Portfolio Construction - Part 9

We’ve looked at some of the more obvious headline problems facing the global economy. A great piece by Joanne Baynham recently picked up on research by Gavekal highlighting the global economic dangers of rising food prices because of the need to produce ethanol as an energy source alongside the advent of higher inflation within Asia. This could have wide implications on the global economy if rising inflation leads to Asian central banks curtailing liquidity and leading to higher real interest rates.
Real interest rates all around the world remain very low which Gavekal believes is partly due to the constant manipulation of their exchange rates by Asian central banks. In preventing their currencies from finding a “fair value”, Asian central banks are forced to buy government bonds around the world. Moreover, the undervaluation of Asian currencies encourages the private sector outside of the US to borrow US$ willy-nilly (hereby contributing to the current ample liquidity environment). Milton Friedman once said that, “You can control your exchange rate, you can control your money supply, and you can control your interest rates. But you can’t control all three at the same time.”
In Asia, policymakers have been very happy to control exchange rates and interest rates, and let money supply growth rip. While there has been no inflation, there was no need for any marked change in Asian monetary policies. However, as we have seen recently, Asia’s bigger players are all becoming increasingly concerned about inflation. Asian policymakers are changing their focus and starting to move to control money supply growth. This will most likely mean higher exchange rates - look at the recent moves in the Thai Baht - probably the currency which at this time is subject to the least commercial or government intervention and therefore is a reasonable bellwether for Asian currencies. In Asia, a significant percentage of consumer spending is still based on “surviving” (a fact which, incidentally, might explain the highest differences in savings rates … poor people need to save, while the rich don’t, as they have the option of curtailing their lifestyles).
This means that Asian policymakers simply cannot afford to take the risk of inflation. Inflation would prove too devastating for the median family’s lifestyle and could thus trigger political instability (note that one big factor behind the Tian An Men demonstration was that inflation in China at the time was running in the double digits). Which brings us to the recent rise in food prices; while rising food prices do not have massive importance in OECD countries (where the median family tends to spend less than 10% of its income on food), in countries such as China (where the median urban family spends around 30% of its income on food), rising food prices should have an immediate impact on disposable income.
With its strong support of ethanol, the US administration decided to intervene in the markets. Unfortunately, this intervention could end up suffering from the law of unintended consequences. Indeed, if higher food prices start pushing inflation rates higher around Asia, then it is hard to believe that Asian policymakers will not step in. For the West, a change in monetary policy in Asia could be a triple whammy. It would mean that:
* Asia would export less capital into western (mainly US) bond markets. This would likely push real rates higher around the world.
* Asian exchange rates would move sharply higher, which in turn would likely mean higher import prices in the US and Europe.
* As Asian exchange rates start to move higher, Asian savers start repatriating capital. In turn, this would lead to collapses in monetary aggregates in Europe and the US.
One interesting side note of that is the benefit for low-cost food production areas such as the many states in Brazil where you don’t even have to irrigate the arable land. The topography and the geography and the lie of the land is so good that you actually don’t even need to invest in irrigation. You can’t say that for most of the rest of the world. Water is going to be a scarce commodity going forward, but certain areas, such as parts of Latin America, still have abundant water resources and they haven’t been over-irrigated or had the water diverted into non-productive uses (furthermore most Brazilian beef is from cows that actually graze on pasture. So you could say free-range beef. But that’s quite important because in the environment where grain prices are going up - because corn is going up because the US is using it for ethanol - in the rest of the world the cows are predominantly grain fed).
Again what to do about this? At the risk of sounding like a broken record - avoid long-only equity exposure, be cautious about long only bond exposure, diversify into all asset classes and particularly be aware of the possibilities for a huge run on soft commodities (preferably through structured note products).
To be continued…

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]@mbmg-international.com.com

Snap Shots: by Harry Flashman

Improving your portraits – Scalp them!

