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May 14 —  Monday

We have spent the last several months revising our SMU energy law and finance textbooks so have neglected to consistently update our blog. LSGI investors have and will continue to receive our monthly updates in the LSGI Report which sets out important trends and changes to our portfolio.


January 30 — Monday: Natural Gas Glut; China’s Demand for Energy Resources

The Financial Times published several charts on the US natural gas sector that supports our comments on the industry made last week in our interview with FSN (link below). The charts speak for themselves:


As we noted in our interview we would avoid companies in the natural gas sector short term. Long term investors might have an interesting opportunty to establish positions in these firms later this summer or fall – with gas storage well above average and production continuing to ramp upward natural gas prices may remain very weak.


Frank Holmes of US Global Investors posted another excellent analysis on the rocketing demand for energy and commodity resources from China. He notes:

Increasing Reliance on Energy Imports
China’s rapid growth and increasing reliance on other countries for key resources has made a powerful case for commodities over the past several years. These three charts from BCA Research illustrate that once the country shifted from exporting to importing a commodity, there was no looking back.


Description: The 'China Effect' on Commodities


You can see in all three how dramatically the energy balance has shifted to an ever-increasing dependence on imports. In each major commodity, after China began importing, growth took off.


China became a net importer of crude oil in 1994, and today, is the second-largest oil importer in the world. BCA forecasts the country is expected to surpass the U.S. as the largest oil importer in only a few years. . . .


Even with these imports, energy consumption is only a fraction of developed countries. The China story is just getting started: Urbanizatin just surpassed the 50-percent mark, hitting what I believe to be the pivotal moment that dramatically shifts buying patterns, driving an enormous demand for housing, consumer staples and durable goods. You ain’t seen nothing yet!


We agree with his assessment on the impact of China and developing economies on the energy and commodity markets. Long term this is a very positive trend for investors in crude oil producers. 


January 27 — Friday: FSN Interview: Natural Gas Glut; The Zurich Axioms Book Review

We were interviewed by Jim Puplava and the FSN network yesterday on the natural gas sector. The short interview can be accessed at the January 26th tab: FSN Interview     We also published a review of the Zurich Axioms: A Study of Risk Management at the FSN site: Zurich Axioms


January 20 — Friday: Equity Ownership & IQ; Investors Flee Stocks; Correlations Remain High—M&A Boom Ahead?

Next Monday, January 23, the EU's foreign ministers are expected to officially approve an embargo on Iranian oil after agreeing in principle to the move earlier this month. They'll likely agree to enforce the import ban from July, in order to give countries time to make alternate import arrangements. Iran says they will close the Strait of Hormuz if the embargo passes. Stay tuned. Concerns about global oil prices are about to get ratcheted up another notch.


And Saudi Arabia said earlier this week it wanted to keep crude oil prices at around $100 (U.S.) a barrel, the first time the kingdom has targeted a “triple-digit” price and a quarter above the previous ambition of $75 suggested by King Abdullah in November 2008. The higher price is needed to fund social programs adopted after the recent “Arab Spring” events.


Equity Ownership and IQ. Bloomberg reports on a recent study that indicates “the smarter you are, the more stock you probably own”. Researchers claim that using historical data they found a direct link between IQ and equity market participation. Bloomberg continues:


Intelligence, as measured by tests given to 158,044 Finnish soldiers over 19 years, outweighed income in determining whether someone owns shares and how many companies he invests in. Among draftees scoring highest on the exams, the rate of ownership later in life was 21 percentage points above those who tested lowest, researchers found. The study, published in last month’s Journal of Finance, ignored bonds and other investments.


Economists have debated for decades what they call the participation puzzle, trying to explain why more people don’t take advantage of the higher returns stocks have historically paid on savings. As few as 51 percent of American households own them, a 2009 study by the Federal Reserve found. Individual investors have pulled record cash out of U.S. equity mutual funds in the last five years as shares suffered the worst bear market since the 1930s.


“It’s what we see anecdotally: higher-IQ investors tend to be more willing to commit financial resources, to put skin in the game,” said Jason Hsu, chief investment officer of Newport Beach, California-based Research Affiliates LLC. About $85 billion is managed using his firm’s strategies. “You can generalize a whole literature on this. It seems to suggest that whatever attributes are driving people to not participate in the stock market are related to the cost of processing financial information.” . . .


             ‘So Strong’


While intelligence influenced things that might naturally increase equity ownership such as wealth and income, the authors said IQ determined who owned the most stocks within those categories as well. Among the 10 percent of individuals with the highest salary, “IQ significantly predicts participation” in the stock market, they wrote. For example, people in the highest-income ranking who scored lowest on the test had a rate of equity market participation that was 15.7 percentage points lower than those with the highest IQ. . . .

American economist Harry Markowitz won a Nobel Prize in 1990 for his theory that owning a larger variety of assets tended to maximize returns for a certain amount of risk. The 2009 study by the Fed found that 51.1 percent of American families own stocks directly or indirectly, and of those who do, 36 percent have shares in one company.


