Chris Lee & Partners Ltd

Taking Stock 19 December 2024

James Lee is joining Chris Lee & Partners as chairman after a 23-year career with Jarden, culminating in six years as its chief executive. Chris Lee & Partners is delighted to have James join the company. He writes the last Taking Stock for 2024.

“This will be the defining learning opportunity in your lifetime, James.”

Those words still sit with me today. At the time, it was the GFC, and the words seemed far from the truth. Markets were tumbling, the Bank of England had just announced its first rescue package, and all investors were under significant strain.

My daily ritual at Jarden in 2008 started with a conversation with three people. The late Lloyd Morrison was generally in competition to be first, and the then Head of Alliance Bernstein was another contender.

What Lloyd meant was that, in times of intense strain, you are forced to learn and innovate. If you embrace the lessons - not the fear of a situation - when environments turn, you will be materially better off. This lesson, coupled with sharing my father’s love of writing, means I end each year with a reflective mindset, which prepares me for the standard Saturday afternoon bbq question: “What does the year ahead hold in store for us?” 

Taking Stock today is my response.

This time last year, we were faced with some significant challenges: two global wars, record debt-to-GDP ratios, stubborn inflation, record heat, and increasing unemployment. None of that should have been good for markets, but the impact was hidden behind the veil of record markets, driven largely by the promise of an AI revolution, leading most markets to rise between 10% and 25% in 2024.

When we look to the year ahead, we see one with lower interest rates, hopes of ceasefires in the Ukraine and Gaza conflicts, inflation closer to acceptable levels, and large investment into new technology. This has led many professionals and non-professionals taking to social media to talk about the expected recovery in 2025. I would venture that when the new year rolls in, the local papers will be full of views suggesting equity returns will be around 10% next year.

In my mind, this is at best an educated wish (at worst, self-serving sales propaganda), as it ignores the reality of what makes us human - our emotions, which for most of us are driven by our confidence. After five challenging years, the average person’s resilience and confidence are low. Fear lurks.

When I think about the year ahead, I look back and remind myself of the biases and learnings from my own experiences. I then consider what is useful to colour my view of the future.

I started my career at the peak of the dot-com boom, 25 years ago. At the time, the markets were soaring, fuelled by the idea that the internet would change our lives. So everyone started an online store. This demand for the internet meant telecommunication infrastructure players, which made this possible, were seen as a sure-fire bet.

The problem at the time was that everyone needed either venture capital (VC) or public money via an IPO to fund their losses as they tried to create the new world order.

The two material stories at the time were Amazon and CISCO. Amazon was a bright star, using the technology to change how we shopped, while CISCO was the global leader in the infrastructure required to service this demand (these were the historical equivalents of OpenAI and NVIDIA).

CISCO's revenue went from $4 billion in 1996 to nearly $20 billion in 2000, while its market cap grew from $30 billion to nearly $700 billion, meaning its revenue multiple went from around 7x to nearly 35x. Amazon grew revenue from $15 million to $1.6 billion. Its market cap went from $500 million to $25 billion. Everyone was trying to copy these two market darlings - either by creating new online stores, like Pets.com, or infrastructure, like Nortel Networks.

The reality was that the technology was so new that the business models of users like Amazon and Pets.com just weren’t profitable. So, VC and public markets stopped funding their growth. This meant the unrelenting demand for new infrastructure ceased, leaving a material oversupply, too much debt, failed dreams, and badly stung investors.

From the peak of 1999, Amazon and CISCO lost more than 80% of their value, while many others just went broke.

While the history books focus on the wipeout of value and effectively make fun of what were preposterous ideas (such as Pets.com), what can’t be forgotten is the advancements this period brought. Today, internet shopping and the infrastructure that supports the internet have changed the way we live our lives. Amazon is a $2 trillion company, while CISCO generates over $50 billion in revenue.

Our lessons from that period were that the market correctly predicted that the internet and online sales would fundamentally change the world, but it had little ability to determine how long it would take and who would win. What it taught us, though, is that despite the constant comment of “a new paradigm”, rationality always returns. But as the adage goes, the market can stay irrational longer than an investor can stay liquid.

