MoneyWeek roundup: A warning to biotech investors

The big news this week was the emerging-market rout.

Argentina has gone (even more) pear-shaped; the political row in Turkey has turned into something of a currency crisis; and vulnerable currencies such as the ruble, the rand and the Indonesian rupiah all had a bad week.

At the heart of it all are two things, said my colleague John Stepek on Monday.

“Firstly, everyone has the wobbles over China’s growth”. In many investors’ minds, China equals emerging markets, so trouble there is trouble all over the region.

Over on the developed market side, “the Federal Reserve is reining in the amount of money it prints”. When the Fed started quantitative easing (QE) “a lot of that money headed to emerging markets as investors got excited and began taking more risks”. However, “as they start worrying about ‘the taper’, people are pulling money back to ‘safe haven’ assets like the dollar, the yen, and gold”.

But stock markets in the developed world are vulnerable too. Stocks across the world, and in the US in particular, have been rising for the past few years because “the amount that investors are willing to pay for £1 of earnings has been rising”.

With the Fed now pulling back, “for markets to remain afloat, companies need to start justifying those rising p/e ratios”. Unfortunately, “in the last three months of 2013, more FTSE 350 companies issued profit warnings than at any time since 2008”.

So where should you be looking to have your money? John says give the US a miss. “A combination of political stability, strong rule of law, and control of the global reserve currency, might even explain partly why the US has spent most of the past two decades trading above its long-term average cyclically-adjusted p/e (CAPE) ratio”. But ”the market is among the most overvalued in the world”, which “makes it more vulnerable than most”.

By contrast, “Japan’s current CAPE is low” compared to its past. And “with money-printing ongoing, and the economy genuinely picking up, I reckon there’s more chance of profits surprising on the upside”.

Of course, this isn’t risk-free. “If the US goes down, most markets will fall, and the Nikkei has slid along with the rest” (and continues to do so). However, John “feels more comfortable buying and holding Japan than I would the US at this point”.

John also notes that this slide illustrates “why you should hold gold in your portfolio as insurance”. After all, “amid the recent panic, it’s one of the few things that’s going up”.

And “the companies that mine it have been performing even more spectacularly”. As John notes, if you’re interested in the gold mining sector, you should check out what Simon Popple has to say about it.

A convert to gold

On that note, it’s interesting that my colleague Ed Bowsher has chosen this week to change his tune on gold.

In the past, says Ed, he’s “struggled to understand why people ascribe so much value to the metal”. Why? Well, Ed doesn’t pull his punches. He’s “not keen on assets that never pay an income. And don’t get me started on the quasi-religious fervour of gold bugs”.

Yet now he plans to “make a small investment in bullion”, all thanks to a piece in the FT.

Said piece pointed out that gold analysts are currently mega-bearish. They reckon the gold price will “average $1,219 per ounce this year, just below the current price of $1,243”.

But knowing how unreliable analysts are (last year they reckoned an average price for gold of more than $1,700, and instead got $1,411), this has just brought out Ed’s “inner contrarian”.

And there are other factors propping up the gold price. For one, today’s level just about “covers the ‘all-in’ cost of production”. In other words, producers are only breaking even (if they’re lucky) on each ounce of gold they dig out of the ground. If the price drops, they’ll stop digging.

Demand from central banks – particularly emerging market ones – also remains strong. And even all the recent talk of deflation could work for gold. “After all, if you’re not getting much income from a bond, the fact that you don’t get any income from gold is not as a big a problem as it might be if real (after-inflation) bond yields were high”.

Overall, “an insurance policy that could also deliver a decent profit sounds good to me”.

Forced saving is a bad idea

On her blog this week, our editor-in-chief, Merryn Somerset Webb, took a look at possible changes to pension rules.

While everyone is now automatically enrolled into the new national pension scheme when their company joins, people can still “decide that they prefer jam today over jam tomorrow, and to say they’d rather not join”.

Sadly all the experts she’s talked to “expect the opt-out bit of the deal to disappear”. Now a think tank – the Policy Exchange – “has come out and actually said it”.

They want to “make it obligatory for people to save for their retirement by removing the opt-out in the existing auto-enrolment scheme”. So “any rise in your pay would come with a compulsory rise in your pension contributions”. Meanwhile, the target savings rate would be increased from 8% to 12%.

