23 February 2009

Coxe still long commodities ~ Boston Globe

Donald Coxe, 73 years old and unbowed, offers no apologies for getting it wrong on commodities in 2008. Instead, by way of explaining why he’ll be proved right in the end, he offers an amazing story about Margaret Thatcher.

The tale takes place more than 30 years ago. Through pure chance, Coxe, then an obscure pension fund manager, found himself at a private dinner with Thatcher, then still the untested leader of the Opposition British Conservative party, at the home of E.P. Taylor, the legendary business tycoon.

At one point, Coxe wound up next to the woman who was about to become the first female Prime Minister of the United Kingdom. She was forecasting the future. And he was entranced. Thatcher told him she would win the next election (which she did the following year, 1979). She also told him that in 1980, Ronald Reagan would become the next U.S. president.

The two would attack the scourge of inflation with tough interest-rate policies, and both she and Reagan would survive the resulting recessions to win re-election. Thatcher, as Coxe tells the story, then predicted that by the late 1980s, “‘We’ll have defeated inflation, we’ll have the West respecting itself and believing in free markets again.’ And then she smiled and she looked at me and said, ‘Mr. Coxe, perhaps also by then we’ll have won the Cold War.’”

It’s apparent by the enthusiasm with which he tells it that Coxe never tires of this anecdote. He is, after all, one of the few prominent Bay Street figures whose love for the markets is matched by a passion for history and politics, especially conservative politics. But as he speaks on this early winter day from his office on LaSalle Street in Chicago, Coxe is not merely reminiscing. He also has a serious point. Well, two.

The first is to let the listener know that he has been around for a long time, and seen more than a little bit of history— financial and otherwise. This is not some 36-year-old economics graduate who was still a university student when the early 1990s recession hit. Coxe doesn’t hesitate to remind people that he entered the world of Bay Street in 1972, and thus has lived through the horrific bear market of 1973 and 1974—an event that had him convinced, by the dawn of 1975, that “I’d probably come into the wrong business.”

But his second point is about the importance of leaders and leadership in tough times. Thatcher had a plan, and it pulled Britain out of stagnation, inflation and economic decline. Reagan’s policies had a similar effect in the United States. Deng Xiaoping, who placed China on the road to a market economy, changed the world. So did Manmohan Singh, the current Prime Minister of India and the Finance Minister in 1991, who used a financial crisis to shake that country out of its decades-long embrace of socialism. “I’m not a believer in the idea that we’re caught up in forces beyond our control,” says Coxe. The right policies, combined with political will, matter. “So once I’m satisfied that we’ve got the smart people in there who are prepared to do whatever is necessary to prevent a collapse, I assume it will be done.”

All of which serves to explain why Coxe—who in December left his post as Bank of Montreal’s global portfolio strategist, to start Coxe Advisors LLC— believes that history will vindicate him and prove that his difficult 2008 was an aberration. While Coxe wasn’t shocked to see a market meltdown last fall, he was caught badly off guard by the way the concomitant financial crisis destroyed prices for the commodities and commodity stocks that he has for years touted as the fastest way for investors to increase their wealth. Oil, after peaking at just short of $150 (U.S.) a barrel in July, fell to $45 (U.S.) by year-end. Corn, from a summertime high of roughly $8 a bushel, plunged to $4; copper went from about $4 a pound, to $1.40.

Few resource companies were spared, except for gold stocks. The shares of many junior mining companies lost most of their value. In the oil patch, even a blue chip like Suncor Energy Inc., a Coxe favourite, was down 56% in 2008. As for Coxe himself, he called the recession correctly, but stumbled on how to play it. “Stay overinvested in commodity stocks whose earnings and performance are tied to stronger economies in the Third World,” he advised his readers in one of his “Basic Points” reports. The date was July 3, 2008. As it turned out, that was the best time not to buy commodities, but to sell them. The Reuters/ Jeffries CRB commodity price index peaked on July 2. Over the next six months, it plummeted by half.

