Written by Michael Waring
31, March, 2007

At the moment, complacency seems to be in abundance. Global equity markets have recovered from their sharp sell-off in late February and a number of indices have moved to new highs. Basic materials have been particularly strong driven in part by renewed buying from China.

Notwithstanding a slowing U.S. economy, we have remained positive on the outlook for Global GDP growth. Inflation rates in most countries are still contained and interest rates remain low by historical standards. And we see strong growth continuing in Asian economies, especially China. Note the Baltic Dry Index, one of our favourite indicators of the current health of global dry bulk shipping activity. (See Chart One)

Chart One: Baltic Dry Index

*Bloomberg

As to the problems in the U.S. sub-prime mortgage market, there are many individuals more qualified to comment than us. However, over the years, we have observed that each time the "next big thing" was going to take down the U.S. economy, it hasn't happened.

We continue to argue for increased global diversification. The growth opportunities that we see in other markets are simply too attractive to ignore. At the same time, we are increasingly worried about the investment risk in Canada since the 'right-wing' minority conservative government is shifting rapidly to the populist left. There is nothing more dangerous than a government in motion. In our view, it's a very unstable situation.

From a broader macro perspective, we are seeking investment opportunities related to the impact of climate change, renewable clean energy and selected Chinese growth stocks. With respect to specific sectors, we continue to like gold, platinum, natural gas, alternative energy, timber and agriculture.

In China, our three main investment themes are:

•  The rising standard of living

•  The agricultural imperative

•  Water scarcity

Within each theme, we have identified companies that we believe are poised to benefit from changes we see occurring in China. No doubt there will be mistakes on the way. But the growth pressure is enormous. According to China's 11 th five year plan, the country will build 25,000km of expressways, long enough to encircle China; expand its rail network by 15,000 km; triple subway length in five years, add a total of 44 new airports with 85% located in the west; construct over 200 new berths as container throughput will rise 15% YOY on average until 2010. China will spend a total of RMB 3.6 trillion in five years.

Our concern at the moment is the rising rhetoric in the Democratic-led U.S. congress regarding trade with China. Tensions are rising with respect to exchange rates, copyrights and trade imbalances between the two nations. This development needs to be closely monitored as it could have serious economic repercussions if it continues to grow. We view this turn of events as a potential negative for the value of the U.S. dollar and another reason to hold precious metals.

Our concluding thought is that we have had very strong first quarter performance in our funds. We suspect a pause in equities is likely in the quarter ahead. We have taken significant profits in most of our uranium holdings and plan to redeploy the cash following a market correction.

In late February-early March, we attended an investment conference in Tokyo sponsored by CLSA Securities. CLSA stages some of the best conferences that we have ever had the privilege to attend. We thought it worthwhile to attach our notes from the sessions dealing with broader, thematic issues. They follow in the order of presentation.

Reflections from Tokyo - The Annual CLSA Investment Conference

And definitely Lost in Translation
February 26, 2007 - March 2, 2007

LNG - Chiyoda Corporation

• Japan was the first country to import LNG (Liquefied Natural Gas) more than 20 years ago so they possess leading LNG plant technology and plant construction.
• The global crude oil stream is getting heavier, increasing the need for LNG.
• Current LNG market conditions are over-heated and the industry cannot meet demand.
• The industry is suffering cost inflation and a shortage of skilled people at all levels.
• Qatar (with the third largest global gas reserves) has undertaken a study on the rate of depletion of its gas fields.
• Until they have the results, a moratorium on new projects is in place
• Because of growing global electricity demand, management expects continued strong growth in coal-fired plants.
• In our overview, this does not square with the growing concerns regarding global warming and CO2 emissions.
• Suggests to us that a debate is necessary in terms of coal vs. nuclear.

