Petrocapita - Monthly Commentary - Recovery, Real or Nominal?

8/8/2019 Petrocapita - Monthly Commentary - Recovery, Real or Nominal?

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If you can keep your head when all about you are losing theirs ... you don'twork for the Federal Reserve

Apologies to Mr. Kipling for using his work to create an inflammatory headline.

A considerable amount of ink is being spilled on the topic of whether there is arecovery underway in the west and if so, whether that recovery is sustainable. Somuch ink in fact that one would have thought that when combined with the mightylabors of our central banks to single-handedly create an ink shortage this lowlysubstance would have been used up long ago.

Fortunately, or perhaps unfortunately depending on your view of my monthlymusings, we haven't run out yet so let me give you my view on the recoverydebate - a recovery in nominal or real terms? With the printing presses runningfull time (ink supplies notwithstanding) some form of nominal recovery will occurin the western economies. Sadly, it's not going to be anywhere nearly assatisfying as other post-war recoveries because it largely will be an illusion in realterms. Our recovery is not being built on the sound fundamentals for growth: Favorable demographics; Low national debt levels; High savings rates; and

Persistent trade surpluses.

Please take a moment and consider which so-called developed nation has thesecharacteristics. Stumped? None. Now turn your gaze to the emerging world - Idoubt you are still stumped as the list is long and obvious.

Take Canada as an example of a country suffering from the western growthmalaise. Canada has: An aging population: Large unfunded liabilities for social benefits;

High total debt-to-GDP levels; Low savings rates; Large and increasing government intervention in the economy; Large fiscal deficits; and An overly accommodative monetary authority.I'm sorry to be the bearer of bad tidings but these are not the seeds from whichmighty recoveries are grown. By insisting on printing over the systemic solvency


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issues in the financial sector, by actively preventing the liquidation of decades ofmal-investment, by subsidizing speculation and consumption to the detriment ofproduction (and so on) our valiant central bankers will not create a recovery.Unless these problems are addressed they are creating an inflationaryenvironment with poor real growth dynamics - i.e. the ideal raw materials for

stagflation in the west.

What are our investment options? It should come as no surprise to anyone whohas read one of my letters that I believe its important to find investments inpolitically stable regions of the world that are directly exposed to emergingeconomy growth - i.e. regions that export what the emerging economies needand are not exposed to emerging economy competitive advantages - i.e. regionsthat do not export what the emerging economies make.

In my funds' backyard, western Canada, energy and agriculture are dominantindustries. In fact, western Canada, with only 10 million inhabitants, is one of the

world's largest net exporters of both energy and agricultural commodities. As weknow, energy and food consumption undergo rapid growth as a developingeconomy makes the transition to a middle class standard of living. Thesemarkets already appear to be tightening and demand is still accelerating. Hereare some quick numbers to give you an idea of western Canada's resourcesendowment:Energy Oil (13% of world reserves; 4% of world production) Uranium (8% of world reserves; 20% of world production)

Agriculture Potash (60% of world reserves; 30% of world production) Wheat (21% of the world export market) Oil seeds (10% of the world export market) Farmland (80% of Canadian total)

The Canadian economy appears bifurcated between the lower growth east andthe higher growth west. Investing in western Canada provides exposure toemerging market consumption patterns in energy and agriculture in a politicallystable market. I believe a good approach is to make direct investments incommodity production assets - in addition to providing less volatile exposure tocommodity price trends, production assets are excellent inflation hedges that,unlike gold, generate cash flow.

In addition, investors who have a value orientation have been provided what Ibelieve is an attractive entry point into the Western Canadian conventional oilmarket. The credit crisis has caused financing to become scarce for junior oil &gas companies while low natural gas prices are reducing theirprofitability. They are being forced to sell assets to stay in business. This has


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created a buyers' market for the acquisition of smaller oil production assets -assets that are highly cash flow positive at current oil prices.

Shifting gears for a moment - I want to ask when we gave permission for centralbanks to take over the tax role of our governments? Central bankers now seem

to feel free to increase the money supply by any quantity they deem necessary tokeep the banking sector solvent. In effect, they are extracting a massive tax fromsavers everywhere via the historically low interest rates they have engineered.When questioned about what they are doing with our money they get downrighttesty and roll out the clich of "central bank independence".

Let's take a look at what that vaunted "independence" is costing Canadians usingsome Bank of Canada ("BOC") data. There is C$1.2 trillion on deposit withCanadian chartered banks. If we assume that BOC actions are keeping interestrates at least 4% below their equilibrium level then Canadian savers are beingtaxed by the BOC to the tune of $50 billion annually in the form of lost interest

income. Canadian federal government income tax revenues are approximately$150 billion, so is it not accurate to say the BOC has unilaterally increasedCanadian income taxes by around 33%?

Let me leave you with this. If central banks really believe that printing money andgiving it to the government and the banking sector is solving our problems and isnot inflationary why not print much, much more and be done with the crisis onceand for all? Perhaps all this money printing will usher in a new era of wealth,prosperity and low inflation - what do you think?

Kind Regards

Stephen Johnston - PartnerPetrocapita Income TrustAgcapita Farmland Investment Partnership

Stephen is a partner at Petrocapita, an energy investment fund built around the corepremise that the world is in a bull market in commodities driven by inflation and a step-change increase in demand and, accordingly, that investments with direct or indirectexposure to commodities in a politically stable environment such as Canada will provideabove average returns. Petrocapita holds a portfolio of low risk, producing energyassets.

Stephen graduated from London Business School and is the founder of one of Canadaslargest farmland investment funds, and Petrocapita. He has over 15 years experienceas a fund manger working for organizations such as the European Bank forReconstruction and Development, Societe Generale and Baring Brothers.

Stephen has appeared on Business News Network and CBC News and been quoted insuch media outlets as Fortune, the Financial Times and The Globe and Mail.

Information contained herein is obtained from sources believed to be reliable, but its


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accuracy cannot be guaranteed. The information contained herein is not intended toconstitute individual investment advice and is not designed to meet your personalfinancial situation. The opinions expressed herein are those of the author and aresubject to change without notice. The information herein may become outdated andthere is no obligation to update any such information.

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Petrocapita - Monthly Commentary - Recovery, Real or Nominal?