It is this bias that guides my view of 2025. It is likely the global economy will get easier, but it is very unlikely to snap back quickly. The protection we received last year in terms of investment into AI and AI-associated infrastructure is likely to continue for a while, but for how long, and how fast it falls, is completely unknown.

The similarities to 1999 are hard to ignore. There are few commercially viable uses for AI, given the extraordinary energy and infrastructure costs. Data centres and AI infrastructure are premised on demand continuing to grow for decades to come, but at what point will the $1.1 trillion going into AI be measured by its returns?

That isn’t to say there won’t be extraordinary winners from the ability to synthesise and comprehend large complex data in healthcare, pharmaceuticals, and energy. But not everyone will get it right, and progress will not be as fast as investors might hope.

Given so many of our returns last year were driven by AI-related stocks, it is a relatively aggressive bet to suggest markets will repeat the same performance next year. NVIDIA is valued at $3.5 trillion (up 172% this year) on revenues of $130 billion (up over 100%). That compares with a $360 billion market cap and $26 billion revenue three years ago. When revenue growth slows, what will the right valuation be?

If the funding for AI investment slows because people struggle to commercialise it, then will data centre growth stall? Will NVIDIA still be able to charge the same gross margin, or will it see competition? Will demand for power therefore stall? Will someone use AI to solve fusion, develop a battery that makes autonomous air travel possible, or create a pill form of the drugs that are so popular for weight loss?

My view on markets is that you should place a bet only when you feel better informed than the market. Today, the main global markets (which really means the US) are trading at expensive multiples by any standard, effectively factoring in full confidence in what is largely unknown.

Whenever that happens, in my mind it is the time to re-evaluate both our risk tolerance and ability to take risk.

Retired investors do not have to take risks with developing technology. They can revert to proven, stable sectors and companies.

While some would say that is why you invest passively - to avoid thinking about those risks - unfortunately today, 35% of the S&P 500 is weighted to just seven stocks. So passive investing effectively means you are taking a very clear and correlated risk related to the market's appetite to continue pouring capital into the unknown.

And this would be my response over the Christmas bbq period, when discussing investing in the S&P 500 next year. Is that a risk you understand well enough to take? Do you need to take that risk? If so, how much of your funds would be the right amount to embrace that risk?

Our advisers are skilled in matching both risk tolerance and risk capacity to your risk strategy.

My interest in financial markets began as a teenager filling in for Dad one summer, so I am both proud and pleased to take on the role of chairman of Chris Lee & Partners, to be a part of the conversation on understanding risk.

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We wish readers an enjoyable holiday period. Our office closes at 12pm on Friday 20 December and reopens on Wednesday 8 January. We will monitor emails over the break for anything urgent but will be unavailable via phone.

Chris Lee and Partners Limited

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Taking Stock - 12 December 2024

Fraser Hunter writes

In an age where the internet uses your digital footprint or even conversations within earshot of your phone to curate content it thinks you will want to see, it should probably come as no surprise that there has been a noticeable uptick in the frequency of gold-related stories popping up in my suggested news during my time at Chris Lee and Partners.A couple of weeks ago, this resulted in several suggested articles about the discovery of a “Supergiant Gold Deposit” in China appearing in my threads.Already one of the world’s largest producers and consumers of gold, China has a long-standing history with the metal, which has for centuries symbolised wealth and prosperity, underpinning steady demand. It also has positioned itself to have a stranglehold on the most precious metals.At first, I dismissed the announcement as China’s large population, expansive landmass, and economic strength have dulled the impact of such headlines. The more I considered it, the more questions came to mind. How material is this discovery? What impact might it have, especially with gold being such a major story in 2024? And, closer to home, how could it impact the prospects of a certain Central Otago gold mine?

The first thing that stands out about the Hunan discovery is its sheer scale. Officials estimate the deposit to be worth up to $83 billion, containing up to 1,100 tonnes of gold. If true, this would make it comfortably the largest known gold reserve in the world.The site reportedly consists of some 40 gold veins, with approximately 330 tonnes of gold already identified. The claimed quality of the gold is equally as impressive, averaging 138 grams of gold per tonne – significantly higher than most gold mines worldwide.To put this scale into perspective, the Hunan discovery would be approximately 30 times larger than the SMI Reserves assumed in its recent PFS. Or put another way, 300 years' supply at Bendigo's planned production rate of 125,000 ounces per year.

