Chris Lee & Partners Ltd

Taking Stock 26 October 2023

WHEN international financial analysts seek to read tea leaves, two of their first considerations are the trends of interest rates and the trajectory of oil prices.

Interest rates are discussed daily. We know that the risk-free 10-year rate is 5.5% in NZ, and bounces around 5% in the world's biggest economy, the USA.

We know that central banks aspire to suppress inflation to a boundary of 1-3% and use interest rates to incentivise or disincentivise demand. (They do not focus enough on supply, the other part of the equation from which inflation results.)

The subject of oil prices is much more difficult, given the world's biggest supplier (Saudi Arabia) is sufficiently strong financially that it could materially alter supply by decree.

By turning off its taps, it can alter supply so quickly that oil can and does vary in price by 20% or more in the space of a few months. The world consumes around 97 million barrels of oil daily or 35 billion each year, having increased consumption since 2012 by 10%, despite climate change pressure.

Demand does not vary much. Supply is at the whim of producers.

Saudi Arabia’s chief supplier is Saudi Aramco, the state-owned oil and natural gas company, headquartered in Dhahran, where Saudi Arabia’s oil was first found.

It owns the world's second largest reserves, 270 billion barrels, and is the world's largest producer, managing 100 oil and gas fields, including 300 trillion cubic feet of gas. It supplies around 12% of the oil consumed annually.

Aramco has arisen out of the exploration successes of Standard Oil of California (SoCal) which struck oil in Bahrain in 1932 and was granted exploration licences by Saudi Arabia in 1933 at a time when Saudi Arabia was a desperately poor country.

For three years the exploration was fruitless so in 1936 SoCal sold 50% of its licence to Texaco. Two years later the new joint venture discovered oil in Dhahran and changed its name to Arabian American Oil (Aramco).

After WWII the company now known as Exxon bought 30% of Aramco, and the company now known as Mobil bought 10%, the remaining 60% shared by SoCal and Texaco.

The Saudi Arabian government finally exercised its muscle in 1950, after Aramco breached the border of the Emirate of Abu Dhabi.

Saudi Arabia's king threatened to nationalise Aramco while negotiating a 50/50 profit share with the American-owned group.

For geopolitical reasons, the US government granted monumental tax concessions to the American owners to ensure the 50/50 split was achieved peacefully, and without losses for its American oil companies.

Headquarters moved from New York to Dhahran.

A year later Aramco discovered the world's biggest offshore oilfield. At that time gas was flared but by 1975 the Saudi Arabian authorities had recognised the value of gas and allowed it to be used to generate power.

In 1973, US support for Israel led to the Saudi Arabian government buying a 25% “participation interest” in Aramco, increased that to 60% by decree in 1974 and by 1976 had taken over full ownership.

In 1983 a Royal Decree created the Saudi Arabian Oil Company to take control of all of Aramco’s activities.

The Persian Gulf War in 1990 saw Aramco take the initiative of underwriting production to ease shortages and to replace the absent production of Iraq and Kuwait. Daily production ramped up from 5.4 million barrels per day (bpd) to 8.5 million bpd.  Saudi Arabia began to direct its supplies to Asia, so by 2016, just seven years ago, 70% of Aramco crude oil was heading to Asia, primarily China.

Saudi Arabia’s production had been increasing dramatically.

By 2004 Aramco was producing 8.6 million bpd. The company had invested US$50 billion to increase production to 12.5 million bpd.

By 2008 oil had reached US$130 a barrel.

The most fervent of forecasters, Goldman Sachs, was then claiming that the globe had hit peak oil and that within a few years oil would be US$200 a barrel.

Who might have guessed that supply and demand, altered by American success in using its shale reserves, would lead to oil falling to US$10 a barrel?

Indeed, at one stage, the futures market had become so distorted that US President (Trump) announced he had bought for America a supply of oil for nothing bar a handshake and, probably, a supply of McDonald's cheeseburgers from his White House refrigerator.

Never let it be said that oil was priced logically!

In January 2016 Aramco had sold 5% of its shares to be listed on the Tadawul exchange (in Saudi Arabia) where it completely dominates the index, its market cap being around US$1.8 trillion, of an index with the total value of $2.2 trillion.

Initially Aramco listed 1.5% of its shares, raising $25.6 billion, accepting only 20% of the bids for the shares. Now 5% of the shares are listed.

The company has endured many attacks, varying from computer virus attacks from Iran, to bombing attacks from Yemen, and regular drone attacks.

During Covid its profitability was reduced (by 45%).

In 2021 Saudi Arabia signed a 50-year deal with China to supply oil and to co-develop technology. At the same time it committed to achieve nett-zero carbon emissions by 2060 and committed to increase production from 12 million bpd to 13 million by 2027.

For the year to May 2023 it made a record profit of US$161 billion. By contrast Exxon Mobil made $55 billion, and Shell $40 billion.

It had explored for oil in Pakistan, then abandoned that, and has diversified into shipbuilding, oil tanker ownership, and oil refineries, seeking a dominant role in liquefied natural gas.

It would be unwise to ignore carbon emissions.

