Investlogic Strategy Update as of July 1, 2012

Global Growth Outlook Weakens

Financial Review as of July 1, 2012

Little was expected from the EU summit, but quite a lot was actually delivered, although some follow-through will still be required if investors are to retain their newly found appetite for risk.

Analysts have generally argued that the euro’s survival depends on further integration of the eurozone economy, emphasizing the need for a banking union, a fiscal union and a political union. There was clear progress on the first and some on the second. And while there was no direct mention of the third, that becomes much easier once the first two are evolving satisfactorily. There was also a “nod” to growth. The main provisions were:

• A single bank supervisor for euro area (EA) banks headed by the ECB will be established by end 2012.  Following establishment of that single supervisor, the ESM can recapitalize EA banks directly—not via the sovereign—and impose only light conditionality.
• Financial assistance to Spanish banks will come from the EFSF until the ESM is established. Support from the ESM will not enjoy seniority status.
• Support to the Irish banks will be re-examined, presumably with an eye to placing it under the same framework as Spain, and other cases will be treated similarly.
• The leaders re-affirmed that the EFSF/ESM will be used to stabilize markets for member states through primary and secondary bond market purchases, but they did not agree to ECB funding for the ESM.
• The President of the European Council (Herman Van Rompuy) was tasked to develop a timed roadmap to further fiscal integration over the medium term. A first report should be published in October.
• A growth pact was agreed, comprised of more capital for the European Investment Bank, allocation of unused structural funds from the EU budget and project bonds for infrastructure development.

Equities: Everything changed on Friday. Equities traded choppily with a generally offered tone over the first four sessions of the week, then exploded to the upside in the last session. Italy and Spain soared 6.6% and 5.6%, respectively, on the day.

Bonds: The opposite was true for bonds. They traded choppily with a generally bid tone until giving up ground on Friday. Of course, there were a couple of exceptions. Italian and Spanish bonds rallied along with their equities.

Currencies: EUR/USD was offered through Thursday, but rallied over two big figures on Friday. 

Commodities: Gold and oil rallied sharply on Friday as concerns about Europe faded.

Investment Strategy 

The political and financial cost of an incoherent exit of the euro would be simply too high, and for Greece, and for other members of the euro area. If the politicians agree in understanding that they dispose of enough funding to keep Greece within the euro, they are as conscious that these funds wouldn't cover all the economic and political repercussions for the zone, hence the agreement to support it by new non-conventional measures of monetary policy by the European Central Bank and the new born European Stabilization Mecanism. Out of the euro area, it becomes visible that total economic recovery weakens. American growth weakened, but shouldn't slow down as noticed in 2011.

In emerging countries, after a recovery of equity markets since the lows of October, 2011, fed by a renew appetite for the risk of the investors, the rebound of the expected profits should carry the next movement of increase. From this perspective, it is the Chinese economy which remains decisive. The weaker growth of former quarters reflects the deep monetary tightening operated the last year to decelerate the activity of credit - quickly overturned when negative effets on small and medium sized enterprises became visible.

If Chinese economy continues however decelerating, a combination of measures of monetary expansion  and of a recovery stimuli plan including investments in infrastructures would lead to a recovery, supporting other emerging markets.

Equities Markets - include from now on the impact of a slowing or no growth seems to have reached a floor on the short term.. The risk premium is indeed at levels which would correspond to an stagnation of profits. Besides, the perspective of an expected coordinated  action by the central banks to lower  tensions on markets should constitute  a floor for actions, even if the timing of an intervention remains uncertain. In the States we are still in an election year which would also provides some supportive measures. The perspectives of the American economy growth, the robustness of the company profits  and the strength  of the dollar US should give some support to the US stock market. Conditions remain also positive for the emerging markets. 

On the Bond side, Corporate and High Yield always introduces welcome diversification and potential higher returns (see below). However,as long as it remains high uncertainties on the European crisis  and in the timing of a global  economic recovery, we are encouraged to protect us of turbulences by overweighting of German governmental bonds and some long-term US T-Bonds, as well as of course as an large part  gold.

Let's go Corporate 

Specifically, Grant is bearish on one of the very “safest” of safe things: highly rated government bonds. “The times may be troubled (they often are),” he says, “and people may be desperate (someone usually is), but that doesn’t mean that low-yielding sovereign debt is the last word in safety and soundness.”

Grant does not assert that top-tier government bonds are necessarily unsafe, merely that they are undesirable…and potentially unsafe. At current yields, many government bonds offer what Grant has termed, “return-free risk.”

As the nearby chart clearly shows, the yields provided by the marquee AAA government bonds of the US, Germany, Switzerland and the UK have been in a freefall for several years. As recently as four years ago, a 5-year bond from the Swiss government yielded about 3%. Today, the 5-year yield is negative! That’s right; an investor must pay the Swiss government for the privilege of lending it money.

