1993 was a gratifying year for us considering much of what we thought has not transpired. Our German debt’s appreciation was partly neutralized by the decline in the currency. Much to our amazement the stock and bond markets continued to march higher, although there was some serious sub-surface weakness. Our good returns were the result of the increase in the price of the gold equities even though the metal itself has been lagging a bit. As we have said to many of you, “Can you imagine if we actually ever get it right?”
As we have pointed out numerous times, the American and international market’s phenomenal climb has been largely the result of the public’s disgorging their savings into all forms of mutual funds. To quote Alan Abelson, “1993 was a great year for the emerging stock markets and their domestic counterparts, riverboat gambling casinos.” We are convinced that the explosive increase in the value of financial assets is not sustainable. We do know that the supply of securities is setting all-time records, but the amount of cash to buy them is diminishing rapidly.
Commonplace expectations of 20% and greater returns on a regular basis are now the norm. The bull market of the last nineteen years has generated extreme complacency. Consider this: an investment by the well known Medici family 600 years ago of $100,000, at a 5% compounded rate of return, would now be worth over $500,000,000,000,000,000 (five hundred quadrillions). Would today’s investor accept such meager results as 5%?
It is obvious that the relationship between paper assets and what they represent have long since parted company. This type of euphoria is what risk is made of. The ultimate change in psychology will probably be caused by a subtle event. Conceivably it has already happened.
Which brings us to how to make money going forward. We continue to feel that our precious metals investment has much further to go, albeit with uncomfortable interruptions. As we’ve discussed before, the metals themselves are simply in short supply. They are a currency alternative, and the primary source of savings to the fastest growing economies in the world, principally the Chinese.
Lastly, it appears that the seeds for inflation have been sown. In the face of virtually every prognosticator’s forecast that inflation will be no problem this year, commodity prices rose over 13% in 1993 to a 3 ½ year high. This has occurred in spite of a major decline in the cost of energy.
The Federal Reserve has been expanding the monetary base very rapidly for more than two years. American manufacturers are paring themselves down to the point that they have extremely limited inventories of raw materials and labor. If the economy continues to improve as we suspect it will, shortages will quickly develop. Commercial and industrial loans become increasingly more attractive to banks in such an environment, which, given the Central Bank’s policy, ensures the money supply will grow dramatically. The only outcome can be inflation.
One opportunity to profit from these conditions is Gulf Oil of Canada. It is a large North American natural gas producer with a steadily improving balance sheet. It sells for somewhere between 2 and 3 times cash flow, depending upon your level of optimism as to the future price of the underlying resource. After production, reserves have grown every year. Gulf lives under a cloud as 70% of the stock was owned by Olympia and York, and is now in the hands of creditors. The perceived risk is that they will sell and drive the price down. We assure you they will sell. As in many similar cases the cloud will be lifted. Sooner or later a better understanding of the company will develop and it will be valued at least commensurate with its competitors.
We have also recently purchased Catellus Development. It was created out of a spin-off from Santa Fe Southern Pacific R.R. and is by far the largest property owner in California. It mainly owns industrial parks and raw land. For the most part, the income producing side is in the north, is in good condition, and cash flow positive. Amongst the principal shareholders are some very clever real estate people that presently have a
substantial paper loss. Northern California retail tax receipts are up very substantially year over year which would lead one to believe that the local economy is finally improving. Both the fact that inflation is on the rise and business is getting better should at least create the perception that real estate is becoming attractive. We are paying a meaningful discount from the true worth of the property and we own a convertible preferred, which should provide some stability as well as income while we wait.
In conclusion, we feel that with a little good fortune we are well positioned for profits.
Wishing you and yours a healthy, happy, and prosperous New Year.
Sincerely,
Edwin A. Levy
Michael J. Harkins
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LEVY, HARKINS & CO., INC.
In 1993 our average account appreciated 21% from all sources, inclusive of all fees.
The statistics below are also from 1993:
GNP Price Deflator………………………..…………+2.6
Consumer Price Index…………………………….….+2.7
Average Treasury Bill Rate……………………….….+3.0
Standard and Poors 500 Appreciation………....……..+7.1
Dow Jones Industrial Appreciation………………....+13.7
New York Composite…………………………………+7.9
Note: The figures above represent the composite performance of all fully discretionary, balance accounts. These figures exclude accounts managed for less than 6 months, accounts using short selling and accounts consisting only of fixed income investments, to more accurately reflect the past performance of fully discretionary, balanced accounts. However, past performance is no guarantee of future results.