In the 1960s, Aramco has emitted 59.2 billion tonnes of CO2, equivalent to 4.38% of the worldwide total emissions in that era, of anthropogenic emissions.

In summary, Saudi Arabia, via Aramco, is an enormous producer, the major influence on oil prices, a major emitter of CO2 equivalent and, through its ability to manipulate supply, is a controlling factor in oil prices and hence inflation.

Those of my age group will recall that in the 1960s, petrol in NZ was around three shillings and sixpence a gallon – 35c a gallon or eight cents a litre.

The average car could be filled at a cost of around $2-$3.

The average wage earner brought home around $2,000 in the late 1960s.

The Prime Minister, Keith Holyoake, earned a little more than $7,000 a year.

So for the average person, the filling up with petrol of a normal car cost around 5% of a weekly nett wage.

Today the average car can be filled for around $135.

The average weekly take home pay is around $1,100.

The cost of filling the average car has risen to 12% of take home pay from 5%.

Blame the Saudis!

The subject is so relevant today because of the volatility of supply, wars in the Middle East and Eastern Europe having the potential to drive petrol prices much higher, creating an accelerant for inflation.

At the same time, a growing percentage of the world wants to see fossil fuels eased out, reducing the anthropogenic emissions.

World famous old-time investor, Warren Buffett, and many other financial sages continue to buy into oil exploration and production, betting that the governments of the world will take many decades to wean us off oil.

While this debate is held, war threatens supply.

Inflation figures are sensitive to energy costs, oil and gas prominent in the calculation.

So do not bet too much on interest rates falling in the near future, on the back of falling fuel costs.

Perhaps bet on some new technology being funded with taxpayers’ money to find some miraculous solution.

Many are trying.

_ _ _ _ _ _ _ _ _ _ _ _

WE ARE now many years past the days when wise investors believed there was money to be made by newspaper groups and the television media, at least in New Zealand.

INL, a listed public company with an impressive market capitalisation, became Fairfax and for all the wrong reasons is now, in effect, Stuff, a group that may have been more honestly named had it added “ed” to its name.

Wilson & Horton was also a company whose shares were in most institutional portfolios. It is now NZME, a company that produces the NZ Herald, owns other media outlets, but is fighting for its life, making pitiful returns on its capital.

TV3’s transition to a public company was supported only by inept fund managers using other people's money. It lasted five minutes on the NZX and now we hear from its auditors that MediaWorks has a grave lack of shareholder funds and may well be heading for the financial cemetary.

Newspapers fail to attract enough readers, and thus fail to attract corporate advertising. They lost their gravy trains - classified advertising - years ago and now observe most young people have neither interest in, nor need for, any newspaper, preferring social media, Facebook etc, as their news source. The newspapers offerings have not helped their cause.

Private equity seems the only hope. The ambition of any new owner would exceed their common sense, in my opinion.

 Now we watch X, once named Twitter, being expelled by Stuff, a decision that is unlikely to be relevant to Twitter, which long ago would have realised that in 2023 Stuff rarely produces compelling journalism, being filled with the irrelevant musings of left-leaning bleak columnists, few of whom have ever created wealth or employment.

Perhaps Stuff has recognised that its central audience, Wellington, is a city of left-tilted public servants with neither interest in, nor appreciation of, wealth creation and high achievement.

Stuff’s lean thus might reflect its wish to humour its Wellington audience, a decision that might seem smart, given Wellington’s electoral outlier preferences in both central and local government elections.

If television and our two major newspaper groups are facing a death spiral, what set of investors would be interested in an invitation to inject capital or to plot a future for their business model? Few, if any, should even consider this.

Professionals should sidestep the sector, leaving the question of how the sector might find a funder.

Salvation, of course, might come via central government, which in recent times has sought to inject adrenalin, first with a “public interest” (come in, Tui) journalism handout of tax payer money, then with a classic bonfire of money investigating an improbable merger of television with radio, an aspiration that had no oxygen.

It remains remarkable that little Malta, with a population similar to Wellington (just 500,000 people), succeeds financially with a national paper printed in both English and Maltese.

It contains mostly international news of good quality, far more than either of NZ’s main newspapers, thus acknowledging the subjects that interest its audience - mostly seasoned adults.

The second secret might be the Maltese paper’s choice of columnists.

They seem to be people of achievement, rarely career academics, almost never undistinguished reporters wanting to interest readers in their cat, the size of their mortgage, their political views, or their ancestry. The columnists used by the Maltese paper mostly produce compelling reading.

If MediaWorks collapses, as suggested by its audited accounts (negative shareholders funds), NZ will have an even bigger pool of people wanting to earn a modest income by producing stuff for which there is a disappearing audience.

Might the solution be a takeover by the Council of Trade Unions, which might find an audience of scale from its membership numbers? Maybe Stuff’s strategy in Wellington hints at that outcome.

The reality for NZ newspapers is that the access, for a modest fee, to outstanding international newspapers has meant there is no room for politicised, parish pump stuff.

Ultimately, my preference would be for an Australasian newspaper with a two-page insert on their “east island” neighbours, written by a small handful of skilled, adult reporters.