The 5-year yields provided by the other AAA issuers in this chart are at least positive, but just barely. All of them yield less than one percent per year. Longer-term yields from these AAA-rated governments are similarly underwhelming.

Therefore, Grant suggests, rather than buying the 10-year German bund that yields a whopping 1.75%, why not buy the common stock of the German chemical giant, BASF, which is currently yielding about 4.3%?

“By the same token,” Grant continues, “we favor Wal-Mart over the 10-year Treasury, and Nestlé over the 10-year Swiss government note. Wal-Mart, which yields 2.4%, and Nestlé, which fetches 3.5%, have shown the ability to grow and adapt in economies both good and indifferent.”

Clearly, the shares out of BASF, Wal-Mart and Nestlé are not “safe” in the sense of providing a certain, government-guaranteed return. They are safe only in the sense of offering a potential return over time that greatly exceeds that of today’s ultra-low yielding sovereign bonds.

Furthermore, equities deliver returns that derive from real-world commerce, rather than from the increasingly dubious promise of a heavily indebted national treasury.

Emergent Markets: internal demand gives a relay for a more permanent growth

If in 2012 emergent equities overperformed, in some respects, of about 3 % the equities in developed countries, the last published figures mention one flat performance since the beginning of the year versus one light advantage to for the developed markets. However as in 2011, this visible under-performance comes out again mainly from a comparison with the American market. Due to the disappointing performances of the most part of Europe and to the weakness of the Japanese rally, the emerging markets continue nevertheless outperform the developed economies, except the United States, of about 3 %. 

As long as questions will persist if Greece is going  to stay in the euro area, risky assets should continue to underperform. This period of uncertainty should be of relatively short term and it could be wise to reinforce the exposure  on the emerging markets later in year. On the basis of the expected multiples (ratio lesson / benefit), equities stay on the whole attractive, but the  stronger growth in benefits within the emerging markets companies should be translated by the higher performances. 

The dynamics which drives the performance of the emerging markets however evolved. Two major topics focalized attention in the course of last decade: 1) the exports of raw materials towards China, 2) exports of consumer goods towards the developed world. The slowing down of the growth of China should weigh on the overall demand of raw materials from this country. Current debate does not limit itself to determine if China faces up a soft landing of its economy or in harder landing scénario. There remains that China still has  huge needs in infrastructures and even the assumption of a more modest growth rate - between 7 and 7,5 % - guarantees a strong demand for a lot of raw materials, particularly industrial metals. Countries and traditionally profitable firms of Chinese demand are going to continue to profit from it, but probably to a lesser extent.  

The accent should be put from now on more on the internal growth of the emerging markets rather than on the demand of of the developed world consumers, which should remain apathetic during several years. On the other side, many emerging countries achieved a level of development such as their internal demand is becoming a factor more and more contributing to  the growth of their GDP. If many investors are already aware of attraction that the Western luxury products have on these consumers, it concerns only a marginal part of the population. True opportunities will be in the consumer goods of lower range. This potential can be noticed in the over performance in equities of consumption goods sector which was 2,3 times superior to that the broad emerging market index since March, 2009, as well as in the performance of small capitalisations, more exposed to internal demand. The sector MSCI Small Cap advanced of 91 % over 3 years against 61 % for indication Broad Cap.

Imagining an end to the dollar’s reign

What is rarely questioned is why the dollar plays this role in the first place. And when you delve into it, it’s hard to come up with much more than self-fulfilling logic: The greenback enjoys this status because it always has. 

But against the blindingly obvious fact that our global financial system is broken, the empty foundations upon which the dollar sits could equally be brought into question. One day, the dollar’s role as the world’s reserve currency will end. It won’t happen overnight — the dollar is too deeply entrenched in the plumbing of international commerce and investing for that and there simply aren’t viable alternatives — but it will happen. 

Economic historian Barry Eichengreen, arguably the world’s leading expert on international monetary affairs, has argued that the dollar will lose its dominance within 10 years. The world needs to be ready for it.

For now, everyone still wants dollars. The greenback accounts for more than 80% of all foreign-exchange transactions, over half of all international trade invoices and two-thirds of central bank reserves.

In large part, the dollar’s appeal stems from the unrivaled depth and liquidity of America’s capital markets. But on many other levels, the U.S. is no longer the bastion of international financial security that it was. It is closing in on $16 trillion in debt, a figure larger than its GDP; it persistently runs twin fiscal and trade deficits; and its foreign currency reserves are barely enough to cover two weeks of imports. 

Meanwhile, other arguments for the dollar’s appeal such as the reliability of its legal system and respect for property rights are beginning to ring hollow when other countries’ judiciaries are equally trustworthy and when foreign investors harbor bitter memories of a financial crisis for which dysfunction on Wall Street and in Washington was to blame.

