The benefits of active investing

Governments have a propensity for treating us all the same. Their ‘safety’ paradigm tends unfortunately to ‘dumb down’ the most aspirational of thinkers at considerable opportunity cost.

Governments believe in education. They believe in education so much that they will ‘move the world’ in order to get the education outcomes they think you should want. No cost is too much. In fact they will waste vast sums making it ‘just right’. Sometimes they establish a gigantic bureaucracy to achieve that task, and on other occasions, they simply outsource the task to the private sector. The US education system is a legacy of public ‘education custodianship’, however it is the northern Europeans who are considered to set the ‘standard’ in terms of education outcomes.

In the realm of investment however, Western governments have tended towards an ‘outsourced’ model of personal savings, where the investor preserves a high level of control, and in which governments direct desired outcomes. The problem is that they are not very good at it. The reason is that governments like to ‘impose’ good decisions upon us. It tends to have the opposite result. Consider the following:

1. Compulsory superannuation for Australians has seen Australians placing 9% of their super contributions into super funds. This has amassed a substantial amount of funds. The problem is that any large parcel of money managed by private funds is destined to end up with ‘branded’ funds, i.e. Traditional household names like banks whom the investor knows. This is not because these companies offer the greatest returns, after all they were privatised government banks which preserve the same culture of entitlement, but simply because these people have been incentivised by tax concessions to enter such schemes, and they don’t know what they are doing.
2. Small funds get ignored because they don’t have the market profile or marketing budget of the major players. Small funds actually make sense because they are discretionary in terms of specialisation, and because they manage less money, they can achieve higher returns by investing in stocks with greater volatility and less liquidity. i.e. Smaller companies. They don’t have to trade ‘vulnerable’ stocks with yields of 3%; they can invest in smaller growth stocks which don’t yet have a yield, but which have huge upside because they have world-class opportunities. The implication is that large companies trade at PE Ratios (PER)of 30-45, whilst small companies trade at multiples of just (PER=) 3-10. This disparity makes any aspiring small companies vulnerable to the majors. So the structure of the industry — caused by governments — has resulted in a ‘have and have-nots’ disparity in ‘means’. This is bizarre because we normally think of governments as helping to achieve an egalitarian society, …you know….like they did with respect to personal income and wealth. Governments give life to egalitarianism….right? Please tell me I’m right?
3. Small companies historically were the respite of ‘mum & dad’ investors who wanted to take a ‘punt’ on getting rich in small mining companies in the case of Australia. In fairness, people like my father never achieved much. When Poseidon was rumoured to have discovered nickel in WA in the 1970s, he saw the stock and bought a neighbouring company called Cliffminex. Nothing became of it, but he developed an interest in stocks. He would buy me a stock called Abrolhos Oil soon after, when I was 11 years old. Today, these investors are gone. Today, I’m a mining analyst. Unlike my dad, I studied geology, mining engineering, mineral processing, finance, accounting, economics, not to mention philosophy, psychology, law, technical analysis, and worked for a stockbroker, boutique mining finance group, as well as an international energy consultancy. The point being, that I educated myself.

Government custodianship franchised

Western governments have taken a different approach. They have encouraged people to invest in funds. In essence, to outsource their funds to people who ‘know what they are doing’. There are several problems:

1. Vulnerability to systemic risk — The government has created a single model for savings which means that everyone is invested in the same model. The implication is that systemic risks arise because everyone is thinking the same way. Hear of homogeneous ‘cultures’ being at risk. Well, our financial system is risky in the same way.
2. Presumption of security — There is a presumption that because people are protected by the government regulator, by ‘stiff penalties’ for breaches of the law, and by the loving care of fund managers (despite their conflict of interest), that we are safe.
3. Presumption of efficacy — There is a presumption that fund managers are actually good managers. The problem is that its too easy dealing with a novice investor ‘thrusted into the deep end of the pool’ with half their savings to be railroaded into savings and investment schemes. They don’t even have to lose money; they only have to be mediocre to be bad. So the problem is financial relativism, where fund managers are able to compare their best manager with the worst results of their peers. They all do it because they all make mistakes. The problem is their entire practice is a false economy because they manage more money than they can optimally invest. This is where smaller funds are actually better. The problem is most small funds are ‘specialised’ so they can’t give you the ‘flexibility’ you might want at different stages of the market, and they want a ‘continued’ relationship. The implication is that you stay with a large fund, and pay more in fees for 2 managers.

Government custodianship gone wrong

The problem with governments acting as your custodian is two-fold:

1. Illegitimacy: Their custodianship was not derived from any notion of efficacy in their field, it was based on extortion.
2. Choice: Their leadership was not a testament to their efficacy, but a testament to the fact that you never had a choice. i.e. Political relativism.

For this reason, there is really no prospect of government ever being a ‘good custodian’. They simply have no efficacy, no accountable and dubious values you should distance yourself from. I’d not even sanction them with a vote…if only to demonstrate your derision for the system. But reasonably, that is not all you should do.