The timing of the discovery appears fortunate, coming at a time when China, along with other nations, have sought to use gold to diversify away from dependence on the US dollar. It also underpins questions about China’s geopolitical ambitions.This aligns with what we have seen with other strategic commodities like rare earth minerals, where China has sought dominance. This discovery would further solidify China’s position as the key player in the global commodities.

Along with the excitement around the announcement, there is also an underlying scepticism. China’s history of opaque reporting and exaggerated resource claims has led many to approach the news with caution.The World Gold Council, for instance, took the initial reserve estimate as “aspirational” until further drilling and independent analysis confirmed the scale and quality of the deposit.Additionally, Chinese mineral reporting does not provide any independent verification. Without this, the discovery could appear more about optics than substance.Even if the deposit estimates are correct, its location—at a depth of 300 metres—means it could be years away from production, meaning the impact on global gold supply is some way off. The global gold market currently produces around 3,600 tonnes per annum.

Historically, there have also been several examples underpinning the need for caution around this type of announcement.In 2020, media reported a 3,000 tonnes gold discovery in India, which quickly drove speculation of India's becoming a major power in the world gold market. The excitement was short-lived when it was confirmed the actual extractable gold amount was closer to 160 kgs, a mere fraction of the initial claim.The more entertaining story is the 1990s scandal of Bre-X, since turned into a 2016 film “Gold” starring Matthew McConaughey (spoilers ahead).In 1995, a small Canadian mining company, Bre-X, claimed to have discovered a massive gold deposit in Indonesia. The claims sent Bre-X’s stock price soaring, reaching a peak market value of over US$6 billion—or approximately 15–20% of Microsoft’s market cap at the time. Over time, the discovery was revealed to be one of the largest frauds in mining history, with tampered samples and no actual gold deposits. The fallout devastated investors and was a major driver of changes in global mining industry regulations.

The Hunan discovery also comes at a time when the gold price is having one of its strongest bull runs in recent history. Over the last year, the price of gold has risen by +36% in USD terms (44% in NZD), closely matching the S&P 500’s gains over the same period.This is especially notable, as gold is often viewed as a “safe haven” investment used as a hedge during times of economic uncertainty or market volatility. Typically, gold and equities move in opposite directions, but 2024 has so far been an exception.Longer-term performance has also been strong, with gold increasing nearly ten-fold since the start of the century, rising from $279 per ounce to its recent highs of $2,789 set in October.This sustained performance has lifted gold’s appeal as a mainstream portfolio asset class and has in turn resulted in a number of new investment options coming to market.In New Zealand, the newest being Smart Invest’s recently launched Gold ETF, which provides a New Zealand-based equivalent to the global gold-backed ETFs. There has also been a rise in demand for physical gold storage companies such as NZ Vault, which stores precious metals in a former BNZ vault in central Wellington. Additionally, listed gold producers like Newmont and early-stage prospects offer opportunities for those seeking exposure to the gold market’s continued growth.

Rising gold prices boost profitability, clean up their balance sheets, and encourage firms to look for growth in the form of new reserves or add high-quality assets. This drives exploration and acquisition activity within the sector as the major players look to take advantage of favourable market conditions and valuations.Notable recent deals include Newmont’s A$19 billion acquisition of Newcrest (NCM.ASX), which created the world’s largest gold miner, and Northern Star’s (NST.ASX) recent A$5 billion acquisition of De Grey Mining (DEG.ASX).It is the latter deal that should be of particular interest to Santana shareholders as the De Grey project was some 12-18 months away from production and had recently raised capital via share market placement and debt (May 2024) to fund project development.

For me, the appeal of Santana as an investment has never been tied to the broader appeal of gold or speculation about future gold prices. It has been more about identifying a potentially mispriced opportunity before the rest of the market catches on. A strong gold price is the kicker.Santana’s discount to Australian peers has been a significant part of this upside, driven largely by doubts about New Zealand’s willingness to approve a new major mining project, an overhang of the previous government.In the near future the company has a few key milestones that could help bridge this valuation gap. The anticipated fast-track legislation approval, expected before Christmas and the submission and approval of consent applications - hopefully within the first half of 2025 - would mark important steps forward for the project. Achieving these milestones could provide clarity and confidence to investors, potentially narrowing Santana’s discount to its peers.