In fact, much of the dollar’s appeal simply lies in what is not. The euro has proven to be a disaster and the other oft-mentioned successor — the Chinese yuan — is the currency of an authoritarian regime whose love of capital controls prevents it from being easily traded offshore. Neither will be a viable alternative to the dollar for years, if not decades.

But for the dollar to lose its influence doesn’t require an alternative reserve currency to emerge. China and other big holders of dollars could simply stop building reserves. Or worse, they could repatriate those that they do hold, a prospect that rises the longer the U.S. fails to resolve its future debt problems. Already, China is developing alternative payment mechanisms that will allow a convenient go-around for nations wishing to trade commodities in currencies other than the dollar — Iran, for example, which would appreciate a means of avoiding sanctions. If there were to be a big enough withdrawal from dollar assets and dollar invoicing, the world monetary system could be thrust into the chaotic state of having no single, dominant currency as its anchor.

For now, it seems hard to imagine that the current state of play won’t be so forever. We remain smugly comforted by the notion that China, Japan and U.S. other big creditors wouldn’t want to upset a market in which they are so heavily invested. Yet such complacency is part of the problem. 

Demand for the dollar means that, despite its multiple flaws, the U.S. government can now borrow at a record low of 1.5% for 10 years. That means that the pricing mechanism, the one with which markets normally impose discipline on debtors, isn’t working. The problem is that this state of blissful isolation from market realities can quickly disappear. Just talk to a Greek citizen.

The U.S. is dangerously addicted to the drug of cheap dollars. Meanwhile, other countries increasingly feel vulnerable to the market volatility that comes with America’s sometime reckless use of the dollar’s dominance. The dollar’s global status means that whenever the Federal Reserve turns to the printing presses — as it will likely do again in another futile bid to fight America’s economic malaise — those freshly minted dollars flow into commodity markets and the currencies of emerging markets. That complicates policy-making in those countries, the same ones that happen to be the biggest holders of dollar reserves and thus the ones with the power to demand change.

For more than half a century, the dollar’s reserve status has assured the U.S. of a prodigious flow of cheap financing. It has bankrolled the most powerful military machine in history and facilitated the rich material existence of its people. But the world won’t forever allow it to enjoy what former French President Valerie Giscard D’Estaing described as America’s “exorbitant privilege.”

It behooves U.S. policy makers to start considering a multilateral alternative to the dollar. An International Monetary Fund-sponsored reserve unit is often floated as one idea — one that currently faces various obstacles but that could be resolved through a well-designed treaty.

But at some point they will need to be part of the national discourse. It is far better for the U.S. to plan an orderly exit from dollar dependence than to have the rest of the world force it into a disorderly one.

Elinor Ostrom : La question des « biens communs mondiaux »

Elinor Ostrom, première femme ayant obtenu le prix "Nobel" d'économie en 2009, est morte mardi 12 juin 2012 à 78 ans. Elle était aussi une des rares "Nobel" critiques à l'égard de la théorie néoclassique. Dans la foulée de la déconfiture de Rio+20 il nous a semblé important de rappeler ses travaux.

Les travaux de E. Ostrom sur les  “biens communs mondiaux” dans un courant néo-institutionnaliste opposé à la théorie économique néo-classique qui ont remis en lumière la préoccupation de dessiner un cadre conceptuel capable de fournir des clés politiques pour une gestion de ce qui échappe - ou doit échapper - au marché.

Un texte de Jean-Marie Harribey,  ainsi que  le texte du discours lors de la remise du Nobel par Elinor Ostrom.

Dans sa démarche néo-institutionnaliste, l'intérêt est tout de même de désigner par "communs" des systèmes de règles collectives et non plus seulement les objets sur lesquels portent ces règles, ni dans leurs supposées qualités intrinsèques, ni dans leurs qualités construites par la société.

Mais la faille de la thèse d'Ostrom est de rester prisonnière de la croyance que les systèmes de règles sont le produit de délibérations entre des acteurs à égalité à l'intérieur d'une communauté. Finalement, le dilemme n'est pas surmonté entre, d'un côté, les droits de propriété individuels à la John Locke, qui fait découler l'Etat du libre consentement des individus à parachever le contrat social qu'ils ont noué, et de l'autre, la remise d'une part de liberté pour plus de sécurité entre les mains du Léviathan à la Thomas Hobbes.

Rousseau n'était peut-être pas le moins perspicace d'avoir situé le fondement du politique dans la souveraineté du peuple. D'où la prudence dont nous devrions faire preuve dans l'usage de l'antilibéralisme, car nous ne dirons jamais assez qu'il s'adresse moins à la philosophie politique libérale qu'à la doctrine économique.

