Dear Partners and Friends,
The economy remains fundamentally strong in the first quarter of 2018, but the public markets have gotten a lot more exciting since we last wrote. With the recent volatility and uncertainty associated with stocks and bonds on the forefront of most investors’ minds, it is an ideal time to reflect on Branzan’s niche and how it distinguishes itself from most other investment firms.
Our risk profile is relatively conservative. Branzan’s focus on illiquid assets and current income has resulted in low volatility during both economic expansions and contractions, and low correlation to other markets. In the inflationary environment we are likely now entering, participating in the ownership of real assets through private investments should help preserve wealth.
The Stock and Bond Markets
While we have long believed that prices of publicly-traded equities and debt were unreasonably high and would revert to the mean some day, we cannot account for the recent volatility in the markets and hope it does not continue. Volatility on this scale is destructive not only to investors’ accounts, but to the very important role of public markets in capitalism.
Having said that, we are no more optimistic about the values of publicly-traded stocks and bonds than we were when we last wrote. In the last couple of weeks, we have learned that our skepticism about several investment vehicles—ETF’s, the VIX and other volatility indices, cryptocurrencies, and the like—was borne out when they failed to perform as the market expected. Instead, they performed exactly as we expected, with substantial losses—some even blew up. We come back to fundamental analysis of mostly-overlooked assets as a safer route to retaining and growing one’s wealth. This InvestTech Research chart shows how past bear markets have sometimes entirely “repossessed” bull market gains.
If the next bear market repossesses all of the gains from the current bull, the S&P 500 and the Dow Jones would revert to their March 2009 lows of 676.53 and 9,093.24, respectively.
The Energy Market
Our views of the market for oil do not reflect those of the Energy Information Agency (EIA), the U.S. government agency responsible for reporting and predicting the demand for and the supply of oil. We find the reporting and predictions of the EIA, at best, unreliable. The EIA has chronically under-reported demand in eight of the last nine years and has had to revise their figures upward by substantial amounts.
We remain bullish on the fundamentals of oil as an investment. We believe the current supply of shale oil in the U.S. is temporary for several reasons. While conventional wells might produce for decades (one of us owns an interest in a producing well in Oklahoma that was drilled in 1950 and still produces), horizontal wells decline precipitously in the first year or two. This means a continuous stream of new horizontal wells is required to maintain current production. It is becoming increasingly apparent that the sweet spots in the Bakken and Eagle Ford have already been drilled, leaving only the Permian to take up the slack. A number of the shale wells completed in 2017, particularly in the Bakken, were drilled in earlier years and left uncompleted, waiting for higher prices. That increase in supply will not be repeated. We conclude that shale production in the U.S. will not be sustained as long as most believe.
On the demand side, there are convincing arguments that the urbanization of India will follow the paths of China and South Korea. More highways will be built (India has about 1100 miles of paved highways today), mopeds and small automobiles will replace vehicles powered by humans and animals, and more Indians will move from the country to the city (city dwellers use more energy than rural folks). So far, India’s top-heavy, bureaucratic democracy has moved slower than China’s command economy to encourage modernization. We believe oil will continue to be more in demand than natural gas in the foreseeable future because gas is relatively plentiful.
One point that bears repeating–Branzan employees and their families are the largest investors in all of our Funds. Every investment decision affects us personally and proportionately with our investors. We think that affects how we consider the risk factors of prospective investments and distinguishes us from most other investment managers.