Cost-free community papers, funded by local advertisements from the retail sector, might provide the training ground for reporters aspiring to a rewarding career with the national newspaper.

Whatever, investors should stay out of the sector.

So should governments, banks, fund managers and any wise equity group.

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Travel Dates

Our advisors will be in the following locations, on the dates below:

27 October – Christchurch – Fraser

1 November – Palmerston North – David

2 November – Lower Hutt – David

8 November – Auckland (Ellerslie) – Edward

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown - Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Taking Stock 19 October 2023

INVESTORS may feel enthused by the end of what one might call a political era when social ideology trumped wealth creation and arithmetic.

But there should be no expectation of any miracle solution for a country which has huge fiscal and trading deficits, poor productivity, an extreme level of bloat in its public sector, a weak currency and, most of all, a heavy reliance on foreign capital.

The most likely solutions for these problems no longer would be supported by the changing demographics, which produce a majority of adults who have demanded that the state is the insurer of personal money deficits.

Investors should watch the bond market, not listen to the media or politicians.

Those who feed the bond market have the power to determine the cost of supplying companies, households, and countries with the money to spend beyond their means. It is they who will force reform.

All the signals from the bond market suggest that those with the money no longer fear the pricing tension that would result from governments which print money, or borrow to spend (rather than to invest). Printing more money would be lunacy.

In the USA, where a set of problems similar to ours is evident, the US government must pay 5% for 30-year loans, and close to 5% for 10-year loans. That rate was much lower two years ago.

Its debt level has created a demand for money that plays into the hands of suppliers of funding.

Our problem is similar. We have lower debt levels than the USA but a much less credible currency.

The USA and NZ came through the borrowings for Covid by borrowing even more, printing money, and providing guarantees.

Both countries gave away money.

Neither country can now credibly print more money, indulge in quantitative easing (same thing as printing money), or manage their societies while imposing austerity. Voters, it seems, would not accept living standard falls.

The result will be long-term high interest rates.

The US 10-year bond rate last week reached its highest point (4.89%) for 15 years.

The NZ 10-year bond rate exceeds 5.5%.

Just two years ago our government could borrow 10-year money at much less than 1%.

The outcome of much higher debt costs is that the power of rate-setting, including the margin to offset risk, has transferred from central banks and governments to pension funds, sovereign wealth funds, banks and foreign investors.

Commercial banks have dumped US Treasuries to the tune (nett) of USD$300 billion in the past 15 months.

The US Treasury, which issued trillions and bought back trillions (quantitative easing), is so overstuffed with its own debt that it has publicly signalled its plan to discount back into the markets $60 billion every month, quitting the very bonds it paid a premium to buy during Covid. Showing your hand rarely works well for the desperate.

The Chinese have responded by selling hundreds of billions of US bonds.

Our political leaders, like Robertson and Ardern, clearly either did not receive useful advice (unlikely) or did not understand the importance of acting on that advice. Neither were financial market trained.

Our Treasury paid more than $60 billion to buy around $55 billion of bonds, that it still holds, but are now worth less than $50 billion.

That loss, as yet undeclared and possibly unrealised, will surface one day either as a giant loss ($10 billion, perhaps) or by hiding itself in much higher interest rate costs, caused by the political error.

Experienced market participants tell me the loss for NZ of that egregious error might be $12 billion, far surpassing any previous loss caused by a finance minister’s goofiness.  One imagines that the uncovering of the loss might be a priority for a new government, to ensure the blame is attached to those who made feckless decisions.

In the US, the annual deficit this year is forecast at $1.5 trillion.

Paying interest to the bondholders, many of whom are offshore, will eat around 14% of the US total tax take, a percentage similar to Britain's, which made the same panic decision in 2020/21.

The NZ interest expense will be nearer 7%, but it is rising and will head for double figures, unless we defer borrowings to rebuild infrastructure, or move to live within our means.

It is not only governments that will be fretting over the high cost of debt.

At least US $425 billion of low-grade corporate debt (referred to as “junk” debt, sometimes) must be refinanced in the next 24 months. Will the market subscribe for the new offers? At what price?

The current cost of that debt is around 9.25%, nearly 4% more than has been the case in most of the last seven years.

Rising costs of “junk” debt cuts into corporate profits, tests the courage of investors, increases default risk and, by staying at elevated levels, becomes a threat to the economy.

NZ investors face similar concerns. A new government will not fix that easily.

 _ _ _ _ _ _ _ _ _ _

As I discussed last week, an early signal of stress is evident in the property market, with the most fragile unlisted syndicates being the most vulnerable to higher, long-term interest rates.

 In recent weeks some such NZ syndicates have sought to make demands on their investors, one demand being for a capital increase of 30%, the money required either to buy interest rate swaps, or to meet repayment demands from banks.

The largely older investors trapped in these illiquid syndicates will not be enthused by shelling out tens of thousands of extra money for shares in a syndicate that pays little or no returns to the investors, is losing value (falling property prices) and may have been destined to fail in any debt market where loan servicing was expensive.