Worse still, the market now had a simple way to track his mistakes. The $300-million Coxe Commodity Strategy Fund, after debuting to a warm reception from investors in June, was down 55% by mid- October. For Coxe, there’s little escaping responsibility; even the ticker symbol, COX.un, makes it clear who is driving the fund.

The turning point was July 13, the Sunday that the U.S. government made its first steps toward what would soon become the nationalization of Freddie Mac and Fannie Mae, two giant mortgage guarantors in the U.S. That event, a precursor to the bankruptcy of Lehman Brothers Holdings two months later, moved the credit crisis to a new phase. Commodities began to sell off viciously. Coxe says that at one point during the downdraft, he had lost $2 million, or 40% of his personal equity portfolio. “From July 14 until, I would say, roughly last week, has been the most stressful [period] of my recent working life,” he said in an interview shortly before Christmas. “You’re talking to me at a time when I’m feeling somewhat beaten up.”

So he’s bruised. But wrong? Coxe doesn’t think the word applies. “When the market seems to have gone to hell, you say, ‘Well, aren’t you realizing in the middle of the night that you were all wrong?’ No!” He believes in the impact of strong leaders, and therefore believes the world—because of the efforts of Barack Obama, Ben Bernanke and the leaders of China and India and Europe, among others—will avoid spiralling into a 1930s-style depression. Not only will their policies breathe new life into the economy, Coxe predicts, they’ll do it so quickly that Bernanke, the chairman of the U.S. Federal Reserve, will be worried about inflation by the end of this year.

Forget about the gloomy headlines: “I’m more and more of the view that we’re going to find out that the surprise will be how strong we come out on the other side of this,” he says. “It won’t be long before inflationary pressures will show up. And, of course, they will show up first in the commodities.” It’s a forecast fit for an optimist, and one that few economists share in the winter of 2009.

The question is, after last year’s debacle, how many other investors will buy the sunny outlook Coxe is selling?

At his stage in life, Coxe has little need to worry about his reputation. He insists that he left BMO on his own terms, and indeed, he’s signed a deal to continue writing research and doing conference calls for investment advisers at BMO Nesbitt Burns, the bank’s retail brokerage. He remains one of Canada’s mostwatched market gurus. One rough year is not going to cause his loyal followers to stray. “For my money, he’s the best in Canada,” says Seymour Schulich, the billionaire investor and philanthropist. “Some of these guys, you look at and you think they’re from Mars.... You know what I like about him is, he’s got a real grasp of financial history.”

Besides, as Schulich points out, plenty of smart people failed to foresee how awful 2008 would turn out to be. Jeffrey Rubin, the highly regarded economist from CIBC World Markets, originally forecast the S&P/TSX composite would rise to 16,200 on the back of constantly rising oil and metal prices (it ended at 8,987). The mutual funds managed by Eric Sprott and his team at Sprott Asset Management, arguably the best resource investors in the country, were ravaged, and the firm’s stock fell as much as 77% below the price of its initial public offering in May.

But if Coxe was hardly the sole exponent of commodity bullishness in Canada, he is one of the most persistent, and certainly the most articulate. His speeches and writing are unlike that of any other investment strategist in the country. How many analysts would dare use a word like “rhadamanthine”

(meaning “rigorously just”) in their reports? A typical Coxe missive is like a random walk through his fertile mind: history, politics, finance, science, investment theory. He is not afraid to use metaphor, humour or even poetry to make his sharp and often-cutting observations. Coxe has noted on more than one occasion that the Nasdaq Stock Market’s headquarters in Times Square are on the site of a former porn shop, and “there is some question as to whether the ethical standards of that corner improved.”

His unique style is a byproduct of his atypical path to the Street. He never went to business school. After graduating from high school in Newmarket, Ontario, he studied English, Latin and history at the University of Toronto, and later went into law. This led, oddly enough, to journalism and the National Review, the organ of American conservatism (the connections from which led, later on, to the dinner with Thatcher).