Ce qui renvoie au fait que le capitalisme, dont le principe est d'élargir toujours la frontière de la propriété privée, ne doit pas être confondu avec le marché, et aussi au fait qu'un après-capitalisme ne supprimera pas le marché en tant qu'une des formes de coordination, forme bornée collectivement bien sûr. En tant que systèmes de règles, le marché et la planification démocratique pourraient alors être considérés comme des… biens collectifs publics. Mais c'est une autre histoire…

Le bien commun est une construction sociale. Apports et limites d'Elinor Ostrom

Jean-Marie Harribey, économiste, maître de conférences à l'université Montesquieu-Bordeaux IV L'Economie politique n° 049 - janvier 2011

Dans les débats préparatoires au « Sommet de la terre » (Rio, 1992), la polémique Ostrom / Harding devint un « standard » de débat écologique. Les « biens communs mondiaux » (Global Commons) désignent alors : l’atmosphère et la biodiversité. Depuis, ils se sont multipliés. L’éducation, l’eau, Internet et les algorithmes mathématiques ou informatiques, les connaissances médicamenteuses et plus généralement la propriété intellectuelle : partout aujourd’hui le débat fait rage entre « l’enclosure » par la propriété privée ou la gestion communautaire des biens communs. Avec cette difficulté supplémentaire que la « communauté mondiale »… n’existe pas.

Le simple usage de l’expression Global Commons dans les débats préparatoires à Rio évoque directement les « commons », c’est à dire les terrains communaux du Moyen Age, que les paysans riches ont enclos à leur seul profit. Il est indéniable que la révolution agricole, qui exigeait l’amendement des terres à long terme, fut favorisée par la mise à la disposition à long terme des terres entre les mains d’un même exploitant. Mais quid de la défense du climat ? Dans les conférence préparatoires à Rio, la polémique éclata entre entre le World Resources Institute de Washigton et le Center for Science and Environment de New-Delhi.

Le WRI , reconnaissant le péril de la dérive climatique, proposait d’imposer une décroissance uniforme des émissions de gaz à effet de serre à tous les pays. Cela revenait à officialiser d’abord les « droits acquis à polluer » de chaque pays (et les Etats-Unis polluaient cent fois plus, par habitant, que le Bangladesh), pour astreindre ensuite les « propriétaires » à des mesures de prudence. Ce que j’assimilais alors à « l’enclosure des biens communaux globaux». Le CSE, dans un rapport retentissant d’Anil Agarwel et Sunita Nerain, taxa la position du WRI d’ « éco-impérialisme », et proposa à l’inverse un objectif de répartition égalitaire de quota par tête, les pays en excédant d’émission devant indemniser les pays moins polluant dont ils empiétaient sur les « droits ».

Cette proposition est à l’origine de ce qu’allait finalement formuler le Protocole de Kyoto et le système européen d’allocation et de marché des quotas. On voit que ce mode de régulation, qui combine une instance politique distributrice de quotas, et un marché de redistribution ( à total constant) est beaucoup plus proche des systèmes de gestion semi décentralisés des biens communs dont parle Ostrom. Les écologistes ne s’y trompèrent pas, qui attribuèrent le prix Nobel alternatif à Anil Agarwal, tandis que la vieille gauche productiviste ne voyait là que « vente des droits à polluer » et « marchandisation de la Nature ».

Copenhague va d’abord se jouer sur  la distribution de quotas plus ou moins contraignants, les pays étant d’autant plus contraints à la baisse qu’ils dépassent le « soutenable ». Mais il faudra aussi, au nom de la dette écologique (c’est-à-dire des stocks déjà émis), aider les pays les mois développés industriellement, ceux donc qui ont le moins pollué dans le passé, à s’adapter plus rapidement aux contraintes. Bref, inventer une réciprocité écologique globale. Vaste programme.

Bien entendu, toute bonne idée est faite pour être trahie, et nous ne pouvons que lutter pour qu’elle soit récupérée par les institutions de la manière la plus correcte possible. Encore faut-il bien comprendre de quoi on parle.

« Biens commun globaux ». Trois mots dont chacun  suscite  d’immenses débats.

« Biens » (goods) d’abord ! L’éducation (l’accès au bien commun qu’est le savoir) n’est pas perçue  comme un bien  par la plupart des enfants, ni même par leurs parents ouvriers et paysans pauvres. L’école, c’est d’abord un manque à gagner. Il a fallu payer les parents (par des allocations familiales) pour qu’il consentent à envoyer leurs enfant à l’école… Mais le contenu des connaissance lui-même, la plupart des capitalistes comprennent leur nature de biens et essaient donc d’en faire des biens «  exclusifs », par des brevets, ou par une fixation sur un support payant…

À l’inverse, se déplacer le pus vite possible en voiture fut longtemps perçu comme un bien privé, et il est encore difficile de le faire reconnaître comme un des « maux «  publics. Même les télévisons publiques retransmettent les compétitions de Formule 1, le Paris –Dakar, sans avoir conscience de commettre une apologie de crime contre l’Humanité.