Globally, higher interest rates are an unaffordable proposition for governments because they have already grossly over-borrowed, just as our government has done. So have many property syndicators.

If the interest cost was 1%, as prevailed when the globe thought it could enforce ZIRP (zero interest rate policies), then the percentage of tax absorbed by interest cost might be 2%, or maybe 3% of our taxes.

If rates are 5%, that percentage of tax receipts becomes ugly, meaning deficits are bigger (then, more borrowings) or austerity begins (welfare cuts) or taxes must increase (realised capital gains tax, or more difficult, wealth taxes).

None of these conditions are easily digested by the private sector, which creates wealth.

No new government or Prime Minister will solve the maths, painlessly.

NZ investors and home buyers will be observing high interest rates for many years. The unlisted property sector is now revealing stress.

The most optimistic investors will hope that the private sector grows the nation’s wealth by improving productivity and by initiating successful new projects (gold discoveries may be a little help), and they will hope that no political ideology will require yet more borrowings to spend. Interest rates might then stabilise and perhaps ultimately fall.

Our new Prime Minister will understand this, thank heavens. He is intelligent.

Discipline, if not austerity, will be his best lieutenant.

_ _ _ _ _ _ _ _ _ _

So investors must reexamine their asset allocations, acknowledging that high debt servicing costs directly link to lower share prices.

Investors with a 10-year horizon may reflect on the amount of their capital they do not want to be volatile.

The one error they must not make is to accept guidance from unaccountable media commentators, or from unrelenting salesman such as we often see from the marketing people in the funds management sector, and from goofy government agencies.

Asset allocation is not structured solely to reflect age, it is not based on accepting that time solves all problems. Time may make problems worse.

It should be structured by needs, by defining the acceptance of risk and by being guided by one's ability to sleep when markets are weak.

For some time we might find a 5% return, without capital volatility, is rather more appropriate for most retired investors, than the hope that a new government will energise the business sector and help that sector to magical levels of profits and investment returns. 

_ _ _ _ _ _ _ _ _ _

Auckland Airport Senior Bond Offer

Auckland Airport (AIA) has announced that it plans to issue a new 6-year Senior Bond.

The interest rate has not been set but will likely be in the vicinity of 6.20%.

AIA has a strong credit rating of A-

AIA will not be paying the transaction costs for this offer. Accordingly, clients will be charged brokerage.

More details regarding the bonds, including a presentation, have been uploaded to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/AIA270.pdf

If you are interested in being pencilled in for an allocation, pending further information, please contact us promptly with the desired amount and the CSN you wish to use.

When the offer opens next week, we will contact those who have been added to our list to seek confirmation before purchasing.

Travel Dates

Our advisors will be in the following locations, on the dates below:

24 October – Takapuna, Auckland – Chris

25 October – Ellerslie, Auckland – Chris

27 October – Christchurch – Fraser

1 November – Palmerston North – David

2 November – Lower Hutt – David

8 November – Auckland (Ellerslie) – Edward

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown - Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Taking Stock 12 October 2023

WHOEVER is our 2023-25 Prime Minister will have on his desk some proposals to strengthen investor rights.

One such proposal is a certainty. The proposal will be specific.

Unlisted syndicates should have a board of directors on which should sit investors, one of whom should chair the meetings.

The fund manager should attend board meetings in the equivalent role of a CEO, there at the invitation of the directors, aware that the directors can choose another fund manager to take over that role if there are irreconcilable differences.

The prospectus for the syndicate would be required to define who qualifies as a wholesale investor under the new guidelines and should in bold type point out that faulty certification is a punishable offence, with meaningful sanctions for the certifier. Any fee paid to the certifier should be disclosed and should be regarded as a “hidden commission” if not disclosed. No retail investor should lose the support of the regulators by being persuaded to describe himself as a wholesale investor.

On request, every investor should be given the name and email details of every other investor, enabling a mass communication to occur.

An extraordinary general meeting (EGM) should be held within 30 days if requested by a minimum of five investors.

At the EGM investors should be allowed the opportunity to veto any plan of the fund manager, such as a plan to issue and underwrite more discounted shares and to make a significant purchase, with or without more debt.

Fund managers’ bonuses and all proposals to underwrite should be approved by the board or, if necessary, by shareholder vote. Underwriters should be named.

I am unsure how each fund can be compelled to provide liquidity after the fund has been established but this is such an important issue that the response of “there is no liquidity plan” for existing shareholders ought to be a warning to investors, if not the trigger for regulatory intervention.

In the case I am currently analysing, the line that investors can exit when future share issues are oversubscribed can be likened to the restauranteur who serves up cow pats and describes them as “bovine protein produced in the hills of clean, green New Zealand”.

Help is coming for investors. They need it. Many property syndicates are now facing damage, if not ruin.

Wise managers of unlisted syndicates should be alert to any chance to sell a property, to enable investors to exit, or to receive a part repayment of capital.

Such wise managers should today declare that all bonuses are suspended, not to be paid for five years, and then only if the purchased property can be sold at a price that advantages the investors as much as it rewards the fund manager.

Help is needed. That is clear.