             ‘Difficult to Justify’


“It’s difficult to justify why someone wouldn’t invest in the stock market, knowing what a good deal it has been,” said Linnainmaa, a co-author of the study from the University of Chicago’s Booth School of Business. “The classical explanations for non-participation have been participation costs. It’s not just that it may be expensive to buy stocks and mutual funds, but people may not have enough knowledge about them.” . . .


             Social Policy


The study’s authors said the findings have implications for social policy. Avoiding stock investments cuts returns and may widen income gaps, they said. Individuals scoring lowest on the tests who still owned equities earned as much as 33 basis points, or 0.33 percentage point, a year less than the highest scorers. One way governments could promote better savings might be with plans that let people opt out of stocks, like 401(k) plans, as opposed to opting in, said Keloharju.


If you look at these people over time, people with higher IQ scores and stocks become wealthier and wealthier at a much faster rate than people with lower IQ scores,” said Linnainmaa. “It makes them worse off in the long run, even more so than the difference in income.”


Bottom line is that the equity markets over time have generated substantial excess returns for investors, which in part has driven income disparity. The study also points out the need for investor education on the role equity markets should play in an individual’s asset management strategy.


Investors Flee Stock Funds. USA Today reports that individual investors redeemed more than $400 billion from stock funds the past four years, which has slashed the assets of some funds in half. Instead of stocks investors have been pouring money into bond funds. And due to global uncertainties investors put nearly eight times as much money into bank accounts as they put into bond funds last year.


Like many markets the price of stocks are driven in part by demand. Due to buybacks and retirements Bloomberg reports there has actually been a shrinkage in equities over the last year, but the demand fall-off has insured that equity markets didn’t have the ‘fuel’ to propel them upward. U.S. companies repurchased $397 billion of stock last year, while they issued $169 billion of new equity, data compiled by Birinyi Associates Inc. indicated.


On this topic Dennis Gartman of the Gartman Letter predicted a 25% gain in the stock markets this year, a ‘melt up’ driven by liquidity and the massive amounts of assets in cash equivalent and bond funds earning very meager returns. Don Hays of Hays analytics also sees a similar rise in the market.


USA Today notes that the equity fund outflows are in part due to demographics, in part due to the substantial drop in real estate wealth and the slow growing economy, and in part due to the desire of investors to have a stable, non-volatile, asset on which they can rely.


Correlations remain at record levels.  The Wall Street Journal reports that equity correlations have been rising sharply over the last few years, with individual stocks moving with the major indexes in a much closer relationship than they have historically. The article discusses a recent study by BCA Research which examines the causes of this high level of correlation.  


The chart, courtesy of BCA, is telling:


With the high degree of correlation it appears some stocks are moving with the market and are becoming mis-priced due to the fact they are much more attractive businesses than your average company. As we progress into 2012 we expect more merger and acquisition activity as firms realize the value, and the ability to add growth at a reasonable price, in a slow growth economy. In this environment we expect to see a takeover boom in the energy sector as assets are valued at levels rarely seen.


January 9 — Monday: Ag Sector Attractive in 2012; LSGI Portfolio Holding Art’s Way Manuf. (ARTW) Best Investment Idea for 2012

Agriculture will be one of the major sector themes of the LSGI Portfolio in 2012. A number of very positive long term global trends are in place in the sector, not the least of which is the fact that farm incomes in the U.S. have rocketed to record levels – great for firms that sell agricultural related products or services.


The U.S.D.A. forecasts U.S. farmers’ net income rose to $100.9 billion in 2011, up nearly 30 percent from 2010, reaffirming the bright spot agriculture represents in an otherwise gloomy global economy. This would be the first time ever that net farm income was above $100 billion. Farm income is expected to continue to grow in 2012. Recent presentations by some of the larger companies in the sector, and USDA reports, paint a very positive picture of current and future trends


The Creighton University Mainstreet economic report indicates that the farm equipment sales index continues to rocket upward. December’s index reading was one of the most bullish in years. The Creighton farm equipment sales index has indicated the sector has grown for 22 straight months (index readings over 50 indicate sales are expanding). A chart of the data illustrates the expansionary mode for the sector:


As noted above the U.S. farm economy has been very strong, with cash receipts and farm balance sheets pointing to a very healthy business environment:


(Charts courtesy John Deere & Co.). Farm income and capital expenditures have correlated very closely historically – and with record farm income we would expect robust capital expenditures in 2012:

(chart courtesy of Agco). Meanwhile the global grain inventory stocks-to-use ratio has declined substantially, to levels rarely seen in the last 25 years:

With inventories so low a weather related shock anywhere in the world could cause food prices to rocket upward. Increased global demand have already pushed prices for many agricultural products to levels well over historical norms – increasing farm profitability and a major reason farm income is at record levels:

(Charts courtesy Potash Co.)


SMU Dedman School of Law

Joseph Dancy, Adj. Professor

Energy & Environmental Law

SMU School of Law


Guest Lecturer & Board Member, Michigan Tech Applied Portfolio Management Program (APMP)

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