India and the IT Industry

• The CLSA analyst estimates that 20-25% India's GDP growth is being driven by the IT sector.
• The sector is forecast to double in the next three years having reached an inflection point.
• Based on a survey of 42,453 responses from IT professionals, the analyst has attempted to measure the impact on the Indian economy.
• A significant impact can be measured in domestic consumption, financial services, entertainment, travel, real estate demand, automobile demand and taxes.
• IT sector employees are definitely in the top of India's Income pyramid and are an elite group with spending patterns very different from the vast majority.
• Our thought is that this concentration (despite the current buoyant outlook) leaves the Indian economy vulnerable to any downturn in the IT sector.
• In addition, India has not spent the massive sums on its infrastructure (power, roads, ports, airports etc.) that China has, meaning that efficiency improvements are harder to come by, which only serves to increase dependency on the IT sector.
• India, as a direct investment, remains challenged in our view.

Going Green - Daniel Esty, Professor of Environmental Law, Yale University

• The private sector is way ahead of the Bush administration on this subject. Leading U.S. companies have embraced the move to green in their business practices including:
• Johnson & Johnson
• Baxter
• Dupont
• 3M
• H-P
• Dow
• Wal-Mart
• P & G
  
• International companies include:
• BP
• Shell
• Toyota
• Lafarge
• Sony
• Unilever - courtesy of Wal-Mart's requirements
• BASF
  
• The author argues that going green can be very profitable and uses example of Toyota & Honda's product line vs. that of the U.S. car manufacturers.
• The Japanese have figured out where car buyers are going and have the right products (hybrids anyone?).
• A recent U.S. public poll revealed:
• 73% believe the global environment is getting worse
• 92% are worried about the dependence on foreign oil
• 93% want development of renewable energy sources & clean technology
• Does this sound like motherhood?
• He sees investment opportunities in several areas:
• Climate change
• Alternative energy
• Carbon sequestration - cost is an issue on this one
• Energy efficiency - lighting is a big opportunity - LED's (light emitting diodes) are the ultimate solution
• Green buildings (smart lighting and heating, better building materials - enormous opportunity)
• Data and Monitoring
• Water - esp. emerging Asia
• Waste Reduction
• Chemicals/toxics
  
• He believes that the Chinese government is serious like never before in tackling environmental issues.
  • China's annual commitment to pollution control has risen from $10 bln/year to $20 bln/year and at the recent 11 th five-year plan, it was raised to $50 billion per year!
  • Note: China's greenhouse gas emissions will exceed that of the United States in 2009-2010.
  • The author sees big opportunities in emerging Asia.
  • From our standpoint, whether global warming is happening or not and whether it is due to human activity is open to debate.
  • However, environmental issues are looming larger and a 'green wave' is sweeping the business world.
  • Regulation is evolving from 'command and control' (govt.) to market mechanisms (economic incentives).
  • Business is now driving environmental progress - not government.
  • Environmental strategy has become a core element of business success à it can be profitable and corporations have to be perceived as "doing something"...perception is everything!
  • "Sustainability is firmly in the contemporary business environment - if you fail to see that, you do so at your peril" - Travis Engen, former CEO of Alcan.
  • From our perspective, the challenge is that you cannot have part of the world regulated while a large part is not - but the sooner we start addressing these issues, the less it will ultimately cost.

Emissions Trading - Rodger Raufer

• The author was trading emission credits as early as 1980.
• Just a brief word here to sum up.
• This is a very complicated subject and still early days.
• Markets are evolving and much is not yet determined as to how these markets will work.
• Lots of 'gaming' going on and the audit of greenhouse credits will be critical.
• Credit pricing has been volatile because markets are finding their way.
• However, the author expects explosive growth:
  • Global Carbon Market Size:
    • 2004: < $1 bln
    • 2005: $9-11 bln
    • 2006: $25-30 bln
    • 2010: $40+ bln
      
• And this growth still falls short of what is required under the Kyoto Protocol.
• Investment banks have recognized this opportunity with Goldman and Morgan Stanley investing millions to establish trading platforms.