The next Prime Minister will soon discover that the Financial Markets Authority (FMA) is well aware of the quite dreadful practices of many wholesale offers and is well aware that many of the so-called wholesale investors do not have the experience and wealth that was intended when permission was granted to relax the requirements of disclosure for those issues targeting very wealthy, experienced investors, clearly capable of making investment choices that needed no supervision or enforcement from regulators.

NZ will provide a better environment for all investors when the next Prime Minister understands the issues and gets some competent minister to do something about it.

The model he should follow has been provided by Simon Power who might have been a future Prime Minister had he not been misled disgracefully during the Allan Hubbard/South Canterbury Finance debacle. (Read The Billion Dollar Bonfire, for context.)

Power addressed the appalling behaviour of thousands of dishonest or incompetent financial advisors during the period 1985-2008 and acted with great speed to bring in the new Financial Advisors Act, disqualifying the pretenders.

Within a year or two more than 10,000 so-called advisors or sharebrokers had slunk off, grateful that their careers had not ended with a bleak horizon, separated by iron bars.

May the next government be as decisive with any greedy property syndicators. 

_ _ _ _ _ _ _ _ _ _

PROBABLY every investor in property trusts and unlimited syndicates knows that times are tough.

Debt costs have doubled; valuations are based on nett rentals; tenants are not tolerating rental increases (in many cases); and in a few cases tenants are defaulting.

The result is that the share prices of listed property trusts have typically fallen by 25% to 40% (eg Stride). The capital value of syndicated properties has been undermined similarly. There are very few buyers to test the true value of syndicated properties.

And the cash returns from unlisted syndicates have fallen, some to 1% per annum, some to nothing. Finding buyers for units in many unlisted syndicates is like finding buyers for rusty car shells.

All of this was highly predictable, property prices having been hydraulicked by an insane era of free money, caused by political ignorance rather than commercial wisdom.

Indeed, our newsletters and seminars have warned loudly about this for at least two years, just as they warned of the fragility of the structure that created Kingfish, Marlin and Barramundi. No level of genius was required to foresee these consequences of the cost of leverage or avaricious managers.

Poorly designed structures, combined with greedy fee levels, produce very poor results for investors, except in years where money is free, falling from the sky for anyone to scoop up.

The good news is that behind-the-scenes pressure is building to ensure that the next cycle of syndicating property is subject to much better rules, better supervision, and better enforcement.

The current problems are highlighted by one wholesale fund that marketed itself five years ago (2018) with a “projected pre-tax return of 6% plus capital gain”.

The front page of its investment statement did not promise to deliver lobster and champagne every Friday night so in this respect it has not failed to meet its projection.

What has happened since is astonishing.

Between 2020 and 2022 it had access to “free” money. It chose to buy more properties (it started out with three), issuing more shares and borrowing more money to pay the prices of that false era.

Its nett profit fell to the extent that its actual dividends, in contrast to its marketing gumpf, deliver 1% and it has taken the “strategic” decision to forgo reasonable cash returns in favour of very long-term potential capital gain. Such a strategy fits uncomfortably with most retired investors.

So, this change in “strategy” has been awfully bad luck for its investors who thought they were likely to get a 6% pre-tax return, in an era when many unlisted syndicates were yielding 8% or even 11.25%, in one case. Of course, those higher returns were also pumped up by “free” money.

Part of the problem was an investor-agreed, most unwise, amendment to the management contract enabling the privately-owned, wide-grinning fund manager to rake in even higher fees.

The agreement allowed the fund manager to charge various fees at 6%, up to a maximum of $2.5m, every time the fund manager elected to raise equity and/or debt to buy another property.

You may correctly surmise that the fund has indeed bought more properties, increasing the gross assets, enriching the fund manager, but doing nothing for investors, at least in the short term.

Clearly there is no case to make for starting up a Give-a-Little page for the fund manager.

However, there is a strong case for investors to start up a campaign for the fund manager to give-a-lot back to the investors.

The concept of bonus fees is, in my opinion, simply unacceptable.

There are other oddities.

The fund was targeted at “wholesale” investors.

Admittedly at that time the definition of who qualified as a “wholesale” investor was loose.

Nevertheless, I am well aware that some of the investors were neither skilled, grossly rich, very highly paid, or well versed in assessing risk, let alone “habitual” investors of such assets.

In that era we had various financial intermediaries being paid to certify that individual investors were “wholesale”. Lawyers and accountants, in some cases, were incentivised to certify eligibility.

To be fair, I have no knowledge of this occurring with the fund I am describing.

The investment statement did not outline a process by which investors could fire the fund manager if it was pursuing a strategy that was not liked by the investors.

These flaws in the product design are likely to be addressed soon.

_ _ _ _ _ _ _ _ _ _

THE sneakily designed property syndicates are not the only financial products to need review.

When I wrote The Billion Dollar Bonfire I listed in its last pages 13 areas that needed to be reviewed by regulators to ensure there would be no reiteration of the 2006-2010 finance company collapses.