At current share prices, I think there is also some risk of corporate activity involving Santana. Its modest $300m market cap could easily be swallowed up by a larger player looking for a future asset to bring online. It is also a company hungry for capital and with a relatively open shareholder base. All of this combines to make it a potentially attractive target for opportunistic acquirers, many of which will have followed the Santana findings over the last couple of years.

I generally find takeovers disappointing, especially when it comes to companies with unique traits or compelling growth prospects. A reminder of this came in a recent article about Diligent, the former NZX-listed growth company which was purchased in 2016 for US$624m. Diligent is now reportedly being marketed for sale by its private equity owners at a valuation close to US$7 billion, or roughly the market cap of Infratil.In past takeovers, a rule of thumb I’ve heard is a 30% premium price should be good enough for investors to take the money and go do something else.De Grey was acquired at an implied price of A$2.08, or a 37% premium to its share price in the lead-up to the announcement. I would view a similar ending for Santana as incredibly disappointing, but it’s a possibility that investors should keep in mind.

Fraser Hunter

Chris Lee & Partners Limited

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Taking Stock 5 December 2024

AS THE calendar year stumbles to its end, one cannot review 2024 and seek an understanding of financial market direction without a concession to utter confusion.

No investor will misunderstand the main events that dominated the globe in 2024:

- Wars destroying lives and trillions of dollars of infrastructural assets.

- Immense increase in sovereign debt, China and the USA the biggest borrowers, debt servicing being met by more debt! US debt is now US$38 trillion.  It was US$1 trillion 24 years ago.

- Fiscal deficits everywhere, at levels that defy all historically valid guidelines.

- Uncontrolled immigration with desperate people seeking new lives in countries with cultures so varied as to be almost reconcilable with immigrants.

- Weather events creating havoc, making many coastal areas uninsurable, perhaps uninhabitable in the future.

- Demographics, highlighting the potentially calamitous drop-off of birth rates in developed countries, raising the issue of how pensions will be sustainable.

So how did financial markets respond to these unsolved messes?

Interest rates fell, making yet more borrowing apparently affordable.

Debt-fuelled US saw its dollar strengthen against most currencies.

Housing prices rose, though not in China. Inequality becomes entrenched.

Sharemarkets soared, as listed below, the biggest gainers, quite extraordinarily, being the world's weakest and most volatile economies (Argentina, Venezuela, Pakistan, Turkey).

Globally, interest rates vary from improbably low (most of Europe, China) to hideously expensive.

(These rates are drawn from available data at time of writing – pricing in local currencies).

Developed Markets:

US 10-year bonds: 4.21%Germany: 2.09%UK: 4.24%Japan: 1.08%Australia: 4.34%New Zealand: 4.34%India: 6.71%Israel: 4.90%China: 2.08%

Emerging Markets:

Turkey: 28.67%Russia: 15.13%Bangladesh: 12.89%Brazil: 12.01%Mexico: 10.47%Indonesia: 7.27%Venezuela: 10.43%Greece: 2.93%

Argentina’s overnight central bank rate is around 35%!

Yet consider these sharemarket returns year to date, with the figures alongside the bond or cash rates.

Share Index (YTD):

Argentina: +142%Venezuela: +85%Turkey: +29%Nigeria: +30%Israel: +23%Pakistan: +62%

Cash or Bond Rate:

Argentina: 35% (cash)Venezuela: 10% (10-year bonds)Turkey: 28% (10-year bonds)Nigeria: 21% (10-year bonds)Israel: 5% (10-year bonds)Pakistan: 11% (10-year bonds)

Does this imply that investors (fund managers) seek out high returns in those markets with the highest cost of money? Is this “long-term” investing, to find sustainable value?

Such logic would be lost on me.

Is Israel's market reflecting its various wars? How does war correlate with economic success?

As noted at the start of this article, confusion reigns (in our office anyway).