The intellectual challenge of journalism fit Coxe; the financial rewards, not so much. “It was a fabulous job to have, but we couldn’t raise a family in New York on $9,000 a year.” Coxe chose to return to Toronto with his family, where he pursued a legal career but without much enthusiasm. In the early 1970s, he landed at Mutual Life, writing speeches, among other duties. Before long, however, he had worked his way into its investment unit, and became known for dispensing his views in a colourful manner. During the inflation-wracked 1970s, he’d tell clients that the right amount of time to hold longterm bonds was “the amount of time you hold a hand grenade after you’ve pulled the pin.” He joined Nesbitt Thomson, which later became BMO Nesbitt Burns, in 1992.

The historian in him never faded, and neither did the writer. When he wasn’t penning his lengthy strategy reports (which he says he will still be writing bimonthly), he was pronouncing his views to a wider audience in The Globe and Mail, the National Post, Maclean’s and elsewhere.

Like all strategists, Coxe got some predictions badly wrong. His bullish calls on gold in the early and mid-1990s were duds. For a time, he was an alarmist about the Y2K problem, writing: “Wouldn’t it be fascinating if the once-in-a-millennium crisis came because creditors were unready for Y2K?” Other predictions he got dead-right. He warned at the end of 1997 that the Asian crisis was far from over, which it wasn’t. He raised a skeptical eye at the absurd valuations on many technology companies in 1999 and 2000, and was right.

But it was his early, prescient call on commodities that cemented his reputation. Coxe says he turned bullish immediately after 9/11. He was pulling together a book titled The New Reality of Wall Street. The technology story was over; the media and telecom bubble had burst. In the late 1990s, America was coming down from the zenith of its economic power. Where would the action be? Coxe had noticed something about the world’s two most populous countries, China and India. Changing times and, in India, changing governments had not budged either nation’s commitment to joining the modern economic world. “This,” says Coxe with typical flourish, “will be the greatest simultaneous efflorescence of personal economic liberty in human history.”

What on earth does that mean? “I define that as people who move into dwellings with indoor plumbing, electricity, basic appliances, and [who] acquire personal motorized transportation. If you’ve got those things, you’ve got more personal freedom than 99% of the people who’ve ever lived.” In other words, Coxe foresaw that the urbanization and accelerating industrialization of China and India would lift tens of millions to a better standard of living, which would increase their consumption on a massive scale.

More cars mean more oil and steel; new houses and apartments require copper and steel and cement; office buildings and factories use tonnes of metals of all types. In 2001, China’s rapid growth was a known fact, but not yet widely discussed or debated in the North American press or on Wall Street. Thus it met one of the most important rules of Coxeism: “You should not invest in a story that’s on page 1. Invest in the one that’s on page 16 on its way to page 1.”

By the middle of the decade, oil and mining bulls were as easy to find as believers in the so-called Chindia thesis. But Coxe took it further, calling for a huge spike in the value of grains and other food. Coxe’s prediction of a farm boom offers insight into how his brain works. It was a conclusion he arrived at not by examining spreadsheets but through a mixture of personal observation and science. Coxe’s father was born in a mission in India, and in early 2006, Coxe went back to retrace his ancestral roots. “I spent my time in the villages,” he recalls, “and from that, I got the sense of the real revolution that was going on in India.” Coxe saw first-hand that as poor Indians became more prosperous, they spent their extra income on, among other things, a better diet. “I came back and I said, ‘The big commodity story now is going to be food and agriculture.’ ” By early 2008, with prices for most basic foodstuffs up sharply,

the words “food crisis” had moved their way from page 16 to page 1. And even though all of those commodities subsequently dropped, he is every bit as convinced he is still correct, because of the latest data on sunspots.

Yes, sunspots. A few words of explanation are required at this point. Coxe believes that theories of man-made global warming are, to be polite about it, a crock. The climate’s natural swings are much greater than we think, and on this point, the man can cite trivia almost endlessly. (Coxe, a long-time friend says, has an eternal fascination with weather patterns.) “At the time of the Norman conquest in Britain [around 1066], the Vikings were growing grapes in Greenland,” he says. Later, the Earth went through an extended cool period, so that by the late 1700s, “it’s recorded that people went from Manhattan to Staten Island on horse and carriage” across the winter ice. Coxe believes the data show sunspot activity is responsible for these changes. And since sunspot activity has recently been lower than expected, Coxe thinks it’s possible we’ll soon be fretting about global cooling. Buy Monsanto. Buy other agriculture stocks. If you have the stomach to play the futures market, buy grain futures. “We’re going to have probably the worst food crisis on record,” Coxe says.