On passe justement de la « mesure » au « sens », du nomos au logos, de l’économie à l’écologie, quand on se demande si ce qu’on appelle bien en est vraiment un…

« Commun ». Le caractère « commun » n’est pas inhérent au « bien », mais un caractère social, historiquement daté et modifiable. Je reconnais qu’un bien techniquement non rival et non-exclusif appelle une gestion comme bien commun. Mais les dominants ne manquent pas d’imagination pour rendre exclusif ce qui ne l’est pas a priori, et faire par exemple de la « terre » (ce fragment d’environnement) une propriété privée : en l’enclosant et en la défendant par des barbelés, un fusil, des lois. On croire, selon une vieille illusion de Marx, que la connaissance collective étant aujourd’hui le principal facteur de production, la passage au communisme est dorénavant inéluctable. Ce fut la thèse de l’école hongroise des années 60 (la « révolution scientifique et technique » de Radovan Richta), c’est aujourd’hui un peu la thèse des tenants du « capitalisme cognitif ». Ce qui est sûr, c’est que la bataille pour l’enclosure de la Propriété Intellectuelle est l’un des enjeux majeurs de ce début du XXIe siècle, dont les batailles sur le brevet logiciel, les DRM ou Hadopis ne sont que des escarmouches.

À noter que l’opposition à l’enclosure des biens communs s’exprime souvent sous la bannière de « droits universel à… » (à l’eau, à la connaissance, etc). Ce à quoi le partisans de Harding répondent évidemment que bien sûr, bien sûr, mais que pour sauvegarder et ne pas gaspiller un bien universel il faut d’abord l’enclore…

« Globaux ». On appelle ainsi (en particulier le pénétrant Olivier Godard) les biens qui, de par leur étendue, ne peuvent être géré par les lois d’un pays ou d’une entité politique constituée (telle l’Union européenne). Ne pas croire que de tels biens (typiquement : les mers) soient des res nullius, des choses n’appartenant à personne. Un droit de la mer international existe depuis Aliénor d’Aquitaine ( Rôles d’Oléron, 1160). Des conventions protégeant les bien communs globaux environnementaux se développent rapidement avec les Accords Internationaux sur l’Environnement (pluies acides, espèces en danger, couche d’ozone, climat, biodiversité), entrant souvent en collision avec les règles de l’OMC, mais pouvant se targuer de l’exemple des règles phytosanitaires (quarantaine) qui prévalent sur celles de l’OMC.

La difficulté, c’est qu’un bien a souvent des dimensions à la fois nationales, infranationales (communautaires) et supranationales (globales). D’où les conflits souvent à contre emploi. Ne dites pas à un sud-américain même de gauche, dans une conférence internationale, que l'accès à l'eau est un droit universel, il comprendra que vous contestez la souveraineté de son pays sur l’Amazone. La biodiversité et surtout, les  connaissances traditionnelles sur son utilité ? nous en sommes redevables aux communautés indigènes ou paysanne pauvres. Mais les Etats les considèrent comme du patrimoine national au même titre que les champs pétrolifères, les firmes pharmaceutiques comme un… bien commun mondial, c’est à dire gratuit !  Nous savons que la maintenance d’un bien commun mérite pourtant rémunération. Comment défendre la gratuité des logiciels et refuser la bio-piraterie ? Vaste sujet de colloque...

Annexe : BEYOND MARKETS AND STATES: POLYCENTRIC GOVERNANCE OF COMPLEX ECONOMIC SYSTEMS Prize Lecture, December 8, 2009 by ELINOR OSTROM

What the heck is happening with oil prices?

How low can oil prices go? 

West Texas Intermediate (WTI) oil is selling in the $80 ranger per barrel — way down from recent postings near $110. Overseas, the Brent price for oil is about $97 per barrel — way down from $125 per barrel as recently as early May.

What’s going on? How low can oil prices go? Are we looking at the beginning of a major price slide? Is the oil and oil service investment space under a pricing assault?

I doubt it. Here’s why: 40% of global oil production comes from places where the national governments cannot afford oil prices to go much lower than they are currently.

The nearby chart tells the tale.

This chart, courtesy of Pierre Sigonney, chief economist of the French oil giant Total SA, describes the oil price level that a series of major producers require in order to balance their national budgets. The red-shaded region at the bottom is the “breakeven cost” for producers (as estimated by Total). That is, the red shading reflects how much it costs to lift barrels of crude oil out of the ground.

As you can see from the chart, many producers lift oil at an overall cost of $10-20 per barrel. Even the major international players (the red bar on the far right) are in the $40 per barrel average for production.

