consumption once a new global energy infrastructure is in place.

Long valuation waves are the secular bulls and bears of the stock and commodity markets. The theory is that due to fundamental (for the last century at least) reasons, stocks and commodities become approximately inversely more or less expensive over long 30-40 year waves. General valuation measures such as p/e help indicate which stage of a long valuation wave the market is in and also what sort of returns you may expect from stocks or commodities.

This is of interest to me because my investment strategy is value based and long term, i.e. I don't like to buy or sell more than once a year and I expect to be investing until I drop dead.

Currently my knowledge of these waves only scratches the surface but here's the gist:

1. Let's say that currently we have the capacity to provide all the commodities that the world needs. Commodity prices are low because of that and so investing in new capacity is very limited as it isn't profitable and we don't need it.

2. Population grows, standards of living rise, partly because of low commodity prices. This increases demand.

3. Gradually this increase of demand, over a period of years, begins to strain the current capacity to supply the commodities. Miners, farmers and others start to make more money and begin thinking about buying more land to plant crops or dig more mines. However, these things require big injections of capital so the producers don't try to increase capacity straight away, they wait until they are sure that it's worth it, i.e. until commodity prices are high.

4. Producers start to build new mines, farm more fields and pump more oil. However, it can take years to get new mines up and running, and the same goes for oil and food production (although less so for food). During this phase commodity prices are very high and this hurts other sectors of the economy as consumers have less spare money to spend on things other than food and fuel, and the other things also cost more because of raw material costs. The rest of the economy starts to make their use of commodities more efficient or just cut back on their use due to the high costs.

5. Eventually the producers do increase supply. At the same time the consumers are consuming less (or not increasing demand so fast) because of high costs. The producers can now supply enough commodities to consumers and prices drop. Prices keep dropping as people don't want to invest in decreasing assets and also as it becomes obvious that supply exceeds demand.

6. We are now back at stage 1. All of this took 10-20 years to go from stage 1 to stage 5, then there may be another 10-20 years at stage 5 as money flows into other areas of the economy (technology or housing for instance) which very gradually increase demand for commodities again.