Australian investors face a heady confluence of macroeconomic and geopolitical changes being driven by a complex set of related events.
The good news is some of these tectonic changes in the global economy, many of which will attract a strong pipeline of capital for years at a time, are still in their infancy and present some very attractive investment opportunities.
The bad news is otherwise-good companies with attractive fundamentals can be pushed around by macroeconomic or technological changes. This means not keeping an eye on developments in the global tapestry is a little like driving with one eye closed.
One way to incorporate the macro tapestry into portfolio construction is to take a top-down approach. If we can identify the big picture international changes taking place, the ones that will transform industries, then from that vantage point we can apply a more fundamental approach to identifying companies best placed to benefit.
US hydrocarbon abundance
Here is a big one. In the United States a momentous energy revolution is taking place that will have multi-decade consequences. Since the peak of crude oil imports in October 2006, imports of oil by the US have nearly halved. US oil production is back at levels not seen since the early 1990s and the glut of natural gas supply is even greater. The US could appropriately be thought of as the Saudi Arabia of natural gas.
Taken together, the rapidly changing dynamics for energy supply in the US, enabled by horizontal drilling and multistage fracking technology, have driven down the price of natural gas in the US to around a third of what it is in Europe and Asia.
Although only a quarter of US electricity came from natural gas in 2011, it should come as no surprise that around 60 per cent of planned electricity capacity additions for the US out to 2035 will use natural gas.
Translating the thematic tapestry
Returning to our top-down approach, once we have confidence in the sustainability of a long-term change we need to look for investments that are well positioned, or are evolving, to benefit. Here are a few examples of translating the US shale-gas abundance into potential investments.
US railroads are a classic play on increasing economic activity in the US or rising GDP. However when we consider the US energy boom, rail’s leverage is impressive. Rail carries fracking sand, pipe, plant and equipment one way, and waste water and gas the other. The next level of activity is important too. Increased manufacturing in the US will also benefit rail freight volumes.
Chemical companies benefit via petrochemical feedstock prices (raw materials for products like synthetic rubber, solvents, plastics and gasoline) that now rival the Middle East. Natural gas liquids, which can be refined off shale gas, can be a substitute for naphtha, which is an alternate industrial feedstock refined from crude oil. Naphtha pricing is linked to oil, while natural gas liquids pricing is linked to natural gas prices. Test this one for yourself: enter “ethylene super cycle” into a search engine.
More broadly, the suppliers to the additional natural-gas refining and power plants being built to benefit from cheap natural gas benefit from the ramp up in business investment.
Unlike Australia’s resource business investment, which the Reserve Bank of Australia estimates is peaking, the US business-investment cycle is just starting to ramp up.
A broader US industrial renaissance?
When China entered the World Trade Organisation, the price advantage to shift manufacturing there was enormous. By the 2000s we saw the emergence of global economies of scale and “asset-lite” companies looking to harness a global sourcing strategy, which meant ceding proprietary production capability and retaining mainly distribution relationships and all the complexities, that strategy entailed.
Fast-forward to 2013 and times have changed. Aside from the emerging US energy advantage, transport costs have increased and networked customers are rewarding shorter inventory cycles. Both of these changes support more nimble, local production.
As importantly the yuan has appreciated and Chinese wages have been increasing by double digits each year. Taken all together, the appeal for American companies to outsource production to China compared with manufacturing domestically or in Mexico has substantially diminished.
Go where the flood of money is going
Investors who can take the pulse of big-picture changes that will drive capital flows for years are in the driver’s seat when it comes to investing in future winners. At the heart of this thematic approach to investing is the concept of asymmetry, meaning targeting an investment has attractive upside with limited downside.
A century’s worth of cheap hydrocarbons that can be consumed to produce cheap electricity or feed into a broad range of industrial products certainly fits this simple equation.
Angus Crennan is an investment specialist at Zurich Investments