So we have government stifling the public in several ways:

1. Investors are incentivised to invest in blue chip stocks with ‘earnings growth’ because otherwise they will pay capital gains tax, or miss tax concessions if they sell.
2. The companies that investors buy will be starved of equity funds, and by implication, will struggle to get bank funding, because government has disincentivised private investment
3. The government has ‘dumbed down’ mental efficacy or financial literacy as an aspiration; instead encouraging investors to outsource their investing, under the pretence that they are too stupid to learn…or distracted by computer games…they don’t say why. Just I gathered from the derisive fashion in which they treat investors whilst displaying no efficacy of their own in this arena.

So the culmination of this publicly sanctioned investment industry is:

1. Big brand name funds having excess cash they can’t optimally invest.
2. Small emerging companies are starved of funding because they don’t have a cashflow history.
3. Small companies are easy prey for large companies
4. Investors in small companies are ‘psychologically’ starved of validation because their investments are starved of funding by the industry structure.

Now, as I have alluded to in this post; Australia’s government manages a ‘Future Fund’, which they use to invest in government bonds. Yes, the government is worse as a custodian of Australian taxpayer savings. Consider that this money could be providing secondary equity to small Australian emerging miners. After all these companies have ‘assets in the ground’, considered ‘bankable’ until Western government buried them under a further ‘10 metres of bureaucracy’.

Case Study of Australian emerging miners punished

I want to describe two companies which were starved of funding, and therein reliant on foreign investors. I want to describe how Australian investors had their wealth pilfered from them by poor government policy.

1. Gryphon Minerals — An emerging gold miner with 4-5Mil oz of gold in Burkino Faso. The company has cash & investments worth $60 million odd, its currently capitalised at $54 million. So basically its 4-5Moz of gold is worth nominally $5-6 billion, or let’s say after 15 years of mining at $800+/oz production cost, its capable of $1billion operating surplus. But its enterprise value is minus $6million. Surprised? Well, given the perceptions of gold, you might expect this from naive investors. You need to consider that this is near-close to how much money they need to start build a treatment facility, which would take 14-18 months. Now, this company can prove up more gold for $25/oz, and yet past investors would now be sitting on value of about $0/oz for a product that sells on international markets for $1300/oz. This seems surprising pricing. Any downside. Well, they can blow the cash on a defective treatment plant, or the country could be overrun by Muslims. The gold would stay in the ground one guesses.
2. Union Resources — This is a company which was wretched from a disinterested Australian public. Lack of knowledge of mining in a ‘mining country’. Only 3-7% of Australians have any connection with mining at any one time. Its exploited in the desert or abroad. This might explain the detachment, and hence the lack of knowledge. Aspirations in Australia are rather ‘concrete’ and ‘mainstream’. This is not just an Australian folly; the Japanese are even worse. Union had a 45% stake in a world-class phosphate resource offshore Namibia, and 35% stake in a mothballed zinc-lead project in Iran, one of the largest undeveloped resources in the world. The Iranian project was mired in state corruption/nationalistic extortion. But given that this $12 mil company controlled (with 35-45% equity) two world class assets, you’d wonder why they didn’t get more support from the Australian government….if not in a conducive market economy, then at least a savings fund that ‘sees the future’ value of Australian resource assets. The government had the opportunity to put in ‘seed money’ to allow them to get bank funding for the next hurdle. In the end, an Omani state gas company acquired 45% stake in the phosphate resource,before taking over Union for $33mil, and getting the Iranian project for free. So they paid $50mil for a 100-year supply of phosphate. Investors took a 100% profit when they deserved 300-500% in a free market. But a free market would have competed that away. Oman’s state enterprise, which employs PhD’ed engineers got the benefit. Australian investors got very little for their investment. A third world country is ‘doing it smarter’ than Australia. Australian investors sit back oblivious to the world of stocks and investments around them.

The problem of course is a lack of financial literacy. In 2010 I recommended a good NZ stock called Xero at $1.60. Today its a $4 billion company, and likely to go higher. Currently its trading at $36. This type of company will not normally be open to novice investors. It was only so because investors don’t expect good IT stocks to arise in NZ. Miners will always be open to investors because:

1. They need cash — They can’t do as Xero did — just use seed capital from a few investors. Being in NZ, Xero actually needed money only because New Zealanders are clueless. Now, foreigners have pushed its value to $4 billion. These opportunities abound in mining.
2. There is a technical hurdle to understanding them that most people will not climb. This is your value proposition. We are told investment returns are inverse to risk. Nonsense; returns correlate to knowledge. Learning is the lesson. Learn about some industry behind some ‘knowledge barrier’ in a market that no one watches, and the profits can be very lucrative.
3. They are ‘boom-bust’ stories — they rally in a strong economy when commodities are rising, and they collapse when the economy falls. They have economies of scale, and are aided by offerings of ‘options’ as well as timing.

This is not just about making money. Its about mental efficacy and preparing yourself for greater aspirations. I started doing this when I was 11yo. There are many possible paths; this is just one of the best ones. There are many things to learn. I have in 450 pages encapsulated the most pressing issues. Picking Xero is a testament to the fact that this knowledge; this sense of efficacy has broader applications.

More case studies are described in the boom. Some exciting stories like Aquarius Platinum and Minotaur Resources. Its time people started climbing the learning curve, rather than living in apprehension. Cave man values are anachronistic. With jobs going to the third world, more Westerners will be under pressure to find value in their minds. The ‘government is not a pot of gold’, its a mirage.