But take a look at that yellow “budget break-even” line. That’s the price at which the major petro-players have to sell oil in order to fund their national spending. Keep in mind that all of the countries on the list — from Qatar to Venezuela — rely on oil sales for the vast majority of their national income.

Specifically, Libya, Saudi Arabia, Algeria, Iraq, Angola, Nigeria, Ecuador, Iran, Russia and Venezuela all require oil prices of at least $80-100 (or more) just to have sufficient income to run their national budgets. Without a strong oil price, these countries will have bread lines and riots. West Texas Intermediate at $82 a barrel and Brent hovering under $100 is the threshold of pain for the world’s largest oil-producing nations.

Now consider that the 10 countries I just named account for about 35 million barrels of global oil output every day — over 40% of total world crude oil output. (Add in natural gas and gas liquids, and it’s even more.) That’s 40% of world crude output coming from places where the national governments cannot tolerate a price drop for long. So no… the oil price shouldn’t go down much from here.

Still, let’s do some devil’s advocacy and think it all through. The European economy is on the ropes. Chinese economic activity is decelerating. Japan is in a bizarre, permanent recession. The US economy appears to be stalling, and is possibly slipping back into Recession II.

So yes… there are problems all over the place. We could see precipitous drops in energy demand from many quarters. But if oil prices fall too far, they probably won’t stay down for long. The world’s largest oil producers cannot afford it, in any sense of the word.

Indeed, an oil price drop will present another re-entry opportunity for investors to pick up more shares of great oil production and/or oil service companies at a relative bargain. Keep in mind that a pullback in share price could also make the dividend yield even more attractive for many oil players.

Between now and the end of the year, I expect to see oil prices firm up gradually, perhaps even violently. We could also see another sharp, upward spike based on all manner of political and technical events.

The consulting firm KPMG recently predicted that oil prices will remain volatile for the rest of the year. There’s a chance we could see over $140 per barrel, according to a wide-ranging poll of energy executives by KPMG. The underlying issues are economic uncertainty, geopolitical risk, rising operational costs and regulatory concerns.

Libya is back online, for example. But according to what I’ve been told, the wartime damage from earlier this year was not properly repaired. Thus Libyan production facilities, pipelines, pumps, etc., are more jury-rigged than not. We could see a sudden drop in Libyan output based on mechanical and engineering issues. And Libya is just one of the ten countries on that chart above.

There is plenty of risk of supply disruptions from the other nine as well.

Buy the dips!

By Byron King

Russian Siberia Update

Approaching point of no return

Russian business monitor RBC daily, the Petersburgskaya Politika Foundation and the Russian Academy of National Economy have prepared a new ranking of innovation activity in Russia’s regions.

It covers the months of spring and shows the Novosibirsk region as ranked number one. The region was number three in the previous ranking in late winter. Experts consider its innovation activity “balanced” and pay special attention to the region’s plans to create a Siberian analog of Skolkovo. The runner-up is Moscow, a region never mentioned among the top regions over the past 18 months. The rankers attribute Moscow’s second place to the “vast reorganization of its industrial sector.” The Krasnoyarsk region is number three now (it led the winter ranking). TheTomsk region, number four, is now on a Top-25 list of international innovation centers. Number five is the Kaluga region with its growing pharma innovation cluster.

Overall, the experts feel there’s a certain slowdown in the regions that have always been considered Russia’s innovation drivers, attributing this to a reshuffle in leadership following the presidential election, and to somewhat unclear government policies as regards modernization.

And it’s no wonder we once again have three Siberian regions highlighted here. I feel there’s long-term, very strong development for Siberia as a regional innovation cluster.

I believe the culture in Siberia is different from the culture in St. Petersburg or Moscow, or the Urals. The Siberians are very independent-minded; their culture is very exploratory and creative. Different leaders in the region are coming to these conclusions that their population and their regional competitive advantages leave them to promote themselves as innovation clusters, and therefore the process will continue.

There’ll be continued development in Novosibirsk, Krasnoyarsk and Tomsk. I think this competition between the regions will stimulate independent development regardless of what Moscow initiatives are or what Moscow support comes. 

Innovation is the necessary next step

Today, just months after the presidential election, government policies as regards modernization may still be unclear. I think that over the course of this year the administration will probably change a few faces and policies. My personal opinion is that these changes will inevitably, in the long run, accelerate the drive toward innovation.

This society cannot operate as a commodity economy indefinitely. As a macroeconomist I can say that the general commodity cycle of the past ten years is coming to a close and the generally high prices of commodities will probably begin to fall.

China, the largest commodity prices driver over the past 25 years, cannot sustain its eight-to-ten percent growth rate and in the next 20 years China’s economy will consume fewer commodities. The European Union is at a point of stagnation and cannot be expected to grow more than one or two percent per annum. The US economy is at a point of potentially growing at a two-to-three percent rate, but it’s not clear if it’s going to achieve that or not; it depends politically on what happens with the election in November. But generally, the prognosis is that the commodity-driven economies will suffer over the next 20 years.

