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Chaos in Iraq could bode well for North American oil producers

A few random ramblings on the markets and the macro investing situation to start the week:

Iraq

The turmoil and chaos in Iraq is putting a bid under the energy markets. This of course is helping to escalate the price of crude oil and energy cost worldwide. I have a couple takes on this, outside of the fact that increasing unrest in the Middle East and its possible contagion will escalate the “fear premium” in crude.

1. North American oil is becoming more valuable. All the unrest in politically unstable regimes throughout the world that supply the global market with crude (Libya, Russia, Iraq) is making secure and politically stable regimes and countries with energy resources more attractive. This bodes very well for North American investment and energy supplies. Canadian tar sand producers which have some of the largest reserves locked in secure and stable regimes should benefit immensely if this instability escalates and spreads.

2. Geographic energy polarisation will rise. The result of this instability and the likely further push to invest locally will increase the world energy polarisation. We are likely to begin shifting at an ever-increasing rate towards North American energy independence — i.e. between the massive increase in US shale production, Canadian tar sand production and Mexican reinvestment, North America is increasingly becoming less dependent on Middle East oil. This could further destabilise the Middle East if western powers that have traditionally offered some form of military stabilisation get increasingly disinterested. It also means Asia will dominate Middle East consumption (think China) and energy pacts will become increasingly East vs. West. A perfect example of this is the Russia/China gas deal that pivots gas to Asia away from Western Europe. The political divide and trade flow implications are likely to continue to evolve.

Endowment and Pension Fund Shortfalls? Blame Alternative Investments

At the recent Trustee Leadership Forum for Retirement Security held at Harvard's Kennedy School of Government, an attempt was made to explain why so many state pensions are underfunded and underperforming. The event produced a consensus that the Yale model — outsize investments in hedge funds, venture capital and private equity — no longer works. This model's performance numbers over the last ten years have quite frankly been horrible. A large reason for this is that corporate pensions and university endowments have missed the rally in stocks since 2009. According to Gregory Zuckerman of the Wall Street Journal: “The average college endowment had 16 percent of its investment portfolio in US stocks as of the end of June 2013, the most recent academic year, according to a poll of 835 schools conducted by Commonfund, an organisation that helps invest money for colleges. That is down from 23 percent in 2008 and 32 percent a decade ago. What is shocking is that the Commonfund poll also suggests that the $450 billion in endowments had 53 percent of their assets in alternatives strategies recently, up from 33 percent in 2003.

This would explain a great deal of their underperformance. Pension funds are not much different — alternative investments now make up 25 percent of portfolios, up from 10 percent a decade ago. Why? I can't prove it but I'll blame it on fear and misplaced marketing. For some reason consultants and their glossy pitch books always seem to claim higher returns than traditional financial assets and have generated much inflated expectations. Add to this by playing on a person's fear and recency bias and you get trustees migrating from what appears to be a higher return in a much safer asset class.

However, it generally pays to disregard excessive hype — if it looks too good to be true it probably is. High expectations and marketed future returns are NOT guaranteed. It also pays to acknowledge what you pay — i.e. the fees charged by hedge funds and private equity fund are still far too high in many cases to justify the returns they are producing. Furthermore, for many markets they play in it requires, to some extent, higher volatility to generate decent returns. The current low volatility and low interest rate environment makes it difficult for many hedge funds to achieve their performance goals. Finally increased competition also reduces excess returns as the sector as a whole continues to become more crowded.

An Island Tries to Transform — Japan

Prime Minister Shinzo Abe's government has finalised a new plan for economic growth. This ambitious package of economic reforms is aimed at revitalising corporate earnings and setting in motion structural changes that put the nation back on a clear path to growth. This strategy follows Abe's first attempt at structural reforms last year where he began the fight against low growth and deflation. Some of the key components of the plan include:

— Corporate Taxes- to be cut below 30 percent from above 35 percent.

— Investing — Pushing pension funds to buy more stocks and indicating tougher corporate governance rules for officers and directors.

— Labour Rules — encouraging more woman workers, taking in more immigrants, and making more flexible work rules.

— Energy — end utility monopolies, restart nuclear reactors.

— Deregulation — cutting red-tape and building special economic zones.

— Gambling — legalise gambling to boost tourism ahead of the Tokyo Olympics 2020 (hot button issue such as this challenge's Japan's normally conservative culture).

While the economic impact of these measures is debatable, I believe it signals how devoted the country is to reform. The aggressiveness of these measures, the signalling of a commitment to growth and the willingness to tackle stale cultural issues may be the shot in the arm necessary to revive Japan's markets and economy. Overall these are great policies for any island with stagnant GDP and a shrinking population … hmmm … sounds like a familiar situation …

Nathan Kowalski is the chief financial officer of Anchor Investment Management Ltd. The views expressed are his own.

Boost from Iraq: The Athabasca oil extraction plant in Canada

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Published June 30, 2014 at 9:00 am (Updated June 29, 2014 at 5:58 pm)

Chaos in Iraq could bode well for North American oil producers

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