Those suggestions were:

1. The introduction and enforcement of new fit and proper persons’ tests for financial market governors and executive.

2. Boards of all in the sector should include truly independent people.

3. Directors must represent all stakeholders, not just the shareholders.

4. Auditors of deposit-takers should be rotated five-yearly and allocated by the FMA.

5. Deposit-takers should display deposit maturity schedules, a breakdown of lending by sector; they should not be allowed to pay dividends from income that had been accrued but not paid; they should display their bad debts by loan type and record the bad debt experiences in the sector to allow a comparison.

6. Trust deeds should be approved by the FMA, be brief and written in plain English. Wilful breach of covenants should be fraud and have a mandatory jail sentence.

7. Family trusts and other such shelters should be taken into consideration during compensation awards against directors, trustees, auditors, management and even regulators.

8. Investment bankers must be fit and proper people, assessed by the Reserve Bank. 

9. Receivers must report to an independent panel and must consider every avenue of redress.

10. Deposit-takers issuing “super securities” (like covered bank deposits) must have their plan approved, independently.

11. Group actions should be changed requiring potential claimants to “opt out” rather than be excluded unless they “opted in”.

12. The Limitation Act needed to be adjusted to allow for delays in discovery.

13. Treasury should be required to appoint a guiding independent panel when a national crisis occurred, such as that problem that required the Government to provide a $479 billion guarantee.

Happily, many of these observations are now mainstream.

However, the dreadful trust companies continue to claim value-add in the questionable level of skill they bring to overseeing the rather sorry rump of our surviving finance companies.

Help is coming!

New law will bring such covenants and deeds under the supervision of the Reserve Bank. The Reserve Bank should be competent.

Trust companies will be appropriately rewarded for the standard of supervision they have provided in the past 20 years. The reward will be summary, uncompensated dismissal, the role being disestablished, in favour of Reserve Bank supervision.

My expectation is that the same fate will one day be dispensed to these companies - the likes of Perpetual Guardian, The Public Trust, Trustees Executors - for their lack of value-add in the role of managing family trusts and estates. Surely those companies are beyond the twilight time and will soon succumb to complete darkness.

In trusts and estates their fees are revolting. Rarely do trustee companies attract and retain excellent people; regularly their fees far exceed any value-add.

It will be a red-letter day when any requirement for trust or estate management is conducted by a new level of professionalism, by licensed and skilled people.

A trust company employee that is talented, has a client first attitude, and wants to add value, will inevitably find their workplace destiny in a much more client-oriented business.

The new law, which will bring an end to the finance company trustees, may be a year or two away, but is now under design. Work has not yet surfaced on the subject abolishing the laws that grant other privileges to trust companies.

_ _ _ _ _ _ _ _ _ _

INVESTORS should know that the composition of the next government will not provide any quick fix for the expensive cost of debt.

Until NZ has a wider tax base, created intelligently and not reliant on theoretical asset values, and a new value-for-money approach to spending those taxes, our country will have interest rates that are painful for those who borrowed, believing the politicians when they advised that very low rates were entrenched for many years. What a shame that they are not accountable for their dreadful guidance.

High interest rates and a weak NZ dollar are uncomfortable settings.

The US 30-year government stock rate of 5% is a much more reliable indicator of future interest rates than the daily changing views of traders and commentators, who thrive on contrived volatility.

The long-standing CEO of JPMorgan, Jamie Dimon, observes that borrowers are ill-prepared for long-term debt rates of 8%.

Free money was an anomaly, the emperor without silk.

Happily, investors now will enjoy returns from no or low-risk securities that will be higher than the returns from risk assets.

How long will that last?

Perhaps equity prices will adjust to restore the historical premium needed to attract money away from higher-yielding risk-free assets, like 5% government stock.

Dimon’s crystal ball is sure to be less blurred than those of traders, commentators, and politicians.

_ _ _ _ _ _ _ _ _ _

Travel Dates

Our advisors will be in the following locations, on the dates below:

17 October – Wairarapa – Fraser

24 October – Takapuna, Auckland – Chris

25 October – Ellerslie, Auckland – Chris

27 October – Christchurch – Fraser

1 November – Palmerston North – David

2 November – Lower Hutt – David

8 November – Auckland (Ellerslie) – Edward

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown - Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Taking Stock 5 October 2023

IRRESPECTIVE of which combinations of our political parties are given the right to help shape our economy over the next few years, three things are undeniable.

There is a possible good answer to one of these three issues which, in short, are:

1. We will be taking on more debt than we ever imagined;

2. We will need to cut the cost of the public service;

3. We do need more tax income, desperately.

It is on the third point that we have some good news to anticipate.

The first two points will need a greater level of discipline than we have seen for many years.

The increase in tax income might not be easily extracted from our companies, where costs are rising, while margins and revenue growth look threatened.

But the gold exploration at Bendigo, Cromwell, that I have previously discussed, might produce a morale-boosting project, as a group of politicians, Australian institutions and, last week, clients of our business, have been told.

The exploration licence, now owned by Australian-listed Santana Minerals, is in the very early stages of applying for a consented mining licence. If no obstacles hinder or prevent that progression, Santana’s project, over many years, will not just spark growth in Central Otago, but will simultaneously add to the country’s tax take by my guess of at least a billion over the first stage of the mining plan (10-15 years).

