Branzan Advisors Commentary | September, 2020
September 21, 2020
It’s instructive, and often humbling, to contrast our earlier thoughts with reality. This was the final paragraph to our February missive to you.
For most asset classes (especially large-cap U.S. equities), 2020 started off as 2019 left off. However, after a strong start to the year, volatility and risk are back. We are seeing significant daily moves in the equity markets due to concerns over the impact of the coronavirus on the global economy. Gold is hitting seven-year highs and the 10-year U.S. Treasury bond yield is at its lowest level since 2016. Oil has been hammered as investors become concerned about global growth. In general, investors are fleeing riskier assets. We are optimistic that the coronavirus epidemic will slow over the next couple months, but in the meantime it could be a rough road. We will continue to strive to be good stewards of your capital.
We did not anticipate the magnitude of the crash in equity prices, nor the rapid recovery from March lows. Our reputation in epidemiology circles suffered when the coronavirus did not slow as we hoped.
It has been a rough road. We believe it will continue to be rough for many months to come. Yelp reported last week that 60% of businesses closed during the pandemic will remain closed for good. About 6 million jobs were lost in the financial crisis of 2007-08 and it took five years to recover them; this year 11 million jobs were lost. Carmen Rinehart, co-author of This Time is Different and chief economist of the World Bank, last week suggested that a global economic recovery will take at least five years. Talk of a V-shaped recovery is no longer heard.
The virus was a catalyst, not a cause. It exposed a financial system that was over-extended and living on borrowed time: too much government debt and too much corporate debt; a Federal Reserve that was out of ammunition, having expended it to fight the crash that began in 2007 and failing to stock up when the economy recovered; corporate malfeasance in the form of stock repurchases financed by debt and, in several cases, financial fraud; and, of course, the tremendous cost of the longest foreign wars in our nation’s history.
If that weren’t enough, the House of Representatives impeached the President, political rhetoric and tempers flared, riots ensued and racial tensions reached a high not seen since the Rodney King riots.
The political response to the pandemic and its effects has, in many cases, been inept. The Treasury has fought the crash with more debt and Modern Monetary Theory is now discussed seriously. The U.S. dollar, the world’s reserve currency, is vulnerable to further devaluation.
We don’t have a crystal ball, but we think prudent, conservative investments are in order. We always have.
Precious metals, primarily gold and silver, are doing well. As we frequently say, gold and silver are our insurance policy against monetary foolishness and monetary foolishness is almost always in season.
The prices of oil and natural gas assets, mostly in the form of producing or prospective mineral rights, have suffered as a result of a decline in demand due to the economic slowdown, climate change fears and political rhetoric. We believe the threat of oil and natural gas being displaced by electricity is illusory. Electricity, after all, is a product of electric generation in most cases by coal, natural gas, nuclear or hydroelectric. Hydroelectric is constrained by geography and solar and wind are constrained by the daily rotation of the earth and weather. As California and Germany are now being reminded, solar and wind are not base-load sources of electricity. All of us, with the exception of emerging markets struggling to modernize, agree that coal is not a desirable generator of electricity. Until there is widespread acceptance that nuclear is the safest of all fuels, oil and natural gas remain the only practical alternatives.
We continue to find opportunities to buy mineral rights at attractive prices. At the same time, we’re always interested in acquiring alternative energy assets, but only those few that make economic sense. At various times, we’ve had hydroelectric, geothermal, wind and solar projects in the portfolios. We’ve owned uranium companies in the expectation that China’s new nuclear plants will supplant some coal-fired electric plants. Currently, we’re looking at a geothermal project that uses depleted oil and gas wells to eliminate the very substantial cost of drilling and completing new wells. It’s an old idea that may have new life.
BP, formerly British Petroleum, last week forecast a permanent drop in demand for oil and natural gas. Following its Deepwater Horizon disaster in the Gulf of Mexico in 2010, BP has accelerated its investment in “green” energy and has adopted the nickname of “Beyond Petroleum”. In the investment world, its forecast of a permanent drop in demand is called “talking one’s book”. The world is in a recession or worse and travel has largely stopped—of course, demand has dropped, but there’s no reason to think demand won’t return as the world’s economies recover.
We still like modestly-levered real estate investments in selected locations. Most of our current real estate is holding up well. On the whole, multi-family projects continue to perform well despite softness in the employment sector. We have strong tenants in most of our commercial office buildings and those tenants have continued to pay their lease payments. While the future of office space is unpredictable, we are fortunate to have tenants with long-term leases in place. We are assessing our existing hotel investments to try to determine how much additional capital they may need, if any. Much of that depends on how quickly travel rebounds. Fortunately our hotel investments are conservatively capitalized which should allow them to weather the storm. We are seeing some new opportunities in the hospitality sector, but are proceeding cautiously as we don’t see a return in business travel and conventions any time soon.
Finally, we believe equities, after the impressive bounce from March lows, remain overpriced by most objective standards, especially the tech stocks which now dominate most indices. Here’s the most recent edition of a favorite chart—the ratio of commodity prices to the S&P 500, adjusted this time to reduce the significance of oil in both measures. The line hit an all-time low in August.
The commodities/equities cycle are long, only three such extremes in the last 50 years. We believe this is a time to emphasize real assets—commodities, real estate and the like--over financial assets.
Very truly yours,
Branzan Investment Advisors, Inc.
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