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The Times: Investing in stuff develops into a fine art

January 16, 2008
Carl Mortished

Stuff you can burn, stuff you can eat and stuff you can hoard. The world is going back to basics. We knew about oil in three digits and gold beating its record and now silver is getting a polish. In Britain, we had forgotten about coal – and the price of the ugly, polluting fuel is riding the up escalator.

Banks that invest in whizzy things such as credit card receivables and mortgage securities are yesterday’s cold turkey. Instead, the moneymen are buying something to stave off the chill, to store under the mattress and to put food on the table. Greed is finding common cause with hunger and people are betting on harvests, scanning grain siloes and plantation warehouses. Are they half-empty or half-full?

During periods of stress, investment is 90 per cent sentiment and 10 per cent intellect. There are some good reasons why commodities are fashionable: demand for basic needs – fuel, shelter and food – is rising because Asia is getting richer. But you don’t have to buy crops; agribusiness is sophisticated and there are good companies that mill flour, process corn and make margarine. So why are fund managers filling their boots with certificates to buy tonnes of wheat and palm oil, to be delivered in March?

It’s not enough that the climate is changing, that China is ravenous, that American wheat stocks are at 40-year lows. Something else is amiss, driving funds to take a tenth of their cash out of financial investments and put it into … stuff.

What is wrong is valuation. The big question that is causing hedge fund gurus to toss and turn on their Egyptian cotton sheets is: how do I know what this piece of paper is worth? The sub-prime mortgage debacle did more than create losses for banks: it forced people to ask whether the techniques used by banks to value debt secured on portfolios of assets that are themselves secured on thousands of homes are meaningful. Each home is an illiquid asset, for which there is uncertain demand; the homeowner/ borrower is a cipher. His specific risk of default is multiplied tens of thousands of times into a bald portfolio statistic, about which agencies collect data, which is always in arrears. Does that make you feel secure?

Then consider a commodity, such as oil. The Brent crude futures market is a huge financial construct, an inverted pyramid. About 240million barrels are traded on the ICE Brent platform, three times the volume of oil pumped out of the world’s wells each day. It sounds even more wobbly if you consider that the Brent field, once a colossus, produces less than 200,000 barrels per day. So few cargoes are shipped each week that Platts, the oil price assessor, had to intervene in 2002, bolting two similar crude oils, Forties and Oseborg, into the Brent assessment because the physical dated Brent contract was at risk of being squeezed.

Funds are comfortable with oil futures because, on a daily basis, the market touches down at 4.30pm in London when Platts delivers its dated Brent price assessment. It’s not a view, such as the credit opinions delivered by Moody’s or Standard & Poors on a company’s ability to repay its borrowings. It’s a little chink of light in the financial hurricane – the price paid for the last cargo of Brent to change hands. There is comfort in tangible things and if what you own is a piece of paper, it is reassuring to know that somewhere real people are bidding real money to buy real stuff.

Oil appeal

Hedge funds like oil, but oil companies are troubled about fitting their business model to the latest political fashion. Five years ago the mantra for all the oil multinationals was probably “more oil and even more gas”, but this week Total said that it was teaming up with Suez and Areva to bid for nuclear power projects in the Gulf. Meanwhile, BP is muddying its green image with investments in Canadian oil sands. Shell is toying with new technology to turn wood chips into fuel. Only ExxonMobil is refusing to play the new game, arguing that renewables won’t deliver many of the megawatts we need.

It’s not hard to sympathise with Exxon, if only because governments give no useful guidance about what is needed. The Royal Society this week gave a bruising critique of Britain’s Renewable Transport Fuel Obligation (RTFO), suggesting that it could do more harm than good. The RTFO implements an European Union directive that requires 5 per cent biofuel content in road fuels by 2010 and 10 per cent by 2020, but the regulation doesn’t stipulate what greenhouse gas reduction is intended. Almost any biofuel will do and the Royal Society researchers indicate that biodiesel made from wheat could cut emissions by 10 per cent or 90 per cent, depending on the technology and crop management.

Small wonder that oil companies are so cynical. Total is going nuclear – zero-carbon – while retaining its South African coalmines. It’s a good hedge against politics.

Sweet music

If all else fails, there is always fine art or even fine violins. A fund has been launched – $80million is the target – to buy up beautiful and rare musical instruments. These hail mostly from Italy and date from the 17th and 18th centuries. There is a finite supply and an original Stradivarius could cost more than $1million.

Apparently, it is entirely serious and the Fine Violin Fund’s prospectus shows charts that demonstrate the performance of violins outstripping everything – shares, bonds, real estate, even art in general – over the past 20 years.

But how do we really know what it’s worth?

http://business.timesonline.co.uk/tol/business/columnists/article3192936.ece

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