Why would fund managers invest in low-yielding bonds in the likes of Greece, Spain, France, Italy, (all less than 3% 10-year bond rates)? The European Central Bank might be the effective guarantor only for as long as Germany tolerates this. Does the collapse of the German coalition government reflect disagreement with the concept of Germany underwriting the likes of Italy and Greece? How close to collapse is the French government?

If Germany is having to fund the Ukraine war while Germany’s critically important auto industry is in disarray. For how long will Germany’s people tolerate the outcome – effectively, austerity; no room for wage increases, tax cuts, or welfare increases? Wages there are lower than in Greece.

Such conundrums abound.

An equally fair question centres on the large fiscal deficits everywhere, with the political determination not to broaden the tax base for fear of losing what are now high-paying, political jobs, largely paid to those whose careers have been limited to the public sector. (What happened to the Holyoake days of community service?) Have high salaries attracted into politics people with the wrong motivation?

To review 2024, and to anticipate 2025, without any reflections on those underlying oddities would be to avert one's eyes from the obvious.

In NZ, interest rates have fallen, job vacancies have fallen, despite some public sector cuts the public sector still is at or around historically high levels, and the new government will operate with huge deficits, yet without a plan to maintain, let alone improve, infrastructure.

Yet no tax reform seems likely, democracy delivers often the least experienced and most inappropriate people (Tory Whanau, anyone?), while governments and councils rack up ever greater debts.

Meanwhile the sharemarket rises inexorably, here and in most countries. Our sharemarket has risen by a double-digit figure amount (around 11%). 

Perhaps there is an explanation for share price rises.

One could argue that if the world keeps printing money (tens of trillions in the last five years) and the money trickles to the wealthy, then that money is going to be invested in assets or in sharemarkets.

The growth investment products today are exchange-traded funds, which by their own covenants must invest without regard to price or value. They invest in existing assets, mostly in shares, without regard to value.

In the USA decades ago, there were around 8,500 public companies listed on stock exchanges.

Today, there are around 4,300 companies that are listed.

If you print money, and it ends up in the hands of investors, who use ETFs, which invest indiscriminately in a diminishing pool of listed shares, then share prices will respond to the laws of diminishing supply and increasing demand. Prices rise inexorably. This may seem stupid, but it is logical.

Just in NZ, there were 400 (plus) listed NZX companies in 1987. Today there are around 140, similar to the ratios in the US, over the 40-year period.

Traditionally, US companies were priced at about 9 to 12 times their forecasted earnings, sometimes as low as 5 times earnings.

Today, the US markets are priced at 22 times the forecasted earnings, though if you extract the top seven technology stocks (Nvidia, Amazon, Meta, Microsoft, Alphabet etc) then the US market is priced at a lower, but still lofty, 16 times forward earnings. Investors might thank (or blame) ETFs.

The effect on investors is similar to the effect of thin air at great heights on mountaineers.

It makes people giddy and increases poor decision-making.

The NZ sharemarket highlights of 2024 included the continued, inexorable progress of Infratil towards its eventual, inevitable status of New Zealand’s biggest company. Just two years ago it had a rights issue at around $4.50.

Today its share price is near to $13. Its valuers have extreme expectations on the worth of Infratil’s data centres.

Infratil’s progress has been admirable; astonishing even.

The recovery of Fonterra is another great story. Its shareholders owe a deafening round of applause to its chairman and its smartest directors, one of whom, Leonie Guiney, has spent years urging the changes that have restored Fonterra. She retired recently, a true Hall of Fame candidate.

Ebos and Fisher & Paykel Healthcare have grown in value relentlessly, and, like Mainfreight, have been governed well.

Air New Zealand and Fletcher Building have been major companies that could do with smarter governance, Air New Zealand perhaps a victim of government involvement in conflating social and financial objectives in what must be extremely awkward times for the hardworking CEO, Greg Foran. Perhaps Air NZ should be wholly-owned by the Crown.

Among the most exciting prospects must be Santana, with its gold mining project apparently understood by the politicians. They would be eyeing the potential royalties and taxes that would accompany the $300-$400 million forecasted nett profits, that assume gold prices do not retreat dramatically.

Such profits would see Santana reach the NZX Top 20. Its entry to the NZX 50 seems imminent, as shareholders shunt their shares to the NZ registry.

