Regarding… Vol 3 no 8 – The Rhyme of History

Dear Fellow Investors and Friends,

Welcome to this edition of my newsletter, where I share my efforts to understand markets and the world around me.  I do appreciate you taking the time to read this.

Today is Thursday, March 6th, the 65th day of the year. There are exactly 300 days until the end of the year.

“I put a dollar in one of those change machines. Nothing changed.” – George Carlin

“The strongest-held beliefs are usually on topics with the most uncertainty. No one is as passionate about geometry as they are about religion.” – Morgan Housel

Quite a few readers have asked whether I have changed my mind about China’s attractiveness as an investment destination.

The short answer is yes, I have. But there is a longer answer.

Europe dominated the world in the 18th and 19th centuries, extracting wealth from its colonies. Europe was a superpower.

The USA was an upstart, barely a proper country after a vicious civil war. But with an increasing dynamism driven by a talented population of immigrants, it became the factory – and creditor – to the world.

Post-WWII, burdensome debt levels caused tough times in sclerotic Europe. Governments were unwilling to inflict any more pain on their population and chose easy money and inflation to ease the burden. This resulted in multiple bouts of currency weakness and depreciation with secularly entrenched inflation.

During the same period, the USA made a different choice in how to deal with financial imbalances – it tightened its collective belt and suffered through what was eventually called “The Great Depression.”

A depression can fulfil a valuable role :

• It’s the hard way; just like going to the gym, it strengthens you.
• It “tempers the steel”, making you more resilient and better able to face challenges.
• It wrings out excesses in the system, which makes capital allocation more efficient.

This happened in the USA, enabling it to assume the “world’s superpower” mantle after WW2. While America was getting stronger, Europe had chosen a relaxing nap on the couch after yet another Big Mac Meal.

Inflation undermines the structures that glue society together. It creates a wedge between the haves and the have-nots and provides cover for radical governance philosophies to take hold. Populist parties become a channel through which scapegoats are identified as the root cause of their problems, thereby avoiding any self-reflection.

Just like obesity is an inevitable result of a poor diet, in Europe, national socialism resulted from lax fiscal and monetary policy.

The Nazis were able to create a strong scapegoat in the “other” – non-Aryans – to blame for their economic travails. So strong that they were able to get their people to enthusiastically fight a war on many fronts, as well as commit genocide against the non-Aryans, principally Jews. The rest of Europe’s poor diet and lack of exercise made them weak and vulnerable to German invasion.

Who came to the rescue? The Americans, who had been dieting and going to the gym.

Where are we today? The Americans are jostling each other at the Big Mac counter, cutting interest rates in the face of stubborn inflation, taking the easy way out.

Meanwhile, China is on a diet and has taken out a gym membership. It is enduring deflation and possibly a depression, wringing out the system’s excesses.

Today, China generates double the USA’s electricity, 12,6 times as much steel, and 22 times as much cement – all in an economy that is only 25% larger than the USA on a PPP (purchasing power parity) basis. In 2023, China produced 30,2 million vehicles, three times as many as the USA. 27 million were sold in China, almost double the amount in the USA. Chinese consumers bought 434 million smartphones, compared to the 144 million sold in the USA. (source – What’s the real size of China’s Economy – Asia Times 6/17/2024)

How strong is the USA, really? If a supplier were forced to choose (due to sanctions and tariffs) between supplying the USA and China, I wouldn’t be surprised if at least some of them started to lean towards China.

Ray Dalio wrote his book The Changing World Order, which discusses how one world superpower supersedes the previous one. The cycle consists of three phases: the rise (characterised by low debt and internal conflict), the peak (marked by increasing debt and conflict), and the fall (characterised by economic weakness and war).

I would argue that the USA is nearing its peak – around where Europe stood at the turn of the last century. If the USA is characterised by high inflation and weak monetary and fiscal policies in the future, I suspect hard assets will outperform capital-intensive ones like AI, especially those businesses being undermined by the rise of gym-hardened Chinese competitors.

Admittedly, this cycle plays out over a very long time, so I don’t think it should influence one’s immediate investment thinking – but it’s always surprising how quickly the market discounts the long term.

For investors considering a commitment to China, the book “The Great Depression: A Diary” by Benjamin Roth is certainly worth a read. What struck me is that during the depression, the one asset that maintained its value was gold. Furthermore, at the height of the depression, if you had cash, you could acquire assets at significantly reduced prices. However, you needed to exercise great caution in managing your cash, as most banks either closed or, at best, restricted withdrawals. Keeping your cash outside the banking system proved effective. Bitcoin, anyone?