I sat down and re-read a book by Robert Farber on fashion photography the other night, and as I flipped through the pages, something became more and more apparent. The photographer (Farber) had scalped his models! I looked again and I could see why, and it wasn’t that they had lousy or outdated hair styles. It was for that magical thing I call the ‘Wow’ factor.
I have written many times about moving in close, but this was taking it to extremes. My next thought, was he doing it in the camera, or post-production? A few pages further on and I had the answer. It was careful cropping done later, as there were some shots not cropped as drastically as the scalped versions.
In today’s digital age, post-production cropping is very simple. No digital photographer with his photographic black box stuffed full of pixels can live without his edit suite from Photoshop or similar. But does he (we) use it enough? I would suggest not.
Digital cropping is so simple. Click on the Rectangular Marquee Tool (that’s what my software calls it) and make your crop lines, then go to “Image” and click on “crop”. It is really that easy. When I think how we used to do it with two L shaped pieces of card over the surface of the print, and then crop with a sharp knife! Photographers get it easy these days.
Returning to the fashion photography book, I looked even more closely at his cropped portraits to see that there were a couple of common lighting techniques that he was using. Strongly side-lit or back-lit with petroleum gel smeared across a filter on the front of the lens to give the light rays an apparent direction.
Now suitably impressed and enthused I decided to see just what could be produced by this cropping and lighting technique, using totally amateur models, and not the expensive professionals used by the fashion photographer. I also used a standard 50 mm lens, the same as is found in almost every camera, including point and shooters. Would it be possible to produce photographs with some kind of ‘Wow’ factor, or at least produce a pleasing result?
Since this was going to be a ‘walk-up and shoot’ project, I had to do some research first as to the location where I could get the side-lighting, to then drag my (hopefully willing) amateur models to the site. I deliberately did not want to use off-camera flash, reflectors or other tricks of the trade. I just wanted to see if I could produce good results that you could, in turn, reproduce.
In the end, I just used a window, and asked the model to face it and then for her to turn her head away from the window and towards the camera. This avoided the square on to the camera pose, and having the light coming from the window meant that there was some shadow effect to give the face some shape.
I liked the effect that the cropping produced, and in retrospect, I think I could have been even more ruthless with the electronic guillotine! I particularly liked the hiding behind the hair effect as well. The severe cropping makes people look twice, wondering ‘why’, and that was obviously the reasoning that Robert Farber had used. I looked twice. Did you?

Modern Medicine: by Dr. Iain Corness, Consultant

Varicose veins? Blame the undershorts!

When you research Evidence Based Medicine as I do (EBM for short, as we medico’s love acronyms), you have to deal with many statistics. Now, statistics is that great pseudo-science where you can “prove” so much by use of applied mathematics. For example, did you know that every child is born within six months of its mother’s birthday? Or even more fantastic, the date of your death will be within six months of your own birthday! That has to be another good reason to stop having birthdays after the age of 50!
Now while that sounds interesting, if you look a little harder you will see that this is just a mathematical ‘truism’ and nothing to do with biology or astrology. If you take any reference birth date, let’s use June 30th for example, then any child born between Jan 1 to June 29 is within six months of its mother’s birthday, as are any children born between July 1 to December 31. In one case it is looking forwards, and in the other it is looking backwards.
If you think that is an abuse of mathematical science, then what about the fact that 99 percent of all people who died traumatic deaths in London last year were all wearing shoes. Does this prove that shoes are the greatest killers of mankind? An absurdity - of course not! Again, this is ‘bending’ the parameters of science. Since about 99 percent of all people in London wear shoes, you can safely predict that 99 percent of those who get skittled on the roads will still be wearing their footwear. (If you wish to statistically look at Bangkok, then substitute flip-flops for shoes.)
Getting closer to home, I read just the other day of a study in Thailand on varicose veins, and how tight underpants were dangerous (as opposed to boxer shorts, I presume) because this study showed that something like 30 percent of varicose vein sufferers were wearing jockey underdaks. What was not stated in the report (in the popular press, so it may have been selectively reported) was the choice of underpants of those who did not have varicose veins, nor what percentage of men wearing jockeys did not get varicose veins. Without these other figures, the rest is hocus-pocus.
Pseudo-science also works the other way too. Classic examples of this are when people will pronounce, with great authority, that cigarette smoking does not bring about your early demise. The ‘proof’ of this is their great uncle Edward who lived to be 112 and smoked two packs of cigarettes every day for 85 years. This great case study of one shows nothing, other than the fact that this shows that great uncle Edward had a wonderful constitution. Nothing else, sorry.
If three of the four people in your office get the flu, this does not mean that 75 percent of the city is in the grip of an epidemic. All that can be assumed is that 75 percent of your office has a problem. Nothing else.
There is a branch of medical science called Epidemiology, which is a study of the incidence of diseases in large populations, and epidemiological research requires the researcher to look at thousands of cases before coming to conclusions. Great uncle Edward alone is not enough. The data we get from thousands upon thousands of cases, looking at smokers and non-smokers, is now enough for us to say, quite categorically, that smoking does put you at a very much greater risk of dying from cancer - that is ALL cancers, by the way, not just lung cancer. And you can add heart disease to that as well.
Forget the great uncle, give up now, before you too are a statistic. And I am sorry, I don’t accept the “it’s my choice” theory. If you saw someone choosing to run under a train, you would try and stop them too. That’s like me with cigarette smokers, sorry.

Learn to Live to Learn: with Andrew Watson

La Dolce Vita

When life is sweet, when love is at its zenith, when the sun shines every day and the moon is endlessly full, peace reigns in the soul. Today is a special day. Twenty-five years ago to the day, I saw the most beautiful girl that I have ever seen and spoke the perhaps presumptuous, but certainly portentous words, “I’ve just seen the girl I’m going to marry”.
It was the summer of 1982, and I had one year of high school remaining. My friends in their droves had piled off to the Costa Brava for the kind of holiday that has always repulsed me - two weeks of costly hedonistic indulgence. What a waste! Two weeks was never going to be enough for me! My best friend, who later went ‘undercover’ with the oxymoronic British Intelligence in Beirut, came to me one day and suggested that for the same miserly teenage budget that our peers were draining in Spain, we could spend two months on a Kibbutz in Israel.
A few years later, this idea had gained considerable currency with British youth, but at the time it felt like we were breaking new ground. The very idea appealed to the pioneer within us, although I must admit that as the moist scent of palms greeted us upon our arrival at Ben Gurion airport, I was shamefully ignorant of Israel and Palestine’s tempestuous past and present.
We drove north through the night, our final destination for security reasons, unknown (although soon to be revealed). The dawn of our first day brought with it a vision that I can still see just as clearly to this day. Sunbeams burst through the window to reveal endless valleys of orchards, olive groves, vineyards and verdant hillsides populated by pine trees. Out of the blue distance arose the dominating, glistening, silver-topped Mount Hermon. We crossed bridges where the remnants of winter’s gushing rivers trickled impassively southwards. There was a freshness in the air, which breathed life into the soul. This was Galilee, the land of milk and honey.
Before us lay Kibbutz Yi’ron, a smallish community founded by Russian and Egyptian Halutzim (pioneers) in 1946, a lowish plateau at the base of rolling hills, punctuated by a central water tower. From a distance, the place looked like an ocean liner.
An apple’s throw north, to our left, the shape of the landscape stayed the same, but the colours changed completely. The spectrum and chromium greens of irrigated vegetation disappeared into dusty yellow ochres and faded umbers. White, stilted concrete homes, perched on the crest of hills, overlooked the red-topped bungalows of the Kibbutz. Dividing the lushness of the south and the ample russet of the north were two rows of barbed wire, separated by a rocky border road. One side was Lebanon, the other Israel.
The first day at a Kibbutz lulls you into an entirely false sense of leisure. Our exuberance disallowed any notion of rest as we were taken on a tour of the environs and regaled with tales of heroic Zionism. Whilst it took a few years before I was enlightened by a more balanced account of history, I was and I remain, in awe of what an embattled and unwanted group of refugees have built for themselves, out of the ashes of Auschwitz and from what was tree-less and predominantly barren and unfriendly earth.
I found out on my first day of work just what turning a field arable entailed. From 6am until 4pm, under a searing sun, we moved rocks, large and small, from one area to another, until the area of a large field had been cleared of impediments to agriculture. But on that first afternoon, recumbent by the swimming pool, nothing could have been further from my mind than the pleasures of hard labour. Kibbutzniks at the end of their day in the fields, began to join us. “This is the life,” we smugly smiled to each other.
Then all of a sudden, out of the silence, there was an easily audible rat-a-tat sound. Everybody heard it, but nobody said or did anything. Then there was another and then, another. One of our number thought it sounded like machine gun fire, but none of the indigenous population had either stirred from their slumber or altered their behaviour in the slightest, so we laughingly dismissed his suggestion. Until, from beyond that bleak hill overlooking the Kibbutz, there came a large plume of black smoke and the trailing sound of a fighter jet. Still the locals remained impassive, whilst only a kilometre to the north, Ariel Sharon’s ill-considered invasion of Lebanon had begun.
It was Friday and as the sun fell to earth, the Sabbath commenced. Even on secular Kibbutzim like Yi’ron, the tradition if not the ritual of Sabbath is celebrated and the whole population gravitates towards the communal dining hall, dressed in their finest finery, frankly something of a fashion mish-mash from old Russia, Egypt, new Israel and any number of other global Jewish and Arabic influences.
We were in high spirits. A sense of anticipation filled the evening air as a full moon bathed the Kibbutz in silvery light and a thousand cicadas kept an unrelenting beat. As we gained the summit of stairs that opened into a dining room full to bursting with four hundred chattering people, something inside told me that my life was about to change.
My eyes met her gaze with pre-ordained immediacy and I was utterly transfixed. She was more beautiful than I could have dreamed possible. Her eyes, as black as darkest umber, sparkled and smiled with life and her hair, tinted blond by the sun, fell in tight black curls beyond her shoulders. Her face was tanned to a tone beyond what seemed credible or indeed fair, a face so sweet, so soft, so enticing and so addictive, that at once my heart had melted. We stared at each other for what seemed like an age. I couldn’t hear anything. She smiled at me and I felt myself smiling back. I was suddenly, completely and utterly in love.
Andrew Watson is a Management Consultant for Garden International Schools in Thailand. andreww@gar denrayong.com
All proceeds from this column are donated to the Esther Benjamins Trust. www.ebtrust.org.uk email: [email protected]
Next week: Apple crates beneath the stars