Older investors, and those who are cautious, will be watching the low-risk property trusts, which are enjoying bank debt servicing reductions and better valuations (for whatever they are worth).

Properties are “valued” at a multiple of nett returns. Lower interest costs help the nett returns.

Of course there is inherent in most properties the issue of tenant robustness. Tenants fail. Property trusts bear the cost. Unlisted syndicates seem especially vulnerable.

The most resilient stocks have been the power companies, the banks, and the small number of excellent companies which maintain competitive advantage and proper margins.

Hallensteins is a long-term surprise example.

There are a small number of good companies needing time to prove or disprove their strategy.

Heartland buying a bank in Australia was a strategy that should unlock better margins by 2027/28. At its current price it must be at risk of a private takeover.

Eroad has tested the patience of investors and made some awful communication errors but hopes to gain business as countries move towards road tax, away from fuel tax. It does have repeat revenues of nearly $200 million.

The retirement villages grew too fast, using models that had been too optimistic. The value of their real estate is real. Time should bring shares prices and underlying value together. Demand is inevitable given that there is no other access to geriatric health support. Their survival is critical (Recall the childish analysis that figured the villages were “profiteering”?)

Some must also be at risk of private equity takeover bids.

All the confusing market behaviour, decoupling prices from the fragile global environment, makes forecasting 2025 a dangerous game.

But as this is my last Taking Stock for 2024 – Fraser and James will write the next two – I offer the following (as I head off to Lake Taupo and then Waiheke for some beachcombing and golf):-

1. Trump will be denied by checks and balances from executing most of his promises. But he will run ever bigger deficits. Expect the Federal Reserve to be stoic. US interest rates might keep the US Dollar strong. Tariffs, if threats are realised, would fuel up inflation and interest rates.

2. If US interest rates remain near current levels, given the immense size of their borrowing needs, global rates might not fall to the expected levels. The US Treasury rates are critically important. In NZ, real inflation is not, and probably rarely has been, less than 2%, except for the mythical person who has a large mortgage and spends his disposable income on technology-driven appliances and devices. I do not plan on the Reserve Bank cash rate falling much below 3.75%. The 10-year bond rate may stay in the 4% - 4.5% range. Corporate bond rates will need to be at a premium to government bond rates. In 2025 I expect corporate senior bonds to be around 5%, and bank subordinated bonds to be offered around 6% - 7%. Mortgage rates may bottom out in 2025.

3. The NZX listings are boosted by pension savings. The smart managers, of which there are two big ones (Milford and Harbour) will enjoy the expected fall in the NZ Dollar, harvesting gains from careful selections of the world’s smartest companies. Those who slavishly follow an index might produce glum results. Hedging the currency might be wasteful. Stock selection will be critical. Excellence is a worthy objective. Note that even Warren Buffett has a staggering US$350 billion uninvested because he invests only when there is value in the price.

4. Many private equity funds would be forced to discount their valuations were they required to provide redemptions. Withdrawals often come in surges, when confidence is tested. Private credit funds will need to be imaginative to hide provisioning for looming bad debts. Such funds take on risk to achieve high returns. Buyer beware.

5. Bitcoin is clearly now an asset class supported by those managing other people’s money. I have no idea if or when the music will stop. Tulip bulbs did have a purpose in the 17th century.

6. Liquidators will make handsome profits. Our retail sector still survives on lean pickings, for now. Liquidations in 2024 rose by 27%. Tourism, hospitality, and even horticulture and non-dairy agriculture all face threats of higher costs and lower revenue. Unlisted property syndicates look vulnerable.

Repeat: asset selection will be important. So will asset allocation. Many investors do not have to chase high returns. For those in retirement, spending capital by choice is far better than chasing high returns and losing capital.

For fifty years I have worked in capital markets. Next year will be the 40th year of governing and managing our business. I am heading to twilight.

Watch for the new blood. Edward and his team are refreshing our offerings.

I will remain a director and hope to be well enough to work for some time yet, and to pretend that I still matter. Our new chairman James Lee will have value to add to our progress.

The challenges of the new environment are compelling, if daunting.

Season’s greetings. May 2025 bring good health, good fun, and may the gold price be strong!

Chris Lee

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