It is a fascinating theory—one that goes against the conventional thinking in scientific and political circles. But then, Coxe is full of fascinating theories. He is surely the only stock market guru in North America who can speak with authority about Galileo’s early records of solar activity, or Mount Pinatubo’s effect on the global temperature. One Canadian portfolio manager says that Coxe is a terrific lunch or dinner companion, a gentleman, and a skilled raconteur. This person loves meeting with Coxe whenever the two are in the same city.

But, adds the manager, “He drove people off a cliff here.” There’s no doubt: Investors who followed Coxe’s advice made a lot of money for five or six years, but gave much of it back in the latter half of 2008. How did he fumble it? “What you had was the sharpest sustained drop in commodities in history, and we didn’t have a global depression,” says Coxe. Coxe says he underestimated the role of the hedge funds. He knew that many of them had gone long on commodities and short on financial stocks—that was rather obvious, and amplified the sharp rise in commodity prices in 2007 and the first half of 2008. What he didn’t realize, or fully appreciate, was how many billions of dollars of those bets were made on borrowed money. Since commodities futures themselves are a leveraged investment, the result was a series of bets in which leverage was piled on top of leverage. The whole edifice came tumbling down during the summer, as hedge fund losses began to pile up and the margin calls came pouring in.

“None of us, or nobody I talked to, thought that much of it was hedge funds that were leveraged 30 or 40 or 50 to 1,” says Coxe. Does he wish he’d figured it out? “You bet. But I don’t know how I could have gotten that information.” As for how the slide began, Coxe has become something of a conspiracy theorist. He believes that the Fed, with some help, engineered the commodity correction to try to bring hedge funds to their knees, forcing them to cover their short positions in financial shares and thus driving those shares up to the point where banks could raise new capital that they desperately needed. “Although it wiped out 40% of my net worth temporarily, I believe they did the right thing. In order to save the banking system, they had to kill the commodities.”

The theory has a nice ring to it, and there may even be some truth to it, and yet it also seems a bit too convenient. (And if the point was to help the banks, it didn’t work so well, judging by the seismic upheaval in the global banking system in September and October.)

The focus on the machinations of traders and fund managers glosses over another truth: Coxe and other oil bulls failed to foresee how quickly things would change on the ground. Take oil: At the start of last year, the International Energy Agency forecast that oil demand would grow by a brisk two million barrels a day. By December, the IEA said 2008 would be the first year since 1983 in which demand fell. Meanwhile, copper is piling up in warehouses at a level not seen in years.

“I don’t know how you could miss that,” says Paul Gardner, a portfolio manager at Avenue Investment Management in Toronto. He’s a long-time Coxe fan, but is nonetheless perplexed by what he sees as a gap in logic exhibited by Coxe and such others as Eric Sprott: If you’re bearish on the economy, how could you think that commodities will just keep going up? “You have to lose some of your shine because of that,” says Gardner. “You’re putting all your chips on China and India, and do you really trust the numbers there?” What Coxe trusts is his own eyes. He recently got back from another trip to India—in fact, he stayed at Mumbai’s famous Taj Mahal Hotel, and departed just five days before terrorists attacked it in India’s version of 9/11. While in the city, he visited Mumbai’s central train station, to people-watch. “They look so much healthier than they did a few years ago,” he says.

“I cannot give you qualitative data. I look at the people’s bodies.” He is as convinced as ever that China and India will be the world’s great economic powers by the middle of this century, that the standard of living of their people will grow, and that the next great investment is food. “I haven’t lost my enthusiasm for the belief that if there’s a world tomorrow, it’s going to be a world that needs more commodities, and that this still is the overarching theme of our time...the opportunities for investors are going to be really marvellous.”


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