FYI | Feb 07 2011
The Triggers for Egypt’s Political Unrest… And the Investment Opportunities That Spring From it
By Steve McDonald, Investment Analyst Host of The Oxford Club’s Market Wake-Up Call Friday, February 4, 2011
Editor’s Note: In this edition of the Investment U Weekend Update, Steve tackles… How the unrest in Egypt could turn into an investment opportunity… How the political cauldron in Egypt could affect oil prices… The Russians’ gold-buying spree… and the point at which you should buy gold on the dip… Broken index funds… The “Slap in the Face” Award
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Take a Long-Term Approach on Egypt
There’s no question that the unrest in Egypt is the world’s primary focus at the moment. But for investors, it could turn out to be a big opportunity. Opinions vary about how this situation will work out, but many analysts think this situation could actually have a very positive outcome for Egypt and investors.
Graham Stock, Chief Investment Strategist at Insparo, described Egypt’s call for change as very similar to what took place in Poland during the Solidarity movement. According to Stock, Egypt is the biggest player in North Africa and says its focus on liquefied natural gas (LNG) and as a pipeline player makes the current selloff a huge buying opportunity for long-term investors. Both LNG and pipelines aren’t going anywhere – and will remain profitable after this situation settles down.
Jim Licata, Chief Investment Strategist at Blue Phoenix, calls Egypt the “Jewel of the Nile” and also sees this selloff as a huge buying opportunity. Licata especially likes Apache Corp (NYSE: APA ) as an Egypt play. It has 20% to 30% of its assets in Egypt and says if the stock retreats to the US$100 range (it’s currently at US$118), it’s a buy.
Nobody is recommending a short-term trade in anything related to Egypt. This situation will take time to improve and requires a long-term outlook. Almost every analyst sees Egypt as being a better investment opportunity after the power transition is complete.
Two Triggers for the Egyptian Unrest
Edward Yardeni of Yardeni Resources stated in an interview this week that the unrest in Egypt is the result of the evolution of globalization and the wealth it’s generated. Specifically, he sees two problems… The wealth generation is concentrated in too small a percentage of the emerging world population. He says we could see Egypt’s situation replicated in parts of Asia. The recent spike in global food prices is the spark that’s driving the unrest – and is exacerbated by the fact that emerging markets are hoarding grains.
As I said last week, food is one of the biggest plays in the world right now and can only get bigger.
How Egypt’s Woes Could Affect the Oil Market
So what impact will the Egyptian situation have on the price of oil? Beyond the incredibly complex political effect it could have in the Middle East, the immediate concern for investors is the Suez Canal. Why? Because 20% of the world’s oil travels through the canal – and if that flow is compromised, we could see big price increases in crude.
Arjuna Mahendran, head of Asian investment strategy at HSBC, said this week that oil is on everyone’s mind. The good news is that there is little to no anti-Western sentiment in the protests and no threat to the flow of oil so far. However, everyone – especially the traders in the NYMEX oil pits – will be watching this situation very closely.
On a positive note, a Wall Street Journal article this week stated that gold is a better hedge against Egyptian unrest than oil. It doesn’t see much threat to the price of oil and there’s a better case for gold to run higher on the uncertainty. And let’s face it… the last thing we need right now is a major spike in energy prices.
From Russia With Gold
The Russian government announced this week that it will buy another 100 tons of gold per year to replenish its gold reserves. This comes after a 23% increase in its gold reserves last year and has some observers wondering if the recent gold selloff is a new buying opportunity. After all, 100 tons per year is nothing to sneeze at and most central banks and governments have increased their gold holdings for some time now.
Jonathan Barrat, Managing Director of Commodity Broking Services, says that commodity-driven inflation and deficits in the developed world will continue to put upward pressure on the price of metals. He sees US$1,320 per ounce as a good chance to buy gold on the dip. Cynthia Carroll, CEO of Anglo American ( AAL.L ), see worldwide demand growth for metals extending beyond 2030 and that mining is the sweet spot in the growth of both China and India.
Remember, as the value of metals increase, it increases the net worth of mining companies that have reserves in the ground. It’s what mining analysts call the “multiplier effect” of the mining industry – and is why many analysts feel that miners are a better investment than metals themselves.
The Changing Nature of Index Funds
For two decades, the S&P 500 and other index funds have been gems for investors who won’t venture into the area of stock picking. But there are big changes afoot in this huge investment area. The most popular index fund type – the S&P 500 and Russell 2000 – weight their indexes by the stocks’ market caps.
But in its latest issue, the Journal of Indexes mentioned that alternatives are available now that are outperforming the cap-weighted funds by a significant amount. One alternative is to weight companies equally and ignore their market value. Another is called minimum volatility, which favors the most stable stocks available in the index.
But the best returns have come from Risk-Efficient index funds that do the opposite, or weight an index by the most volatile stocks in that index. The results are very surprising. The high-volatility-weighted funds have far outperformed the market-value-weighted index funds. Even the stable and equal-weighted funds have fared much better than the traditional market-value-weighting.
Conclusion? Cap-weighting index funds could very well be out of touch. During the first 25 years of index investing, the S&P 500 turned a single dollar invested in 1975 to nearly US$17 by 2000, net of inflation. But over the next 10 years they lost US$0.29 per dollar invested, turning US$1 into US$0.71. That stinks!
It might be time to take a look at your choice of index funds.
The “Slap in the Face” Award
This week, it goes to Greece… again. My apologies to the cradle of civilization! Despite the fact that there’s a revolution happening on the streets of Egypt, it still costs about half as much for Egyptians to insure their debt as it does for the Greeks. That’s how bad Greece’s money situation is.
For example, it currently costs about US$835,000 to insure US$10 million dollars of Greek debt. But even with the political instability the Egyptians have at the moment, they’re only paying about US$440,000 to insure the same amount of their debt. At the World Economic Forum in Davos this week, a chairman of a major bank (he remained anonymous for obvious reasons) said the Greeks must be smoking dope if they think they’re going to pay back their debt. It looks like the Greek mess is far from over. And I’m concerned about what that says about the rest of the PIIGS.
That’s all for now. Catch you next week.
Steve McDonald
Reprinted with permission of the publisher. The above story can be read on the website www.investmentU.com. The direct link is: http://www.investmentu.com/2011/February/a-positive-outcome-for-egypt.html#more-18232
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