Global Biofuels - James Newcomb

• The author seems very knowledgeable on the subject.
• The realty is that biofuel opportunities only exist if the price of oil stays elevated.
• It is causing a convergence of energy and agricultural markets and will have a big impact on agricultural commodity prices.
• The Biofuels market will show us what's to come from the biotech revolution as plants are genetically modified to be more suitable for energy use.
• The industry has drawn serious interest from Bill Gates ($30 mln invested in Pacific Ethanol) to Kleiner Perkins (established a 'think tank') to Goldman Sachs (invested $1.6 bln in renewable energy).
• To 2020, the author expects biofuels to emerge as a $150 bln market sporting a 25% growth rate per year.
• He identified a number of major trends:

1. Rapid growth:   +25% CAGR to 2020
2. Consolidation - there will be several large players that leverage advanced technology - he named Archer Daniels as an example.
3. Diversification away from main food crops (i.e. corn, sugar and palm oil) to alternatives such as switch grass and sweet sorghum - this will take a decade at least.
4. Increasing international competition - he mentioned that Brazil is the Saudi Arabia of biofuels.

• A number of governments have mandated that biofuels replace a percentage of gasoline demand over time (ex. Japan, U.S. Germany, China, U.K.).
• The U.S. and China are particularly ambitious in this regard. China is moving offshore to the Philippines and New Guinea in order to meet biomass demand. Africa is next! Think plantations.
• There is tremendous pressure to raise crop yields leading to upward demand on fertilizers and most importantly, water à water is the key and the limiting factor, especially in China.
• The demand for biofuels is leading to a change of crops to be planted, less barely and soybeans, more corn.
• Without annual crop rotations, soil will be less productive and corn yields will be challenged.
• The rising standard of living in Asia means higher meat consumption.
• This represents a collision course since meat production is water intensive à in a water-starved country such as China, how can higher meat consumption coexist with the demand of biofuels?
• China's corn production is struggling to meet demand.
• There is tremendous room for improvement as China's corn yields are just 55% of what U.S. farmers achieve.
• Again, big ramifications in our view for Chinese agriculture from tractors, to fertilizer use and water.
• In conclusion? It probably doesn't make a whole lot of sense to use food to power cars but governments have embraced the move, in part because it garners votes (think Iowa).
• It will lead to dislocations in agricultural commodity markets and food inflation à including beer!
• Yet if oil remains above $50 per barrel, this seems to be the direction we are heading, as misguided as it may seem.
• We are concerned here that there are numerous ramifications that have yet to be thought of - at least not until we have the transition to alternatives such as switchgrass.
• And the potential impact on global fresh water supplies could have serious repercussions.
• Do governments realize the potential impact on food inflation? We doubt it.

Genomics & Bio-Engineering - Juan Enriquez - Harvard Business School

• We have evolved into a knowledge society à leading to a concentration of wealth in the top 10% of society.
• Rates of change have dramatically increased in the last 10-20 years.
• Next revolution will be DNA driven by digitization.
• Life science databases are driving growth in storage and computing.
• As a result, in a sense, IBM is becoming a life science company.
• The information is becoming more important than the hardware (big pharma is at risk).
• There is a new generation of artificial materials based on plants or bacteria as opposed to petro-chemicals.
• In the last five years, plant seed companies have been acquired because seeds are simply programmed DNA code - there is huge opportunity here.
• We now can use bacteria to operate as a chip - binary operation, 1 or 0, on or off.
• Storage is going to change dramatically - it will be based on bacteria.
• We can now manipulate genes to alter animal DNA to produce certain characteristics.
• Animals (cows, goats etc.) in effect become drug factories.
• DSM (a Dutch company) is moving into genomics away from basic materials.
• GE is moving the same way becoming more of a life science company - GE just bought two labs from Abbott Labs and they are selling their conventional plastics business - Dustin Hoffman was given bad advice, it just took 30 years or so to see it.
• The opportunities are in the picks and shovels companies (i.e. suppliers of services and materials).
• Two companies he mentioned were Human Genome and Monsanto.
• The author points out that in the early 1970's many of us regarded the computer fraternity as "geeks and nerds".
• There are now many geek and nerd millionaires and billionaires.
• He argues that the some thing is about to happen here - do you really want to miss it?
• He went on to state that he is not a futurist, it's all here now and its happening.