Roth’s book also reminds us that the depression lasted much longer than most anticipated – and by the end, many believed it would never conclude! Changes like these occur at an almost glacial pace, yet they surprise us with their all-encompassing destruction of previously held convictions.

Finally, if the trend is structurally changing in favour of China as a superpower, that bodes well for the Global South and emerging markets everywhere.

History never repeats, but it sure busts a mean rhyme.

This is precisely why the cockroach doesn’t make any forecasts.

This is one of my favourite companies and a significant holding in the “hard asset” allocation of the MWI Worldwide Flexible Fund (aka the cockroach). The share price tells a good story, a thirty-bagger over the past 10 years:

TPL was founded in 1871 to own land given to its parent, a railroad company that had gone bankrupt. As a result of owning the land, it earns royalties on oil and gas produced on its land and other “easements” over the property.

Due to the boom in fracking, oil and gas production on TPL’s land has surged. Today, TPL achieves an operating profit of $500 million on $600 million of revenue, with almost no capital requirements.

Looking to the future, it is entering the water business significantly. Every barrel of fracked oil produces four to five barrels of water, which must be treated and stored. Importantly, TPL only provides the land for this and earns an easement, incurring no costs. Additionally, a considerable amount of gas is flared off due to insufficient pipeline capacity; TPL’s land could serve as an excellent base for large, energy-hungry data centre campuses. Finally, nuclear power stations need a lot of water to cool them, which is abundant on TPL land because of fracking.

TPL is rife with optionality.

A reader sent me this podcast explaining the business.

My take: You rarely come across a true capital-light business with significant growth optionality. When you do, the best thing to do is buy it and hold it for a long time.

Speaking of capital-light oil and gas exposure, HCI also comes to mind. For those unfamiliar with it, HCI is an investment holding company. It contains a mix of good South African businesses (hotels, gaming, media and property), some mining assets (coal and platinum) and interests in offshore oil prospecting blocks.

The market does not like the current configuration of HCI’s asset base:

For a business run by one of the most astute dealmakers on the JSE – evidenced by a long-term growth in NAV per share that far surpasses that of the JSE All-Share Index – to trade at nearly 50% of NAV is mind-boggling.

Effectively, the market values HCI’s offshore oil and gas exposure at zero. HCI has de-risked this exposure by consolidating its various holdings off the Namibian coast into a single farm-out arrangement, which means it does not need to invest any capital in developing the prospect. HCI’s proportion of capital costs are repaid from production revenues, after which HCI will receive its proportionate share of those revenues.

HCI also has a significant interest in prospecting blocks off the south coast of South Africa, not far from Mossgas.

My take: I guess current low oil and gas prices dampen the value-creating prospects of HCI’s offshore prospects. However, these are long-term assets with zero capital costs for HCI. Who knows where the oil price will be in 5, 10 or 20 years? HCI remains a core holding in the MWI Value fund.

Multichoice (MCG) is currently the takeover target of the French pay-tv operator Canal+. The price offered to minority shareholders is R125 per share. MCG is trading at R100 per share, which is essentially unchanged since its listing nearly 10 years ago:

This week, the long-stop date of the offer was pushed out from April to October. This led to a sharp drop in the MCG share price, as the arbitrageurs now must wait longer for the transaction to be consummated. If it does happen, the regulator is playing hard to get it.

Of course, apart from waiting for the R125 offer to finalise, there was another way to make money. That was to hope Canal+ would offer its paper in exchange for MCG shares instead of cash. But in the wake of Canal+’s disappointing IPO towards the end of last year, that hope is fading away.

My take: Hope is never a good strategy, while MCG’s expansion into Africa is also not a good strategy. In financial markets, as opposed to maths, two negatives don’t make a positive. And do you really want to go up against Netflix?

Like the pay-TV industry, tobacco companies like BAT face a decline in customer numbers. However, they possess significantly greater pricing power, enabling them to offset the reduced sales volume with increased prices per unit.

Naturally, this cannot last, so all tobacco companies have invested in “next-generation” products. To some extent, these products have been filling the void left by declining cigarette volumes. I always believed that some form of vape was next-gen. However, it turns out the heavy lifting is carried out by nicotine pouches such as ZYN (sold by Philip Morriss International – PMI) and VELO and LYFT (sold by BAT).

The market seems to think they have a good chance of moving their clients to these next-gen products. Recently, BAT hit a new all-time high:

Reinet giving up and selling out removed somewhat of an overhang.  At the same time, PMI has been on a tear for a while:

Zyn does seem to be selling very well:

A de facto endorsement from the Secretary of Health and Human Services is also advantageous. Robert F. Kennedy Jr. seemed to pop a Zyn pouch during his Senate confirmation hearing on 30 January, three months after the Trump administration cabinet nominee was seen in Los Angeles holding a tin of the nicotine product.

