Sunday, May 28

Week 308 - Barron’s 500: Agricultural Production Companies

Situation: Food commodities are coming back in favor as investments, as protein sources are becoming more affordable. Demand for meat, milk, soybeans, and cereal grains is robust. Companies that help farmers and ranchers produce those protein-rich commodities stand to benefit.

Mission: Apply our standard spreadsheet to all of the companies on the 2016 Barron’s 500 List that support agricultural production, and have a 16-Yr trading record that has been analyzed statistically by the BMW Method.

Execution: see Table.

Administration: You’ll want to know how to invest in the companies that emerge from the ongoing need to consolidate operations: Potash is buying Agrium, Bayer is buying Monsanto, and duPont’s CEO will run the agricultural assets of duPont and Dow Chemical once that merger is completed. So, 5 of the 9 companies listed in the Table are “in play”; you can learn a great deal about what each company offers its merger partner by studying the Table.

Bottom Line: Companies that supply farmers with their tools for production are slowly emerging from a financial wasteland (caused by the overproduction of agricultural commodities). Their finances have improved only because of consolidating operations and dialing back production, which has been brought about through mergers: Dow Chemical with du Pont, Agrium with Potash, Syngenta with China National Chemical, Monsanto with Bayer. Only time will tell whether lean production will translate into enough demand to sustain these new companies. China will be the key source of demand, whether we’re talking about food commodities or solar panels.

Risk Rating: 8 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into Monsanto (MON) and also own shares of Agrium (AGU).

NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 4-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K ( Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 32 in the Table. The ETF for that index is MDY at Line 16. For bonds, Discount Rate = Interest Rate.

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Sunday, May 21

Week 307 - Silver Is Perhaps The Most Interesting Alternative Asset

Situation: Stocks and bonds have been at or near the tops of their historic valuations for over 5 years. No corner of those markets has been overlooked; “crowded trades” are everywhere. In such circumstances, investors will reach for value by looking at alternative asset classes. Real Estate Investment Trusts (REITs) are my favorite (see Week 274). The goal is to find assets that are a) “non-correlated”, i.e, have low Beta because price-action is often out-of-sync with the market, and b) have enough economic utility to occasionally generate Alpha, which is a high “return on investment that is not a result of general movement in the greater market.” 

Why is silver interesting, given that it has only gained 3.9%/yr in value over the past 30 years? For comparison, the lowest-cost S&P 500 Index fund (VFINX) has gained 9.4%/yr and the lowest-cost investment-grade bond index fund (VBMFX) has gained 6.0%/yr. Reason #1:  A key use for silver is growing exponentially, which is the build-out of solar power toward a United Nations goal of generating 30% of the planet’s electricity by 2030. Copper and aluminum can be used in solar panels instead of silver, but those substitutes are less efficient and have not proven to be commercially viable, partly because the amount of silver needed per solar panel continues to decrease

Silver has a fascinating history. For example, in 1979 the Hunt brothers attempted to “corner” the silver market and were able to borrow enough money to buy 1/3rd of the world’s supply outside government hands. This resulted in more than a 700% price increase but brought attention to the high leverage used in purchasing commodities. After the commodity exchange (COMEX) adopted “Silver Rule 7” on January 7, 1980 (to restrict the ability of speculators to purchase commodities on margin), the price of silver promptly fell 50% and the Hunt brothers were unable to meet their bank’s margin call for $100 million. They ultimately declared bankruptcy.

Could this happen again? Yes. Silver prices fluctuate more dramatically than gold prices, since silver has greater industrial demand and lower market liquidity. The rapid proliferation of solar panels will no doubt aggravate that problem; sovereign wealth fund managers will be tempted to hoard silver. Let’s do the math. World silver reserves are just under 600,000 tons. Solar panels in currently contain ~2/3rds of an ounce of silver: A ton of silver is consumed to make ~44,000 solar panels, and 4 panels are needed to make a kilowatt-hour (kWh) of electricity. So, a ton of silver generates 11,000 kWh. A billion kWh = 1 TWh (terawatt-hour). Currently, ~21,000 TW are used every hour on our planet ( A goal of producing 30% of electricity from solar panels by 2030 implies that those panels would need to generate ~11,000 TW per hour (after allowing for population growth). A ton of silver generates 11,000 KW per hour, so a billion tons of silver is needed to generate 11,000 TW per hour. Assuming that an ~10-fold increase in efficiency will be achieved by then, only 100 million tons of silver will be required. World silver production in 2015 was ~31,000 tons. Multiply that by 13 yrs and you get ~400,000 tons. Adding that to the current reserve of 600,000 tons, you’d have one million tons available for all industrial uses on the planet through 2030. Where are the remaining 99 million tons going to come from? 

Mission: Examine ways to invest in silver, using our standard spreadsheet analysis.

Execution: (see Table).

Administration: There are 4 ways to invest in silver: 

1) Purchase ingots, coins, or shares in a silver ETF (SLV).

2) Purchase stock in a silver mining company, the largest and most successful being First Majestic Silver (AG). 

3) Purchase stock in a financial company that loans money to silver miners in return for claims on the “stream” of the silver produced. The main silver-streaming company is Silver Wheaton (SLV) but the dominant company for financing both gold and silver mines (in return for gold royalties or a stream of silver production) is Franco-Nevada (FNV). 

4) Purchase shares of a gold mining company that produces large amounts of silver as a by-product. Both companies having the largest reserves are based in Canada: Goldcorp (GG) and Barrick Gold (ABX). 

Bottom Line: This is gambling, on steroids. To be successful, you’d need to have infinite patience and have enough time to update information on silver inventories every week, as well as work-in-progress for solar panels relative to demand. You can probably do well by gradually building a position in silver or the silver ETF (SLV). Professional stock pickers who focus on natural resources like to stick with the companies that a) have the largest reserves and b) develop new reserves at least as fast as they consume reserves. Barrick Gold (ABX) wins on both counts.

Risk Rating: 10 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10).

Full Disclosure: I have no silver-related holdings.

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