Alan Greenspan - A conversation

1. The U.S. is going through a soft spot - a function of two inventory adjustments:
   • Housing Liquidation of new homes running at 10-15,000/month
   • Overhang is 200,000 units
   • We appear to have gone through the worst but more to go
     
2. Higher than usual corporate inventories
   • Need a month or two to return to normal levels

• Corporate profit margins appear to be flattening out which suggests the cycle is very mature.
• There is a risk of recession late this year but more likely the global economy will continue along just fine.
• Inflation is generally under control and global interest rates are low.

Guessing at the Future:

• We are in a very special period that began with the end of the Cold War and with it, the end of central planning.
• This brought 100 mln people into the world economy (i.e. Russia).
• The same can be said about China's opening up and its continued rural to urban migration:
  • Wage rates down
  • Prices down
  • Inflation down
• The high savings rate in Asia has also contributed to liquidity and lower interest rates.
• The peak in the direction of change in China is probably still 2-3 years away.
• At some point, this will start to reverse and we will return to a world more like pre-1995.
• In the short run, things are still reasonably good but the current cycle is mature.

Q & A for Mr. Greenspan

• The sub-prime market problems are serious.
• This is due to a lack of home equity.
• Little indication that it has spread to the primary market because the primary market has a greater percentage of home equity.
• He does not expect a fall-out on other lending.
• It is not clear what impact housing values have had on consumer spending and what will happen with a cooling in prices.
• The U.S. trade deficit with China is currency related.
• Just look at the build-up of reserves in China to almost $1 trillion.
• It's in China's best interest to stop building these reserves.
• Why is the Yen carry trade persisting? If demand to borrow is high, then rates should move higher.
• The reason it hasn't is the high savings rates of Japanese and their holdings of JGB's.
• The collapse in Japanese real estate had large implications for Japanese banks - could not determine their net worth for a number of years.
• Question is that U.S. energy policy is driving higher price inflation (for example, food)
• Offset is that U.S. economy has grown less commodity intensive over the last 10-20 years.
• Does he think it is meaningful to the inflation outlook?
• Unit labour cost is the key to watch in his view.
• The decline in real interest rates has caused the build-up of global liquidity.
• When the decline ends, liquidity will drop and certain asset categories will see a reduction in values.
• And when it happens, it will happen quickly.
• Hedge funds seek to exploit inefficiencies and make the economy more efficient and therefore we should be careful about regulating them. They play an important role.
• Real rates are rising in China but prices are still dropping suggesting that productivity is still rising.
• At some point this will stop and Chinese inflation will begin to increase but it does not appear to be happening in the near term.
• India is not the factor in could be because of bureaucracy.

Addendum

Never wanting to miss an idea and always trying to keep an open mind, I offer the following comments from Juan Enriquez, the genomics speaker and expert:

"The first protein structure was unraveled in 1957.... By 1990, only 589 protein structures were publicly available....   And it cost hundreds of thousands of dollars to unravel each protein...A process that took three to five man years. But things are getting a lot faster.... By mid-2000, there were 12,777 proteins published. Argonne National Lab has characterized a 3-D protein crystal structure in 6 ½ hours... In January 2001, a company claimed it had 115, 693 distinct proteins.... Celera now wants to sequence thousands of proteins per hour. It just got its first Beta machine from PE Biosystems...

The first of 100...

And soon hopes to unravel 30,000 protein structures....per machine...per day.

As gene maps open a new world...Celera is ground zero.

Sam Broder.... One of the worlds greatest brains.... AIDS research....ex. Head of the National Cancer Institute...Who could have worked in any number of NGO's hospitals, corporations or universities...

Chose to become Celera's chief medical officer... Because that is where he thought he had the best chance...of identifying proteins in blood in spinal fluid...to diagnose cancer before symptoms appear while helping develop cancer-specific vaccines.

Broder's office is next to that of a soft spoken gentle giant...Ham Smith...Who won the Nobel Prize in 1978

Celera's small group of privateers...took on governments, companies and universities around the world...with a project that seemed impossible.

And accelerated everyone's timetable by years. It is because of their drive and ambition that we now have two rough images of four species.

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