My take: These charts do not represent dull companies whose customers are fading away. There’s something different happening here. Tobacco companies have a significant advantage over new competitors: established distribution channels. This is a crucial strategic benefit.

Regular readers of these letters will know I have a penchant for “formulas for life.” This week, I read a piece by one of my favourite writers, Morgan Housel, and he came up with a zinger:

Happiness = Independence + Purpose

You can read the piece here.

My take: If truth bombs could win wars, Morgan Housel would be a one-man global peacekeeping force.

Andre Coetzee, a recently qualified CA(SA) – congrats, Andre! – and the newest recruit at RECM, didn’t take long to realise that I have a passion for history. He handed me this article, which was penned by a certain Sir John Blubb in 1976.

It’s long – 26 pages – but written in the style of Will and Ariel Durant, who wrote my favourite book ever, “The Lessons of History” – it is a joy to read. The piece offers some good perspectives on how empires come and go.

My take: With the tectonic plates of the USA and China slowly grinding up against one another, it’s helpful to take a step back and gain a ‘birds-eye” view of the changing of the guard in previous times.

The reality of daily life in South Africa creates a perception that if it isn’t the most corrupt country, it is somewhere close to the top of the list worldwide. So, we take all our Rands offshore to the USA, Europe, Mexico, Brazil, India, and China.

Because we don’t live in those countries, we believe they are all fine and dandy. Maybe some pesky pickpocketing, consensual credit card fraud, or even a little light larceny. But there is nothing like the constant barrage of government-sponsored gangsterism we have here.

Or so we believe.

But here are the actual global corruption ratings (the lower the number, the more corrupt the country is):

The bottom line is that our capital’s preferred destinations, China, Mexico, Brazil, and India, are all more corrupt than the good old RSA. Eastern Europe is also worse.

My take: Many product pushers are vested in keeping you negative about our country. However, while South Africa is certainly not a bed of roses, it doesn’t compare too badly against the competition. Would you have all your eggs in the SA basket? Hell no! But be careful about the grass on the other side.

The first book was also the first one recommended by Ted Gioia in his 12-month humanities course. It entails reading approximately 250 pages a week from books that have shaped our understanding of the world. It will take me longer than a year, as I’ll struggle to get to 250 pages besides my other reading.

a. The Death of Socrates, by Plato (c 380 BCE)

I had previously encountered the term “Socratic Questioning” and had a vague idea of its meaning. For a proper definition, I turned to Google: “It involves asking systematic, thoughtful questions to stimulate critical thinking, uncover assumptions, and explore the validity of ideas.”

Well, this book illustrates that process effectively. It takes us – through dialogue between Socrates and his friends – into his reflections on his trial, imprisonment, and death. Despite believing that the charges against him were baseless, Socrates accepted his fate with dignity, emphasising his commitment to truth over self-preservation. While in his prison cell, the dialogue explores justice and obedience to laws as he rejects an offer to escape. The final dialogue, just before he drinks the poison that will end his life, addresses the immortality of the soul and the philosopher’s readiness for death.

Plato’s depiction of Socrates’ death has had a lasting influence on Western philosophy. It raises critical questions about democracy, free speech, moral duty, and the tension between individual conscience and societal laws.

b. Crossroads by Jonathan Franzen (2021)

Crossroads tells the story of a typically dysfunctional family in rural America in the 1970s. However, the only way to know the period it is set in, is through references to the Vietnam draft and the folk music scene. This book is entirely about the characters – a family led by a failed church pastor whose wife once lived a very different life. The four children in the family each have quirks, some more serious than others.

For a long time, the story appears to meander as Franzen establishes and develops the characters. However, once he has accomplished this, he triggers a series of explosions that culminate in a drug-fuelled act of arson.

Franzen’s skill in crafting realistic, flawed characters and his nuanced storytelling make the book compelling. Following the diverse cast was enjoyable, and new treasures were unveiled on nearly every page.

This book was a Pulitzer Prize for fiction finalist and is the first in a planned trilogy. I can’t wait for the next two.

That’s all for this week.

It’s time for the Cape Town Cycle Tour again this Sunday. It is one of the most enjoyable days out you can have on, and off, the bicycle. If you see me out there, give me a shout. Except if you’re passing me, of course!

My wife Amanda and I will be in Hermanus next week for the 7th BizNews conference. If you’re there, do say hello. I’m always more than happy to have a chat.

If you’re riding the Cape Town Cycle Tour, be very careful! Even if you’re not, you still need to take care.

Piet Viljoen
RECM