A working mine could employ 500-550 well-paid people, at current prices it might produce around $620 million of exported gold each year, pay royalties over 15 years, pay PAYE tax, and pay corporate taxes.

A 15-year project, at today’s figures, might pay to the Inland Revenue Department around:

Royalties - $130 million (1.5% of gold sales)

PAYE - $370 million

Corporate Tax - $1125 million

The cost to the Crown of authorising and supervising this project (with a Mines Inspector visiting every month) might be a few million, at most.

So how do those numbers work?

The mine would employ 500-550 people (approx.) at an average of perhaps $150,000 per head (working long shifts, including at night). 

The royalties would be at least 1.5% of gross gold sales.

The company's profit before tax, at current gold prices and my estimate of annual mining cost, might be at least $270 million, meaning a corporate tax payment of around $75 million per annum.

No doubt others would qualify these figures by referring to the unknown events that could change production, its value, and the costs, but if it were in operation today the numbers are fairly easy to crunch.

What makes this project special is likely to be the quantum of the resource (still being expanded, still being audited) and the extraordinary grade of the gold as measured to date.

The gold exploration has unarguably uncovered one of New Zealand’s largest-ever greenfield discovery, and the highest yield rock ore of any large discovery (perhaps three times the grade at Macraes, 90 km to the east of the find).

Santana’s inferred resource, at last calculation eight months ago, was around three million ounces (NZ$9.6 billion), at a grade of around 2.3 grams per tonne.

Further results were released last week to the ASX which has strict rules about such releases. The grade is more likely to increase than decrease.

The result shared that new drilling has uncovered further high grades of gold, Hole ID 192 being the second-highest result achieved to date, recording two metres of rock (5.4 tonnes) that yielded 263 grams per tonne.

For benchmarking purposes, gold mining is profitable at 0.5 grams per tonne. Mines stockpile tailings that produce 0.3 grams per tonne, to revisit should the gold price rise.

A measurement of 263 grams per tonne is extravagant but in richness only the second-highest find, an earlier hole finding a metre of rock that released more than 1100 grams per tonne, a figure that created world headlines in the mining sector.

For further benchmarking purposes, Macraes Mine, New Zealand’s biggest-ever producer, today makes very tidy profits with an average grade of around 0.9 grams per tonne.

It is by using Macraes’ costs, production and yields, that one can try to assess the likely mining costs, and therefore margins, that Santana can expect. 

Santana itself has yet to reveal this sort of arithmetic, or at least in public, waiting for independent assurance about the quantum and final grade of its find to date. Understandably it is very cautious.

What it has done is release its last independently calculated figures, of around three million ounces at 2.3 grams per tonne.

The quality of the discovery, and the economic projections, explain the visits of multiple politicians, the interest of the council and the people of Cromwell (around 5,600 people), and visits from Australian brokers and institutions, as well as iwi.

At least three Australian brokers have done what I have done, that is project the expected production values, using today's prices and today's estimate of costs.

Collectively my approximate figures could look like this:

Sales of gold annually - NZ$600 million

Cost of production - $200 million

Capital costs recurring - $100 million

Royalties - $30 million

Recurring gross margin - $270 million

Tax at 28% - $75 million

Approximate net profit - $195 million

EPS (if 230 million shares) - $0.84cents

Obviously these figures are my guesstimates and may or may not occur, but it helps as a guide after some assumptions. Indeed the conversion from an exploration licence to a working, consented mine requires a guess.

The Australians often bring up the “Ardern” factor, a synonym for green opposition to mining, recalling the same contentious call on offshore oil and gas exploration.

Their nerves would be more settled on discovering that the permits are almost entirely on private land, though there is some Department of Conservation involvement in paper roads, and in the actual cross-Dunstan Ranges four-wheel-drive track from the Omahau to Bendigo via the Thompson Saddle. It is not used as a fossil fuel, it is gold, used in batteries, technology and jewelry.

So, yes, there are many unknowns, and much more work needs to be done to produce a complete application for consent.

The consenting process is beginning with ongoing work that must demonstrate attention to terrestrial fauna and flora, to issues like weather patterns, air quality, rock and soil geochemistry, water flow and water quality.

There can be no shortcuts in satisfying the appointed body.

There will be full scoping exercises, then a comprehensive feasibility study including the costings of forming a mine, of any need for tunnelling, design of the mine, likely (huge) cost of the gear required (eight machines required would each cost around $8 million).

If consented by 2026, as targeted, the project would require funding, and would probably involve processing the shallow gold-bearing rock during the formative months, to create immediate cash flow. 

The costs might be funded via a combination of a share placement, and once production was guaranteed, bank debt and perhaps a gold loan. A gold loan occurs by borrowing stored gold, say from a pension fund or the Crown vaults, repaying the borrowed weight of gold with gold as you produce it.

Gold is a ubiquitous product.

The user of a gold loan borrows say, 100,000 ounces, around 3 tonnes of gold. At current prices the borrowed gold would be sold for around $300 million. The cost of borrowing gold might be around 3% per annum.