Merryn accepts that “on one level this makes total sense and it is a system used in many other countries such as Australia”. However, she also points out that, “we are absolutely obliged to pay endless income tax to cover our state pensions”, which should be “enough on the compulsion front”.

She also worries about the “horrible temptation” that such a scheme could present “our debt-ridden state”. After all, “How long do you reckon it would be before that huge pile of compulsory savings was mobilised to invest in government debt?” This isn’t ‘Help to Save’ so much as ‘Force to Save’.

Readers seemed to agree with Merryn. ‘GFL’ predicts that, “when the money runs out they will come for your savings! Directly or indirectly!” ‘Tyler Durden’ thinks that, “such an idiotic scheme would deflate wages, salaries and the real economy still further”.

Meanwhile, ‘Ellen12’ makes a particularly pertinent point about the contradictions in government policy: “they want us to spend everything we’ve got, borrow more and spend that while, at the same time, save large amounts for retirement”.

A warning to biotech investors – don’t get carried away

Tom Bulford writes our Red Hot Biotech Alert newsletter. So you’d expect him to be happy that the industry has been doing so spectacularly well.

Instead, Tom’s concerned. In his latest issue, he warns that simply jumping into a hot sector in an attempt to make up for missed opportunities “is thoroughly bad advice”.

It’s vital that investors “keep a close eye on valuation”. And it’s also important not to become too carried away by recent advances – there’s still a lot of work to be done. In short, “we must not become so enamored with biotechnology that we forget to do the number crunching”.

So how do you take part in the biotech bull market without getting wiped out when investors aren’t so excitable? Overall, Tom is particularly wary about the potential for groundbreaking new drugs. He prefers “picks and shovel” stocks – those that will benefit from providing equipment to the biotech companies themselves. He also likes “businesses that give us a more lateral exposure to biotechnology”.

It’s crucial that companies have “real revenues and profits”, or “offer genuine innovation that can have commercial value in the near and forseeable future”. And even when a company meets those criteria, there’s one more key ingredient – it needs to represent good value. Don’t overpay.

Overall, “in our enthusiasm for the promise of biotechnology we must remain hard-headed”.

This could be a great opportunity to invest in Mexico

Returning to the emerging-market rout from the perspective of those caught up in it, was James McKeigue, co-writer of The New World newsletter.

James took a look at how the recent market turbulence is affecting Latin America – and the potential opportunities coming out of it all.

“Falling commodity prices and slowing Chinese growth have hit exports”. The Fed’s tapering of its bond-buying programme “has scared investors away from exotic markets”. This has “hit some of the worst-run economies – such as Argentina and Venezuela – very hard”.

However, while “some of the finance world’s biggest names think that investors should get out of all emerging markets”, James reckons “it would be a mistake to tar all Latin American markets with the same brush”.

Sure, “Argentina’s woes don’t bode well for its major trading partner, Brazil”. This is because “the two dominate the Mercosur trade bloc, and Argentina is an important market for Brazil’s manufacturers”.

And Mercosur’s other major market, Venezuela, is unlikely to come running to the rescue either”. This is because “it’s one of the most mismanaged economies on the planet and the government’s recent decision to stop airlines from repatriating sales revenues has led many to stop selling flights in the country”.

However, “not all of Latin America is like Mercosur”. Indeed, James likes the Pacific Alliance, “made up of the open, well-run economies of Chile, Colombia, Peru and Mexico”.

While “these countries aren’t completely immune to the problems being faced by emerging markets”, they are, “certainly a lot better off than investors are giving them credit for”.

Chile exports a lot to China, but “it has shrewdly built a buffer of reserves to protect it from falling currency prices”. And “its free-floating exchange rate allows it to adjust to capital outflows”. It can ride out this storm, although growth may slip.

While Peru is also commodity dependent, “it has invested heavily in improving its terrible infrastructure, which should help to boost productivity”.

But its Colombia and Mexico that James is really keen on. Both “count the US as their major trading partner”. So while tapering is unnerving for investors on one hand, it will also coincide with the US economy improving. And that’s good news for the nation’s trading partners.

Better yet, Mexico’s status as a major manufacturer means it will benefit from the slowdown in its big rival, China. Finally, it will also benefit from economic reforms. Overall, the “this current panic is a buying opportunity for the long-term investor”.

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Have a great weekend!

MoneyWeek
The MoneyWeek team
Merryn Somerset Webb
John Stepek
Matthew Partridge
Ed Bowsher
David Stevenson

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