Russia, in my opinion, has no choice but to diversify its economy and modernize as rapidly as possible. One of the key steps to be taken over the next two years should be to incentivize medium and large-scale Russian companies to invest in themselves. This will subsequently create a greater-scale market for innovation inside of Russia. If more Russian companies buy Russian innovation and prove to the rest of the world that Russian technologies can save money and improve efficiency, it will lower the risk for foreigners to buy those technologies.

Another step is restructuring the Russian tax policies to encourage angel-level investors to take risks investing in early-stage technology projects to bring them from the innovation laboratory into commercialization and into markets. At Investlogic we plan to be part of it !

Outsourcing to Russia: Nizhny Novgorod

As an example of development and outsourcing destinations in Eastern Europe we looked at Nizny Novgorod, a town with a well-established software development industry.
Russia’s IT industry is typically dominated by its two largest and economically strongest cities, Moscow and Saint Petersburg. Nonetheless, the slightly smaller city of Nizhny Novgorod does not fall behind and has currently established itself as one of the major centers in the Russian software development sector. With a population of 1,250,615 Nizhny Novgorod is currently among the leaders in quantity of software application developers.

One of the most prominent players in Nizhny Novgorod’s IT market is Intel, who has been present on the local market for a significant period of time. Intel has two main departments in Nizhny Novgorod – a software development center, employing over 500 software engineers, and a data center. Nizhny Novgorod also attracts a number of nearshore outsourcing companies, such as MERA Networks, Teleca, Luximax and Tecom, among many others.

In terms of training and education, Nizhny Novgorod has 25 scientific R&D institutions, focusing on telecommunications, radio technology and theoretical and applied physics. Situated in the city are also 33 educational centers. Among the ones that provide the most focused training for working in the IT sector are Nizhny Novgorod State University, Nizhny Novgorod Technical University and Nizhny Novgorod Institute of Information Technology.

The latter used to be a former MERA Networks training centre, which reflects the close cooperation between local educational institutions and employers of software developers. Nizhny Novgorod Institute of Information Technology provides courses in IT, software development, system administration, telecommunications, Internet services and IT management.

MERA Networks is one of the biggest Eastern European outsourcing services providers. The company has been on the Russian market for 20 years and currently employs about 1200 software engineers. Its customers include some of the world’s leading telecommunications equipment manufacturers and IT software solutions providers, such as Ericsson and Tiesto.

Another large multinational company operating in the field of outsourcing services for the mobile communications industry is Teleca. The company was established in 1991, under the name Telma. In 2006, Telma Soft was bought by the Swedish Teleca AB. Its Russian branch is currently the leading one in number of employees and completed projects. Teleca works primarily with mobile phone applications and one of its biggest customers is Motorola, for whom they’ve completed over 400 projects.

IT salaries in Nizhniy Novgorod are almost a half of that in Moscow. For example, according to Superjob.ru research conducted last summer, the salary of a Java specialist with at least two years of experience is $1800 net per month. A monthly net salary of a more experienced software developer with solid knowledge of Java may reach $2600 per month.

Nizhny Novgorod is a rapidly developing economic centre. Another one of its attractive features for investments is the fact that it has been selected as one of the four sites in Russia, for building an IT-oriented technological park, which would offer a competitive tax and customs policy. Nizhny Novgorod is also easy to reach from Russia’s capital Moscow. Apart from direct roads, there is also an express railway service, which connects the two cities in 5 hours. Nizhny Novgorod’s airport, Strigino, links the city to major Russian cities. German Lufthansa operates flights from Nizhny Novgorod, connecting the city to Frankfurt and other major German cities.

Scouting Emerging Markets : Mongolia

Diesel, Dust And Dreams : The Triple D New Frontier Markets 

Things do not seem very joyful on many fronts: crisis of the European Union, budgetary and monetary madness in the United States and problems of debt which threaten Japan - to name only three. For many investors who concentrate only on these markets, the morning waking must be difficult. But the world changes. The dominance of Western markets (including Japan) is no more what it was. They are losing  of their importance as the time passes and as the rest of the world catches them.

Scouting Opportunities : Which countries ?

Most people, when they think about investing in emerging markets or when they think about markets outside of the U.S. at all, they probably think first of the so called BRICS – Brazil, Russia, India and China. 

We would say that most of the more remarkable markets we have identified were not in that category. 

In South America we would prefer Columbia, looking how developed and safe that had become. As someone who had grown up in the ’80s, back then Medellin was Pablo Escobar’s hometown, and now you can go there and it’s a perfectly safe place, and again fairly developed. As we favor Chile and Peru over Brazil that is much less appealing. Brazil is a market that I think a lot of investors generally have a favorable opinion of as a place that will bloom and continue to bloom, but a lot of investors don’t appreciate how difficult it is to do business in Brazil. 

You can look at the “ease of doing business” rankings compiled by the World Bank every year, and Brazil scores very low. It’s easier to do business in Rwanda or Pakistan according to those rankings. That’s not to say that, over the long haul, there won’t be interesting ideas from there, but that was one market that surprised me because it wasn’t what I expected it to be, in a bad way.

We are positive on Cambodia  over India, and prefer Mongolia over China. Exploring these different markets, you find some markets that are not so much in the limelight that are appealing. Another market that I really like now is Mongolia, which is a market that certainly is on no one’s radar, but is really coming on fast and growing 50% this year.  

Below is the story of our HK partner's trip to Mongolia :
by Isaac Schwartz

Mongolia : Diesel, Dust And Dreams

Ah, I love the smell of a bull market in the morning. It’s that mix of diesel, dust and dreams that gets you going!

I’ve spent nine days in Ulaanbaatar, Mongolia. I’ve met with three of the four largest banks here, the largest beverage company, the largest cement company, the largest broker, three different real estate companies, a really hairy coal company, several investors and even a former member of parliament. I’ve got a stack of meeting notes and reports. My challenge is to digest this pile and make some sense of it all.

I haven’t spent all of my time in UB. Last Sunday, Harris Kupperman (CEO of Mongolia Growth Group), a couple of other investors and I went out to the countryside. About 40 miles from UB is a national park called Terelj. It sits at the southwestern end of the Henti Mountain range, which run northwest into Russia. These are old, weathered mountains and the homeland of Chinggis Khaan.

My focus has been on the city of UB because that’s where all the money pools. But the Mongolian countryside is really beautiful and worth seeing. I have lots of pictures, but none seem to really do it justice. There are stunning rock formations, expansive grasslands, picturesque streams, gentle hills and forests of larch and pine — all under a big blue sky full of white fluffy clouds. We also ran into grazing herds of yak and horses.

Of course, the source of all the new wealth in Mongolia comes not from what’s in UB but what lies under the ground in Mongolia’s open spaces. Mining is the big engine driving the economy today. But the country also has a rich supply of livestock. There are some 32 million livestock animals in Mongolia; about half of them are goats for making cashmere wool.

Mongolia is the world’s second-largest producer of cashmere wool, after China, making up about 28% of the world’s supply. It’s an important business for the million or so people (about 36% of the population) that still live the nomadic life. Cashmere sales brought in $180 million last year.

Mongolia’s livestock is also an important producer of dairy products and meat. Because the growing season is so short — only about 100 days — animal husbandry produces 80% of Mongolia’s agricultural output.

While mining gets all of the attention, there are opportunities in agriculture. Mongolians drink a lot of milk, for instance, but most of it is imported and comes from a powder, incredibly enough. So an opportunity exists to produce fresh milk, and there are companies here investing in milk production.

Anyway, we stopped off to meet with a family that still lives the nomadic lifestyle. Here is a picture of their ger, note the satellite dish and solar panels.

The ger was surprisingly open and airy inside. We sat on a bed, and the lady of the ger prepared us a lunch starting with fried bread and milk tea. Then she cooked a mixture of noodles, potatoes and bits of beef in a pot over a wood fire. It was starchy, greasy and very filling. It was also, frankly, a bit bland. I was looking for some hot sauce.

So Mongolian food is not my thing, but I enjoyed spending the day in the countryside. If I had more time, I would’ve liked to check out one of the secondary cities, like Dalanzadgad in the south near the Gobi and the prime staging city for the great Oyu Tolgoi mine, or wander north into the Hovsgol region, said to be the most beautiful in Mongolia.

I enjoyed the company of my fellow investors as well, as we tried to sort out the opportunities not only in Mongolia, but the world. For what it’s worth, Myanmar was another market that kept coming up in conversation as the next frontier. I think Myanmar will be the big story of Southeast Asia for the next decade.

Harris is a like-minded global traveler and an investor with a keen nose for opportunity. He’s recently been to Kazakhstan, which is often seen as a kind of road map for what could happen in Mongolia in terms of enjoying a similar jump in wealth. He’s also explored parts of eastern and southern Africa. One of his favorites is Namibia. It is, like Mongolia, a country with a small population about to experience a rapid and massive influx of cash (in this case, from offshore oil).

It felt a little surreal to be sitting in Mongolia talking about Namibia, but these kinds of odd connections happen frequently when I travel in the far-flung corners of the world, and Mongolia was no exception. Yesterday, I met with a Mexican who studied for an MBA in Japan and is now running businesses in UB and in Myanmar.

There is opportunity everywhere really, if only you look.