A mine producing 200,000 ounces per year would plan to repay the gold loan without discomfort.

My description of the plan and the outcome is my own, based on published material and my own calculations.

It will not be astray by an extreme amount but should not be regarded as anything other than an estimate.

One issue will definitely please a wide audience.

The mine at Bendigo would be more electrified than traditional mining and would be using electricity from the renewable source of the Clyde Dam. Some of the processing gear would be run by electricity and there would be a prospect of much more electrification, replacing diesel.

Various other mines, including Macraes, are planning to trial electrifying plant and more electric vehicles in a bid to reduce the use of diesel and possibly reduce costs.

The Bendigo project will be watching this with interest, hoping to observe the success of such trials.

Santana's chief executive, Damian Spring, a mining engineer with genuine international experience, has just returned from a symposium in Colorado, USA, where he was asked to present the project to a global audience of miners, institutions and investors.

Following his presentation, he was sought out for 30 one-on-one meetings.

The next government in New Zealand should rejoice, urging on the project, celebrating its remarkable and ongoing discovery news.

For the cost of a few million at most the Crown can tentatively include in its projections more than a billion in tax receipts.

That will delight those who believe that growing the country's wealth is a much more credible pathway to better living standards than seeking to redistribute historical wealth.

_ _ _ _ _ _ _ _ _ _

THE Americans are now telling us that at last their people are understanding that higher interest rates are normal and are here to stay.

They observe that in recent days the following has been signalled:

1. The 10-year US bond rate has headed towards 5%. (The NZ rate is 5.4%);

2. The US regional banks are experiencing deposit withdrawals, reducing bank appetite for lending;

3. Artificially boosted by the Covid printing of money, the home savings level has collapsed, reducing resilience and appetite for discretionary spending;

4. Oil prices have risen;

5. Student loan repayments are resuming after a three-year Covid holiday;

6. Auto loan delinquency rates have risen sharply;

7. The car manufacturers face a troubling strike, as workers face income reductions from inflation;

8. The long serving respected CEO of JPMorgan, Jamie Dimon, has warned that the USA is ill-prepared for 8% borrowing costs, which may be on the horizon.

Unsurprisingly asset prices have not yet rejoiced as these topics hit headlines.

For NZ investors, the 5.4% 10-year NZ Government bond rate would be highly attractive if there were conviction that government spending would soon be harnessed, inflation capped or falling.

That would be a real benchmark for all deposit takers and would be a good guide on the future of mortgage rates, a guide that ought to bring back to the front of mind that critically important word, “affordability”, a word that ought to bring sobriety to house sales.

The world's hope is that technology will solve problems in ways that are not costed into projections today and might stave off the mayhem that is feared by those who are paying attention.

The book “The Fourth Turning is Here” by Neil Howe quotes historical patterns and cycles that are portents of an imminent era of austerity and dysfunction, perhaps lasting a decade. But he concludes that intergenerational change always leads to fresh solutions overseen by the brightest of our young people.

Nothing can stop interest rates being much higher than they were over the past several years but Howe would argue that ultimately nothing can stop favourable changes, resulting in a better world after the decade of austerity.

Those who follow the outstanding achievements of one of New Zealand’s greatest achievers, Nick Mowbray, would very likely see one solution in his progress in producing outstandingly designed, prefabricated houses at prices that seem unimaginably low.

Mowbray’s three-hectare factory in China, to be replicated by him elsewhere in Asia, exclusively uses robots to build houses individually designed by the intended owner, at prices around 20% of the cost of the current building methods. Follow him closely. He is quite magnificent.

Perhaps the Americans should be watching the product he will deliver.

Perhaps our next government should prevail on a handful of people like him and persuade him to serve on a Prime Minister’s advisory panel, that in effect steers Cabinet into businesslike decisions.

Pardon me while I duck under my desk to avoid missiles from those who dislike the idea of running NZ in a businesslike manner!

_ _ _ _ _ _ _ _ _ _

New bond issue

Kiwibank (KWB) has announced that it plans to issue a new 5-year senior fixed rate note.

The interest rate has not been set but will be in the vicinity of 6.25%.

KWB has a strong credit rating of AA.

KWB will not be paying the transaction costs for this offer. Accordingly, clients will be charged brokerage.

More details regarding the notes, including a presentation and investment statement, have been uploaded to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/KWB1028.pdf

If you are interested in being pencilled in for an allocation, pending further information, please contact us promptly with the desired amount and the CSN you wish to use.

When the offer opens next week, we will contact those who have been added to our list to seek confirmation before purchasing.

Summerset Senior, Secured Bonds

We've secured a limited quantity of Summerset's 6.59%, 5.5-year senior secured bonds. The total price, accounting for accrued interest and brokerage, is below par (meaning 10,000 bonds are priced slightly under $10,000). If interested, please email us and we will send through a contract note.

Travel Dates – October

Our advisors will be in the following locations, on the dates below:

11 October – Christchurch – Johnny

17 October – Wairarapa – Fraser

24 October – Takapuna, Auckland – Chris

25 October – Ellerslie, Auckland – Chris

27 October – Christchurch - Fraser

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd