Natural resource companies – only themselves to blame? And BHP Billiton results.

I believe John Redwood recently said that it was odd that commodity prices have been falling while Chinese demand has been steadily rising as forecast. As their economy turns more to retail consumption, the demand for consumer products and energy which drive the commodity markets has been rising as China is definitely the elephant in the room in terms of its influence on global demand.

An article in the Daily Telegraph by Ian McVeigh on Friday (28/8/2015) explains this conundrum, with a particular focus on mining companies. He points out that over the period of 2003 to 2015 (that of the commodity boom or “supercycle”), mining company shares actually managed to underperform the FTSE AllShare by 39%. He calls it a “dismal outcome for investors”.

Why was that? Hubristic mergers and excessive capital investment are his answers and he is no doubt right. Commodity prices did actually rise during most of that period but the large miners geared up with high amounts of debt to develop mega projects. These drove massive increases in production capacity which resulted in the current position where there is more production than there is demand, and hence declining commodity prices. The impact on the profits of these companies has been even more severe.

Mining is a typical “boom and bust” economic market. It’s like the economics of farming we all studied at school. When prices are high, or forecast to be high, then farmers invest in more sheep, cattle or land development. Two years later there is then a bust when the investment comes into production and prices collapse. This was of course the reason given for food price stabilisation measures such as the Common Agricultural Policy to protect farmers from their own enthusiasm. Let us hope that the miners do not argue for the same.

But for investors, or the directors of mining and oil companies, what should be examined very carefully is whether capital investment projects, particularly those financed by debt, will get a decent return even in the bad times. The time delays on bringing new mines or oil wells into production are larger than those in farming so the boom and bust cycle tends to be bigger and more extended in time.

BHP Billiton, who recently announced their annual results, demonstrates exactly the problems explained above. Earnings per share down 86% and return on assets now a measly 6.4%. Debt is now over $32 billion. Needless to say they are now cutting back on capital expenditure. But they have still increased their dividend slightly so they now yield over 7%HoHow. However analysts are still forecasting a further fall in profits next year, so investors need to take a view on how long it will take for the cycle to fully unwind and production capacity to be taken out of service. Unfortunately when commodity prices fall there is a tendency to increase production to ensure the sunk costs are recovered and correction only really happens when a few producers go bust.

Roger Lawson

An Unpardonable Inequity

There was a great article on the nominee system by John Hughman in FT Money yesterday (see ). Under the heading of “The unpardonable inequity that blights UK equities”, John spelled out in simple terms why nominee accounts are indefensible. They deprive shareholders of their rights in the name of convenience and cost which are myths promoted by brokers for their commercial advantage.

Here’s one pithy quote from the article: “In fact, I’ll go further – it is an indefensible embarrassment to a country that claims to be one of the fairest and most financially advanced in the world. I too am angry now” (he reports numerous complaints from shareholders).

Thanks John for giving this issue more publicity. Perhaps readers could post some comments on the FT web page given above to support some action on this matter.

Roger Lawson

Dunedin Enterprise and High Discounts

If Alliance Trust shareholders might be concerned about the high discount to NAV their shares trade at, then that’s nothing in comparison with the position of investors in Dunedin Enterprise Trust. At the time of writing it is trading on a discount of 38%!

On Friday (28/8/2015), they reported results for the half year ending June – and it was another very disappointing set of figures. Net asset value total return was -0.1% for the half year and over three years they are down 5.9%.

When most private equity investment trusts fell to deep discounts during 2008/9, ShareSoc made representations about what might be done. Subsequently the company undertook an aggressive programme of tender offers financed by disposing of some of their portfolio assets. This enabled investors to exit at a good price to some degree. However, as with any investment trust, if the fund performance does not improve then any discount control mechanism will only work to a limited extent. They are now back in the same difficult situation.

The new Chairman, Duncan Budge, says that there are prospects of good realisations, but the previous Chairman said much the same thing before departing. It’s unclear when or if matters will improve.

ShareSoc has made representations to investors and the directors on this company in the past (search our blogs for previous comments), and I have again written to the Chairman making some suggestions and requesting a conversation. Anyone reading this who is a shareholder in this company may care to contact me.

Roger Lawson

The Case of the Disappearing Shares

Another example of the wonders of pooled nominee accounts has come to my attention. When you buy shares through a stockbroker, you expect to receive them. Indeed settlement should now take place in 2 days if traded electronically as most now are. So if you are using a stockbroker’s nominee account they should appear in that account in that period. You will see them on your account so they will be there will they not? The answer is not necessarily!

Take the case of New World Oil & Gas (NEW) that developed earlier this year. It is an AIM traded company where there was a large placement of shares anticipated to refinance the business in April. But is seems that there was a lot of naked short selling taking place (i.e. selling shares the seller did not own), perhaps on the basis that the sellers could acquire shares to settle the trades from the placing. As much as 3 times the issued share capital might have been short sold. Readers might remember the case of Room Service back in 2004 where likewise many more shares were sold short than the company actually had in issue, which meant the deals could never be settled. It resulted in heavy censure by the FSA. What happened at NEW seems very similar.

A significant number of holders of NEW wanted to requisition an EGM to change the board, but found they could not get their shares re-materialised into paper certificates because market makers had not delivered stock they were supposed to. Given the settlement issues that there were in NEW’s stock, as acknowledged by the London Stock Exchange in three separate market notices, this problem was well known.

What was less well known were the problems some long-term holders of NEW faced in getting their shares re-materialised. There were at least four instances of clients of Barclays Stockbrokers and Share Centre, who had bought and held their NEW stock long before the forward selling controversy began. Holding a combined 3,000,000 shares, these people requested re-materialisation of their stock only to be told by Barclays Stockbrokers and Share Centre that they could not because neither broker held the shares anymore!

Why? Because other purchases into the “pool” had not been settled as expected (presumably ones that were trades with the short sellers). Other clients had sold holdings from the pool, thus leaving a totally inadequate number to meet the request for re-materialisation.

In other words, the brokers had sold the clients shares without their knowledge, and allowed sales by those who had purchased shares and not received settlement of them, because they were all mixed up in a pool.

These problems effectively defeated the initiative of the New World Shareholder Action Group (see ) who could not get past the 10% holding requirement to requisition an EGM even though they believed they had 60% of shareholders supporting them. Thanks to Ben Turney who is promoting the Action Group for some of the information herein.

So the moral is: if you hold shares via a brokers nominee account, as most investors do, the broker may not in reality actually own the shares. And they won’t necessarily tell you that the delays in settlement are affecting your position. At least if you are dealing via a Personal Crest Account or in Certificated form you might know about the problem so this is another good reason why ShareSoc would like to see nominee accounts, particularly pooled ones as are most of them, discouraged. Go here to read about our campaign on this issue:

In addition it surely suggests that naked short selling should be banned as it is very likely to lead to settlement problems as happened in this case. The LSE (who regulate AIM) and the FCA seem to be very little concerned about these issues which is surely symptomatic of their attitude that “anything goes” on AIM.

Roger Lawson

Corbyn to tackle the High Pay issue?

You know when a challenge for the leadership of the Labour Party is becoming credible when the person gets profiled in the Financial Times. Yes Jeremy Corbyn is now heavily tipped to win the election irrespective of the allegations of “dirty tricks” by folks of both extreme left and right persuasion registering just to vote for him. But the really interesting aspect to this writer is that he has adopted a policy that might be very popular with a number of people, even stock market investors. To quote from the FT article he said “I do think the salary levels and the bonus levels again have to be looked at. Some of it is ludicrous and so I am looking at the gap in every organisation between highest and lowest levels of pay.”

Corbyn is of course from the same mould as Ken Livingstone. An advocate of populist left wing policies who has such extreme views (or shall we say, uncommon and uncosted views) on so many matters that he seems to have fallen out with the leadership of the party and most of his colleagues in Parliament many times in the past. In other words a born rebel.

But the pay issue may be a real hook to mount a serious challenge to the Conservatives as many people think it has not just got out of hand, but is massively socially divisive and damaging to economic development. It’s surely not good enough to ignore this issue and simply say company directors should pay themselves whatever they want because institutional investors rarely seem to complain (who are the ones who control the remuneration votes).

The High Pay Centre have just issued a note on a couple of forthcoming meetings on this topic. One points out that the average FTSE100 CEO’s pay went up to £5 million in 2014, from £4.1 million in the previous year. It’s now 183 times the median for full time UK staff.

One of the meetings will have Vince Cable talking about the impact of his reforms on pay regulation – not a lot in essence. Perhaps he may have some ideas on what more should be done because we sorely need them.

Roger Lawson

Rensburg AIM VCT AGM and Blinkx AGM

Did the directors postpone the Rensburg AIM VCT AGM, originally scheduled for the 22nd July, as they knew the votes? And even more importantly, what is the future for AIM VCTs? These were some of the questions that arose at the Rensburg AIM VCT AGM yesterday (on the 25th August). No answer was obtained to the first question, but there was coverage of the second question which may interest anyone who invests in VCTs.

All the resolutions were passed, but all three of the directors managed to obtain votes of 20% or 30% against their re-election which surely demonstrates that a number of shareholders have lost confidence in them as a result of past decisions.

The resolution to proceed further with the merger with Unicorn AIM VCT and the proposed tender offer was passed though so it seems likely therefore that this will be concluded in due course.

A report on the meeting is present on the ShareSoc web site here:

On the same day as the Rensburg AIM VCT AGM in Leeds, the Blinkx AGM was held in London. After the latest profit warning there were a number of shareholders present asking awkward questions about the future prospects for this business. The grant of new options to the CEO, Brian Mukherjee, was challenged and at the end of the day he also managed to get 20% of shareholders voting against his re-election on a poll. It’s surely going to take a long time to re-establish confidence by all the shareholders in this company while the current CEO remains as he never seems to find it easy to explain in simple terms how the business makes money and the future strategy.

Again there is a full report on the meeting on the ShareSoc Members Network which is an invaluable source of AGM reports for investors and not available anywhere else. A list of recent reports is given on this web page:

Roger Lawson

Coping with Panics, and is the Market Cheap Enough?

I may be a day late to comment on stock market panics as the UK market bounced back today (25/8/2015) after sharp falls in the previous few days. But I had the chance to reflect on recent events after a trip to the somewhat stormy Rensburg AIM VCT AGM. It seemed pretty obvious to me that the markets worldwide were being driven by fear and emotion on the whole. Explanations given were both numerous and dubious such as the collapse of the Chinese stock market driven by retail investor sales, the slowing of the Chinese economy, that impacting on commodity prices generally, the collapse in the oil/gas price due to a glut of those products from more production while demand is falling, and the possible end to the long running bull market. Some of these might have an impact on some companies, but share prices are falling across the board which tells you that investors are selling holdings regardless. And lower energy prices should boost many companies and whole economies so not all the news is negative.

The stock market is one of the few markets where buyers don’t welcome falling prices. If you went into your local supermarket and found prices lower than the day before, would you not buy more? But there are numerous “trend followers” in the market because “momentum investing” has been shown to work both when prices are going up and going down. Once a minor trend has developed, it’s self perpetuating, compounded by the influence of index tracking funds and “closet trackers”. Redemptions by inexperienced and panicked retail investors in funds also generate sales of stocks even when the fundamentals of companies held by a fund have not changed.

As a retail investor who invests in individual stocks, can I suggest all you should be doing is looking at the fundamentals and outlook for those stocks and ignoring short term market trends. Therefore you should welcome price falls. Indeed if they become cheap you should buy, and if they become cheaper than when you bought them, when presumably you justified the valuation, you should buy more, assuming the financial fundamentals and prospects have not changed.

That presumes you have some spare cash, so it’s always worth having some cash in your portfolio to exploit such circumstances. At the start of an obvious panic, it can perhaps be worthwhile liquidating some of your least favourite or losing stocks which is always a good thing to do anyway. This frees up some cash for exploiting later buying opportunities when the market falls further. This is part of the “sell the losers – buy the winners” strategy which many experienced investors have learned to use. It’s a strategy that ensures you don’t get too emotionally involved with stocks but rebalance your portfolio to ensure you are buying successful companies and removing the duds.

Note that I am not suggesting that market trends should be ignored altogether. Medium to long term trends are different to short panics. And trends in individual stocks can be helpful to follow. But when most of your holdings are all falling as buyers have simply left the market because some Chinese investors are in a blue funk (compounded in recent events by it being an August holiday period), then I suggest that you need to think a bit differently.

In essence, if you were happy with the valuations of your investments a few days or weeks ago, is there any great reason to change your mind? Perhaps on commodity related stocks but they have been in a bloodbath for many months.

These are of course my personal opinions. But I am looking forward to the market becoming cheaper when I can pick up more of the stocks I like at better prices. So the answer to the question “is the market cheap enough” is no as I always prefer it cheaper, but it might be getting there.

Roger Lawson