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Volume IV, Issue 9 / September 2010

Welcome Letter

I was leaning over the kitchen island in Jim Rogers´ townhome trying to find Banja Luka on the map when he said it.

¨The obvious, inevitable and momentous events take longer than you think and then even longer. You know they will happen but it is hard to understand why it takes so long. And when the obvious doesn’t happen right away or in the timeframe we expect the tendency is to think, ´Well, if it was going to happen, it would have happened already.´ Then when it happens people call it unexpected or unforeseen.¨

Jim had invited me to his home to talk about the break up of Yugoslavia not markets. Yet he was emphatic that the same principles apply to big market moves as they do to big geopolitical moves. He launched into a friendly lecture about how Wall Street analysts and fund managers will miss the big obvious moves because they are busy dissecting the day-to-day minutia.

It was the first time we had met in person although we had spoken and corresponded for several years. I first wrote him after I returned from a multi month deployment. I had read his book Investment Biker in what is called a ¨hide position¨, which is nothing more than a hole in the ground from which we conducted static surveillance. It’s not fun. It could be dangerous but it was almost always boring. Our team spent all day and night taking turns manning laser range finders and binoculars on the off chance we might need to call in an air strike. Unlikely. All we had seen for days were herdsmen, livestock and dust.

The only thing that kept me sane was Jim’s book detailing his trip around the world on a motorcycle with his girlfriend who just happened to be the daughter of one of his university girlfriends. ¨If this is what international finance is all about then sign me up. I like exotic travel¨ I thought as I peered out over the war torn landscape. It sure seemed like his way of seeing the world had more to offer than Uncle Sam’s version. He invested globally and traveled with an attractive blond twenty plus years his junior. I remember thinking, ¨What am I doing in a hole in Bum____ Egypt with a team of guys who have not bathed in a fortnight? Maybe. Just maybe, this finance stuff is not just for sissies. ¨

Mind you, everything I knew about finance in those days could have been neatly written in a matchbook with a crayon. My very limited knowledge came from two mandatory economics classes at West Point and what I picked up from reading the Wall Street Journal, The Financial Times and The Economist. I got a C in the Economics courses (too many charts and graphs) and mostly I skipped to the World and Politics sections of the WSJ and FT. I invested most of the money that hit my checking account while I was on deployment in mutual funds but would have been hard pressed to explain why I picked those funds. I just knew that if I didn’t stick the money somewhere out of the grasp of my ATM card, I would clean myself out on one of those skiing trips to Cortina. But I digress.

What matters is I wound up in the kitchen of one of the worlds most well known global investors to talk about what was unfolding in the Balkans. The visit morphed into an important discussion that would have a lasting and profitable effect on my future. We spent several hours talking about everything from technology to travel to market timing. Jim told me he was the ¨world’s worst trader¨ and that weakness was his greatest strength because it forced him to rely on his analysis and not be tempted to trade out of positions if the price moved against him. Sure he would sell if the basis of his analysis changed but otherwise he would stay put or even add to his position until the ¨inevitable finally arrived.¨ I walked away from those hours spent on Riverside Drive with a different perspective on investing and it planted a seed that would germinate over the years ahead as I left professional skullduggery behind and entered the financial world myself.

Last month I wrote about the temptation to ignore obvious danger if you are not immediately confronted with negative results. People want to believe that just because they ran the red light a couple of times and didn’t get sideswiped, the risks of getting sideswiped have diminished. It is not true. This month we are talking about a second fallacy that is all too prevalent today. This is what Jim was talking about in his kitchen those many years ago. When something momentous and negative seems imminent and then fails to materialize, humans are quick to conclude, consciously or subconsciously, that the likelihood of it happening has been reduced. In the markets this is complicated by the many cheerleaders and shills in the media who have a vested interest in claiming the ¨threat¨ was never real or has now passed. The powers that be would like you to believe that the dangers have passed and the recent problems were much to do about nothing.

This is an increasingly easier sell in today’s world of instant information and limited attention span. The CNBC viewers want dramatic charts and ¨Fast Money¨. But for the patient and prudent amongst us let’s take a look at a couple of looming issues many have assumed are no longer as dangerous or likely. Write this down. The Euro crisis is just getting started. The commercial real estate crisis is still coming. The private equity leveraged loan losses are coming very soon. Civil order in Euro land is starting to unravel. Unemployment in the US will remain high. And the interest rate slingshot is still progressing towards max elasticity. Are we surprised events are unrolling so slowly? Yes. Should we be? No. The sheer amount of interference by governments in their economies and the economies of others will naturally slow the inevitable calamity. They are borrowing borrowed time from each other. It will end badly and it will end ¨suddenly¨. As we wrote about at length in July economic and political events unfold very slowly and then happen all at once. Please do not get sucked in by the argument , ¨If it was going to happen, it would have happened already.¨

Are We Prepared?

How do you prepare? We hope you are already prepared or preparing. If you are a long time reader your physical metals are up dramatically. Gold was under $700 when we loaded up and it just peeked its head over $1300. Since we have a third of our portfolio in physical precious metals we feel the core protection is in place. With another round of quantitative easing in the US and a Euro crisis looming, gold should continue to do well. It might pull back if there is forced selling of the GLD, which we think is more likely than most. There is a lot of momentum money in the gold ETFs right now. Much of this money could flow out quickly if banks and funds are forced to raise cash quickly. We would not be surprised to see a dramatic pull back in gold and if we do see one we will be adding to our position. Our view is gold may fall back but it will be over $2000 before this cycle is over and perhaps much higher. If gold should drop below $1000 we would buy all we could afford.

We still have a third of our investment portfolio in cash. We moved it into US Dollars at a good time but we are now getting ready to reduce our cash holdings to buy unlevered productive real estate. Cash will remain an important part of our portfolio and will provide you with the opportunity to pounce on great buying opportunities when markets correct. Remember we are talking about cash in your investment portfolio and not the cash reserve you maintain to finance your day to day living expenses. Everyone should have a cash reserve set aside before they allocate their investment or speculating funds.

Our stock portfolio continues to do well. We have a portfolio review edition coming up but in the interim we are comfortable with all of our holdings. Endeavour Financial is now renamed Endeavour Mining but the story and the stock symbol remain the same. We are up dramatically on this position and have no intention of selling. However, with the vast majority of Endeavour’s resources now dedicated to gold mining we wanted to find another merchant banker for the portfolio. We have found just such an opportunity. Our Actionable Intelligence is a Canadian resource focused merchant bank with a portfolio of assets around the globe. We like the management and their portfolio and it is selling at a steep discount to net asset value.

But first we bring you a Dispatch from the editors of the Asia Pacific Dispatch. Their new monthly letter will highlight Asian investment opportunities. Without Borders subscribers will receive a three-month free trial subscription. We hope you enjoy what they have to say. This does not mean Without Borders will no longer cover Asian companies. Far from it – we will always go where we see the best opportunities. The launch of the Asia Pacific Dispatch only means that you will have access to a letter that has a more focused mandate.

Finally, it is with a very heavy heart that I put together this addition. As I sat down to write this month I learned of the tragic death of my friend Polaco. Since we moved to Uruguay he had become a fixture in our family’s daily life. Polaco was a noncommissioned officer in the Polish army when the Berlin wall fell. Soon after the paychecks stopped coming so he went west in search of opportunity. His search ended in the French Foreign Legion. After his time in the Legion he wound up in Uruguay where he was a bodyguard for several wealthy Europeans in the high season and a boxing coach and personal trainer in the off-season. I had been fighting off some reoccurring health problems when we met and Polaco got me back in the gym and back in the ring.

His infectious enthusiasm mixed with that Legionnaire’s menacing stare brought me back faster than I could have imagined. The mental and physical benefits were immediate and I learned to respect and admire his attitude towards life. We worked out three days a week when I was in town and every Saturday morning he would take me through my workout while his son taught my two boys how to box. Eventually he became my wife´s personal trainer. His sudden passing had us scrambling to do what we could for his two sons who lived with him and left us with a void in our lives. Polaco lived a life without borders. He was a true adventurer with a fighter’s heart. He will be missed. He was our friend.

Until next time, thank you once again for subscribing. We appreciate your patronage, patience and persistence. We believe it will pay off handsomely.

Yours in Exploration,

Fitzroy McLean
Chief Bon Vivant and Speculator

Dispatch: Philippines

Fitz Here. I was going to include the second edition of our series on Turkey this month but thought it was better to wait a while as the situation in Ankara is changing day by day. So while we will save Turkey for another edition, this gives me an opportunity to introduce to the soon to be released Asia Pacific Dispatch. Every month subscribers will benefit from insights and recommendations on investing in the Asia Pacific region.

We covered the Philippines once before in these pages and believe that this update is both timely and helpful for those interested in the Asia Pacific region.

Asia Pacific is a big place, in fact it’s huge. So when we thought about the places we should write about first a lot of very obvious ones popped into our minds. China, Thailand, Singapore, Malaysia, Indonesia… How about Mongolia (which we LOVE by the way). But lo and behold we chose the un-likeliest of spots, the Philippines.

Why? Simple, the Philippines is a beautiful country, with an intelligent and engaging population of (mostly) friendly people. The weather is excellent, if you like hot, tropical locales, and the living is ‘easy’. Not to mention the stock market is soaring. We’ll talk details further along, but suffice it to say that we think the Philippines is coming into its own, and we don’t want you to miss the ride.

The Philippines is a small, yet very ‘spread out’ country, made up of approximately 1500 islands, dispersed across some 300,000 sq. km. It’s home to over 92 million, and because of its relatively compact land mass, is one of the most densely populated nations in Asia Pacific, and the 12th most populated on the planet.

A Spanish colony during the 16th century, the Philippines was named after King Philip II. Manila, which is located on the northern island of Luzon, was established as the capital in 1571. Naturally the Spanish immediately began converting the indigenous population to Roman Catholicism, although Muslim Filipinos in the south and indigenous upland tribes in the north resisted. Islam arrived in the Philippines between the 12th and 14th century with the arrival of Arab traders from the Arabian Peninsula and their followers from several sultanate governments in the Malay Archipelago. The resistance continues today.

The island-nation was ceded to the US in 1898 following the Spanish-American War. Not happy with that decision, independence activists waged a guerrilla war against the new colonialists. It was relatively short-lived, and the rebels were brought under control. Political reforms were introduced and the country prepared for independence.

The self-governing Commonwealth of the Philippines was officially established in 1935, with full independence planned to follow within 10 years. Then newly-elected President Manuel Quezon was chosen to lead the country. However, WWII and the Japanese occupation during that time put a damper on those plans. It wasn’t until 1946 that the Philippines regained its independence and began digging itself out of the rubble left by the war.

Today the Philippines is a constitutional republic with a presidential system of government. The country has had its ups and downs, and it is definitely NOT the poster child for bloodless democracy. Most will remember Ferdinand Marcos, who ruled for 20 years, up until 1986, when an uprising referred to as “EDSA 1” forced him into exile. Marcos was an unmitigated disaster for the Philippines. His tenure brought martial law, rule by decree, politicization of the military, tribunals, militarization of the police force and more than a few ‘disappearances’ and deaths. It was a dark time for many Filipinos, politically, economically and socially.

Since Marcos’ rule we’ve had Corazon Aquino, Fidel Ramos, Joseph Estrada and Gloria Macapagal-Arroyo take their turns at the wheel. Just recently the Philippines elected a new leader, Benigno Simeon “Noynoy” Cojuangco Aquino III. If you can commit that name to memory it should surely impress at your next cocktail party. By the way, take note of the last name, we’ll revisit this shortly.

“Noynoy” Aquino

So how did the most recent elections go? Well, on the 10th of May 2010, 18 people were shot dead, 8 bombs exploded across the country in election-related violence, and according to the Enquirer, the leading English speaking newspaper, during the preceding 200 days of the election campaign there were 82 “incidents” and 68 “casualties”. The fanfare was less than usual for a country whose elections are fraught with violent protests, which often result in bloodshed. “Less than usual..?”

Looking more closely however, the actual facts on the ground are even more shocking, since included in this count should have been the Ampatuan massacre in Mindanao, where on 23rd November 2009, 57 people were killed in campaign-related violence.

Despite what some would call “horrific” bloodshed, this ended one of the most peaceful elections in the country’s history! In fact, it was a landslide victory for Noynoy, who took office just a few months ago now, on the 30th of June. And yes, you read it right… “peaceful elections.”

So who is this new president? Aquino is seen as a pseudo-intellectual, having spent time in the private sector and with an education in economics. This gives some of the wealthy Filipinos hope that he will be pro-business. He comes from a long lineage of politicians (notice the surname again). Most recently his mother, Corazon Aquino, held the presidency. His father made world headlines years ago after coming out of exile, only to be assassinated shortly thereafter. His death was linked to his opposition of Ferdinand Marcos. Encouragingly enough, both parents were well-regarded, and not considered “scoundrels” by local standards.

“Noynoy” did well because he was up against the former president, Joseph Estrada, a (now) convicted criminal, although that is probably a tautological statement. Despite Joseph having raided the government coffers in the past, he is still a popular figure. The other contender for the title was Manny Villar a self-made businessman with what were likely the deepest pockets of all the candidates. Not deep enough apparently.

Meanwhile, most intellectuals we’ve spoken with were rooting for Gilberto Teodoro, who on paper seems to be a hard working civil servant with a blemish-free record and a penchant for honesty. His one flaw seems to have been his association with the Arroyo regime, which preceded Noynoy’s. It´s complicated, we’re told.

What should be obvious by now is that the Filipino people are very passionate about their politics, and they get ‘involved’ in the process. The voter turnout was estimated to be in excess of 80%. This is unheard of in the western world, with the exception of places like Panama (and others), where voting is mandatory.

As is the case with most politicians, “Noynoy” won because he told voters what they wanted to hear. His key themes were eradicating poverty and corruption, which are noble pursuits. However, like his Western counterparts, he was very light on the details of how this will be achieved.

Noynoy will be at the helm for the next 6 years… unless he follows in his father’s footsteps and gets gunned down, or is otherwise removed in the interim, which is always possible if not probable. Mutiny in this part of the world is an ever-present threat and storming the Malacanang Palace is a favorite pastime in Manila.

Have we lost you yet? We hope not. Does the politics of the place scare us? Not really. We think the opportunities that are available, which we will discuss shortly, are greater than the risks. Remember, perceived risk is different than actual risk, and being able to ‘arbitrage’ the two can produce extraordinary gains.

What About the Economy?

The Philippines is the 48th largest economy in the world. In 2009 the country notched up $161 billion, trading with China, the US, Japan, Hong Kong and others.

The country’s economy is transitioning from agriculture to one based more on services and manufacturing. However, agriculture still employs close to 32% of the workforce, although it contributes less than 14% of GDP. In contrast, the industrial sector employs around 14% of the workforce and accounts for almost 30% of GDP. The services sector, including the booming business process outsourcing industry, is responsible for over 56% of GDP and almost half the country’s jobs.

The Philippines has enjoyed reasonable economic growth since 2001, when Macapagal-Arroyo took office, averaging about 4.5% per annum. But then in 2008 the government abandoned its balanced-budget goal in order to help the economy weather the global downturn. Despite previous robust growth, last year the economy grew a bit less than 1% .

The Philippines weathered the storm better than some other countries in the region, due to minimal exposure to securities issued by troubled global financial institutions; lower dependence on exports; relatively resilient domestic consumption, supported by large remittances from four-to five-million overseas Filipino workers; and a growing
business process outsourcing industry. All those Filipino house keepers in the middle east are sending cash back home to their families, and new jobs are sprouting up in call centers. These twin trends translate into greater savings, investment and consumption domestically. These are all good things!

Just recently the Asian Development Bank stated that the Philippine economy was expected to jump 6.2 percent in 2010 – up from an earlier prediction of 3.8 percent. All of Asia is humming along, and the Philippines is no exception.

We just hit you with a string of statistics, all very impressive, but now we are going to tell you to forget about those. For the most part they’re completely out of whack and questionable. That’s true all over the world, but even more so in places like the Philippines. But don’t panic, this isn’t necessarily a bad thing.

It works like this… The young guy we paid to fetch us a case of San Miguel Pale Pilsen, while we loitered around publicly, certainly never “reported” the exchange. In fact, when he goes down the road and spends the money at the local roadside stall for a plate of kare-kare, the odds of that transaction being recorded in any government statistic are also zero… and when the roadside stall owner himself spends the money at the local sari-sari store you can rest assured that only a small percentage of that business even gets recorded.

That scene plays out every day, all over the country and in far more industries than you’ll typically find in more developed parts of the world. Therefore, to rely on some government statistic that tells you what is being produced and consumed is just plain delusional. In some cases the government statistics inflate the prospects of a country and in some like the Philippines it underestimates the prospects.

Given the fact that a very large chunk of the cash in circulation in the Philippines never enters the banking system, we are encouraged by the reported numbers, because we know they are so underreported. If fifty dollars comes back to Manila tucked inside an envelope, and then is spent in the cash economy, it never hits the official data reports. That is a good thing in our view because it can’t be taxed, regulated or otherwise squandered by the system.

The Bond Market

We’ll be brief here. As we recently wrote in Global Speculations, the Filipino’s haven’t been having much trouble raising capital in global markets. They just closed a successful bond offering referred to as the Global Peso Bond Fund. It’s a Ps44.2 billion (US$1 billion) long-dated 10 year deal. It is denominated in pesos, settled in US dollars, with its interest payments indexed to the peso spot rate. It pays a 4.95% semi-annual coupon. These 10 year notes were rated Ba3 by Moody’s and BB by S&P.

We said the following in our GS post:

“With the peso´s rise closing in on 9.5% in the last 12 months, and expectations of it rising another 3% by year end, the demand for these bonds was huge.

How huge?

The deal attracted an order book of US$ 13.5 billion. Remember they were raising a mere $1 billion. As such most investors walked away disappointed.

The Philippines has proved a sophisticated borrower when accessing international markets three times this year alone. In January they went to the market with a US$ 1.5 billion dollar-denominated tranche, and then with another US$ 750 million issue in July. They also did a ¥100 billion bond issue earlier this year.”

So why are people chasing, rather falling over one another, to get a 4.95% yield in a country historically plagued by corruption, defaults and social unrest? Growth! And the fact that in today’s interest rate environment 4.95% is considered a high yield.

We suspect it could end badly for global bond investors, and we wouldn’t recommend you put your money into Philippine bonds, but in the interim the Philippines is attracting capital on the cheap. In fact, the yield on the Philippine 10-year government bond has decreased more than 2% in the past four months, which some think is reflecting lower perceived risks after the election of Noynoy.

A healthy government bond market is great, but what about stocks, and how do we play it?

The Stock Market

The Philippines, although a frontier market in many ways, maintains a sophisticated financial system that is efficient, transparent and accessible. It’s not Mongolia or Vietnam, that’s for sure.

For some historical perspective, it’s curious cocktail party fodder to know that the Philippine Stock Exchange (PSE) was created from a union of the Manila Stock Exchange (MSE) and the Makati Stock Exchange (MkSE) in December of 1992. The MSE dates back to 1927, while the MkSE was established in 1963. Today it is a mature, publicly traded, member-governed organization with over 250 listed companies trading, totaling close to $150 billion in market capitalization.

It is well-regulated, with the Philippine Securities and Exchange Commission overseeing the activities of market participants. We don’t care much for regulators, but it gives some investors, especially institutional ones, comfort. Like other mature bourses the world over, the PSE has SRO status (Self-Regulatory Organization), which means just that – it can impose its own rules and penalties on issuers.

To be sure, Philippine stocks are on a tear. The stock index has surged 28 percent this year alone, the largest gain among the 15 biggest Asia Pacific markets. Why is the market so hot right now? Export growth may have something to do with it. In July exports soared almost 36 percent, driven by strong demand for electronic goods, which the Philippines produce and ship worldwide. Export shipments totaled $49 billion last year and are the country’s largest source of foreign exchange. Rising exports helped drive Philippine economic growth of 7.9 percent in the last quarter, the fastest pace in three years.

Foreign purchasers are also pushing up the index. Purchases of stocks by foreigners in 2010 have already surpassed all of 2009. According to one money manager at Union Bank of the Philippines, “There’s a strong belief that we are entering a significant bull market backed by fundamentals.”
The praise is almost universal, which would normally scare us away like a scalded dog, however this market appears to have legs. ING reported that, “Some funds in North Asia are shifting to the Philippines and Southeast Asia, drawn by the region’s resilient domestic markets. The Philippines is in a sweet spot.”

Fund Inflows are very, very strong. The total for 2010 so far is over US$ 427 million, according to stock exchange data. In 2009 the total for the year was a net US$ 419.57 million. The trend is clearly up. In fact, the consensus is that the Philippine index will gain another 10 percent or so in 2011, a bit of a slowdown from this years torrid pace, but exceptional growth nonetheless.
Macquarie Group Ltd, a large Australian-based investment house, and a fixture throughout Asia Pacific, expects economic expansion and earnings growth of 23 percent this year, which it says will push Philippine stocks into a “massive bull market.” We like the sound of that, and you should too.
But even after this year’s gains, the Philippine market is not getting the love it deserves from the institutional community. Many are still under-weighting it in their portfolios.

It would appear that although the bond market seems to think the risk profile has been reduced, foreign equity investors, have not yet come to the same conclusion. Of course the bond markets usually lead, so we do expect the equity players to wake from their slumber, and if the recent breakout of the index is any measure, it looks like they have started to ‘shake off winter.’

How to Play it

Buying stocks on the Philippine exchange, if you’re using a typical on-line US-based broker like E*Trade or TD Ameritrade, isn’t possible. You’ll need to open an account with an overseas broker, but we feel the extra effort will be worth the potential rewards. Not to mention, by buying the stocks on their home exchange, in pesos, you get to capture the currency appreciation as well. The peso is up over 9.5 percent this year against the greenback. This year the index returned over 31% for US dollar investors. Of course this can also work in reverse, but we see the odds of a dollar rally as somewhat less than a meteor strike.

Our favorite Asian-based on-line broker is Boom Securities in Hong Kong. They still take Americans, so if you’re serious about participating in the Asia Pacific markets this should be the first thing you do after reading this dispatch. They trade all the major markets and all the Asian markets we’re going to be recommending regularly.

For those who just don’t want to open an account overseas, or for some reason cannot, never fear, some Philippine stocks trade as ADR’s on the NYSE and the over-the-counter exchange in the U.S. (there are about 15 right now), making them easy fare for those with a US brokerage account.
And… wait for it… the first Philippines ETF hit the market just days ago (good timing on our part huh!), on September 29th in the form of the iShares MSCI Philippines Investable Market Index Fund (EPHE).

The underlying MSCI Philippines index is a free-float adjusted market capitalization weighted index designed to measure the performance of the top 99% (by market cap) of equities listed in the Philippines. This long-overdue ETF will give most conservative investors the exposure they want to the Philippines without much headache.

The five largest stocks in the ETF are Philippine Long Distance Tel 12.7%, SM Investments Corp 9.7%, Ayala Land Inc 9.5%, Manila Electric Company 9.0%, and Bank of Philippine Islands 7.6%.

Being the first ETF targeting the Philippines means that EPHE does not have any direct competition. The country has a small 0.50% weighting in the MSCI Emerging Markets Index and a barely noticeable 0.06% weighting in the MSCI All World Index. So, investors looking for an easy way to get exposure to the Philippines in their portfolio will find EPHE a convenient way to accomplish that task. You can get more information here: EPHE overview.

For those with a more aggressive bent, we’ll be recommending individual stocks in the Asia Pacific Dispatch that we feel are positioned to capitalize on the domestic growth, while minimizing exposure to another broad market sell-off. But again, if you want broad-based exposure now, we think EPHE, at about US$ 25 is a buy.

Trends

What trends do we see in the Philippines? We believe there are two, scratch that, three dominant trends. They are:

The Rise of Technology Businesses

You’ll likely hear this theme from us repeatedly and we don’t mind being repetitive. Technology transcends borders, politics, religions, ethnicity and any other social barricades that may exist. The Philippines is one of the few Asian countries with an educated workforce that is English-speaking. The literacy rate is over 93 percent. Wages are also amongst the lowest in the world, providing a one-two punch for overseas businesses looking to invest.

Call centers dot the Manila landscape, however we think that the market for high-value services such as finance, medical transcription, architectural services, legal transcription, animation and other such services is still largely untapped. Frankly, most back office operations could likely be done in the Philippines, and done well.

The business process outsourcing (BPO) industry has grown 46% annually since 2006. To put some numbers on this, Philippine BPO is forecast to earn between US$ 11 and US$ 13 billion this year, while employing just under a million people. In a country of 92 million people that may not seem like much, however this industry was almost nonexistent a decade ago in the Philippines.

We’ve personally done business with Philippine-based BPO operators, and can tell you that the experience was superior to that of doing the same in India. That’s not a dig on the Indian BPO industry in general; it’s just our observation. Another competitive plus for Philippines-based outsourcing companies is that they can offer Spanish and English bilingual employees. So when you next dial 1 for English or 2 for Espanol you might wind up going to the same employee; and, what digit you press will only determine if the young Filipino on the other end of the fiber optic cable says hello or hola.

Transition to Agribusiness

92 million Filipinos have to eat, and the amount of arable land is very limited. Over the last 10 years there has been a significant improvement in rural and agricultural infrastructure. Food production has moved from small farmers just beyond the subsistence level, to organized agribusiness companies.

The problem that the Filipino farmers encountered in the past was a truly awful infrastructure, which created extremely high costs because of low productivity and prohibitive transportation and distribution expenses. Industrializing the food industry was hopeless without well-maintained roads and infrastructure. This has been a dramatic change, which continues to improve.

This was immediately noticeable on the Philippine nautical highway, which has now made it possible for agricultural products to be transported quickly, cheaply and efficiently from the island of Mindoro, where much of it is grown, to the main destination for the products, the urban markets in metro Manila and Calabarzon, where the bounty typically includes rice, clamansi, and bananas. The improved nautical highway also makes it possible to get those products all the way to the southern islands of Panay, Negros and Mindanao now as well.

Other land-based highways, which were horrible roads not too long ago, now connect Clark, Subic, and Tarlac in central Luzon. It is said that roads are the veins of a countries economy. They carry the blood which brings nutrients to all parts of the body. It’s a good analogy. The farmers and now the larger agribusinesses can transport products reliably, cost-effectively and over much greater distances than they could before, which opens up markets and expands opportunities.

This new infrastructure has led to an increasing proliferation of businesses that are processing food products for both local as well as export markets. This is when a company takes a raw product, say bananas, and turns it into something like dried banana chips, banana baby food, banana _______. You get the picture. As a result of this, there are new signs of rural farmers experiencing increasing living standards.

Interestingly, we spoke with Harbest, a private seed company that is importing some of the best agricultural technology from Taiwan to the Philippines. What Harbest sees in the Philippines is the same set of opportunities that presented themselves during Taiwan’s rise from poverty.

Without going into excruciating detail (since this is a dispatch on the Philippines), Taiwan, a small island off the southeastern coast of China was a poor, agricultural backwater not so many years ago. It’s relatively quick industrialization and rapid growth during the latter half of the 20th century is actually referred to as the “Taiwan Miracle”. Along with Singapore, South Korea, and Hong Kong, the four countries are known as the “Asian Tigers”.

We’ll cover Taiwan in detail at a later date, it’s a truly fascinating transformation and truly an economic miracle. In 1962, Taiwan had a per capita gross national product (GNP) of US$ 170, which placed it alongside the poorest nations on the planet, and by 2008 Taiwan’s per capita GNP, adjusted for purchasing power parity, had soared to US$ 33,000! In roughly 45 years they multiplied their GNP by 194 times!

Today, agriculture constitutes only two percent of the GDP, down from 35 percent in 1952. Taiwan is phasing out a lot of its low-value agriculture, since labor costs are high relative to neighboring countries and land is scarce. Traditional labor-intensive industries have been mostly moved offshore, with more capital and technology-intensive industries replacing them. We’ve all seen the “made in Taiwan” sticker on the back of almost every electronic gizmo made today, its ubiquitous.

We feel the Philippines is on a similar trajectory, but due to their much larger land mass, also has the opportunity to exploit high-value agriculture, which is where Harbest comes in. They are bringing in profitable crops such as sweet papaya, ampalaya, eggplant, and lettuce to replace those that are more common, and lower margin.

Following this trend through, we found that Nestle is also helping small farmers in Batangas and Cavite return to growing coffee, which they were doing profitably before WWII. Additionally, Dole and Del Monte are distributing high-value products to China from the Philippines. Nearly 60% of all bananas imported by China already come from Mindanao. China is an important trading partner, and the Philippines is positioned to cater to its insatiable demand for food.

We could go on and on listing agricultural products that are still in relative infancy in terms of productive capabilities, but the point we’re trying to make is that this is a sector full of opportunity. The introduction of large-scale farming technology, the improvement in nautical and land-based transportation highways, the demand from domestic and overseas consumers and a low-cost agricultural workforce are all factors that will contribute to the growth of agriculture in the Philippines. The winners will be those companies that can create new demand from high-value products and market those products broadly.

Modernization of Infrastructure

The third trend is a simple one, infrastructure modernization. We’ve already talked about roads, nautical highways and the new agricultural technologies that are transforming the Philippines. Now let’s discuss the urban landscape.

Roughly 8 years ago when we first visited the Philippines, the place was a basket case. In some ways it’s still a basket case, but there is much less wicker in this basket. 15 years ago much of Kuala Lumpur was a slum, but today it’s totally unrecognizable, in a good way. The trend across this entire region is unmistakable. Remember our brief discussion on Taiwain?

Back in 2008, president (at that time) Arroyo had ordered the fast-tracking of the completion of 148 priority infrastructure projects, including 27 public works in Mindanao, through stronger public-private sector partnerships. The building of roads, bridges, airports, clean coal electric plants and other high-priority projects, including Internet access in the schools, all intended to make the place more efficient and competitive.

In addition, in the transport sector, a joint venture of Metro Pacific Investment Corporation and Harbour Centre Port Terminal Inc recently signed a contract for a concession to operate the Manila North Harbour. The company will invest US$ 311 million to modernize and expand the port and will operate it for 25 years.

Another key infrastructure development driving growth will be renewable energy. The Philippine government’s Renewable Energy Act (passed in December 2008) has caused the renewable energy sector to become very attractive to investors. The area has been identified as a growth opportunity by a number of domestic banks as well. Banco de Oro (BDO) is the latest Philippine bank to team up with the International Finance Corporation (IFC), which will provide the bank with advice on financing renewable energy projects. The agreement follows a similar one between IFC and Bank of the Philippine Islands (BPI), and before that with Metropolitan Bank & Trust (Metrobank).

Nuclear power is also on the horizon. After a botched attempt at going nuclear back in 1984, a South Korean company, Korea South East Power Company (Kepco) and an unnamed French company, have expressed interest in building a nuclear power plant in the country. If successful it will add 600 – 800MW to the grid by 2025.

These types of investments, renewable and nuclear, will help to ease the crippling power shortages that have been plaguing the Philippines for some time, which will raise the standard of living even further.

This brings us to our final discussion.

The Expat Experience

The country is endowed with pristinely beautiful beaches, great weather and fertile soil. If you want a place to retire and spend an absolute fraction of your money on living the good life, then this may well appeal. English is widely spoken and the people are genuinely friendly and welcoming. We won’t go into detail, but every type of lifestyle, including alternative ones, is available to those who are looking.

What is clear from the expats we’ve spoken with that are living here, is that there is a clear lack of “western style” accommodation, especially that which caters to the retiree bracket. Currently we see some opportunities in tourism, but not in the conventional gringo method of trying to sell some overpriced condos to westerners seeking sunshine, cheap beer and possibly cheap sex. Be very careful of anyone trying to sell you any property. There are plenty of better places for your money without taking the substantial risks that come with a property purchase here.

There isn’t room this month to go into detail about property rights and real estate purchases in the Philippines. Foreign individuals cannot own properties in the Philippines outright. Foreign nationals, and corporations may own a Philippine condominium or town home outright without the need to form a Philippine Corporation. Individuals can invest through a local company, but they can only own up to 40%, but have a contract with the 60% shareholder that allows them greater economic rights – like 95% of the proceeds of a future sale or any rental income. It is a mess and the government knows it. There is legislation in the works to allow full foreign ownership. For now, let’s just leave it at, “it’s too complicated to be desirable.”

We think the heretofore-mentioned lack of suitable accommodation presents an opportunity for any expat entrepreneur willing to get of their derrières and get on a plane. Setting up a property management business in one of the main cities, managing apartments for other owners and locating accommodation for both the tourist and business traveler market is a niche that makes a lot of sense to us. By providing properties with upscale furnishings, as well as other “hotel” style services to foreigners, one could carve out a nice niche. You avoid exposure to ownership, with the side benefit of being on the ‘inside’ of the property market to identify opportunities if and when ownership becomes desirable and possible.

If you are musically inclined, or have a penchant for the import/export business, we have an interesting idea for you… The province of Cebu, which consists of Cebu Island, a long narrow island stretching 225 kilometers from north to south, and 167 surrounding islands, is world famous for guitars. Apparently their guitars sound like nothing else available. I’ll take their word for it, they certainly sound nice enough, but then I’m happy listening to scratchy music coming out of a roadside vendors beat box if the company is right.

Although we haven’t done an exhaustive study on this, savvy buyers should be able to get export quality guitars in Cebu and sell them somewhere like London or NY for a hefty profit. This would also be a fun business in our estimation. You get to travel to the Philippines a couple times per year, load up your container and enjoy a week or two in the tropics. If you do it right, you may just have a nice little lifestyle business in short order.

If you choose to do business as an entrepreneur here just remember, as always corruption is endemic and when working in places like the Philippines, Zimbabwe or Bolivia you need to use contacts and cash. Cash for “tea money”… think of it as taxation up front. Call it what you like but cash talks. The nice thing about doing business in this environment is that you get to negotiate with the thief face to face while paying him, try doing that with the IRS.

Conclusion

Things are looking up, but not necessarily because of politics. Although Noynoy seems to be a charismatic and competent (enough) leader, we don’t expect complete nirvana, for citizens or investors. However in general we believe the Philippines will excel and profits will be both hard-earned as well as handsome.

The Philippines is a fascinating and wonderful place, full of contrasts and opportunities. We’ll have more to share on the Philippines at a later date, including some specific investment recommendations that we believe will benefit from the countries growth. Meanwhile, an investment in the new ETF we mentioned earlier would be a good starting point for most.

Actionable Intelligence: Aberdeen International (TSX:ABB)

Background

Unless you are a new subscriber, you know that we like the merchant-banking model. Merchant banks have multiple sources of revenue as well as a portfolio of investee companies. One year ago this month we recommended Endeavour Financial when it was trading at CAD 1.65 per share. We pointed out that the company had talented management, the backing of a proven financier in Frank Guistra, steady fee income and an investment portfolio worth significantly more than the market capitalization of the company. Today the shares are selling at CAD 2.77 and they are still undervalued. We will give you a full update on Endeavour in the upcoming portfolio review. This month we want to bring to your attention another merchant bank with equal promise.

Aberdeen International is a resource merchant bank listed on the Toronto Stock Exchange (TSX:ABB). To understand Aberdeen you have to first understand another merchant bank: Forbes & Manhattan. Stan Bharti, a Toronto based financier who has developed a solid reputation for taking resource companies from early stage ideas through exploration, development and production founded F&M at the beginning of the resource bull market. The firm has the critical elements that a small resource company needs. They have 25 geologists and as many mining engineers on staff and four full time securities lawyers. They also have a handful of full time investment bankers and accountants on staff. This is a critical advantage for junior resource companies in the early stages as they can tap these ¨in house¨ resources. F&M or Bharti as an individual, provide the seed round of financing. As we have mentioned in these pages before, the key elements a junior resource company needs are; a strong management team, the ability to raise capital, a prospective asset, the ability to promote the company’s prospects and a tight capital structure. F&M was set up with the express purpose to nurture early stage companies with that in mind.

So if F&M is the key, why are we recommending Aberdeen? F&M is private and Aberdeen was set up to give institutional investors the ability to co-invest alongside F&M. Here is the way it played out. F&M and Bharti put together a string of successes and attracted some deep-pocketed institutions that knew little about the sector but wanted in on the party. The deals F&M were putting together were too small for funds to participate in directly because seed rounds are only five million dollars or less. So in order to give the new money a way to join the party F&M created Aberdeen and raised about a hundred million dollars. This gave the funds the ability to invest side by side in every deal that F&M generated without having to invest deal by deal.

Sounds like a great plan right? Well it would have been if the capital weren’t raised in mid 2007. As you can imagine the shares of Aberdeen and it’s portfolio companies were crushed during the crisis and the new hot money ran like a scalded dog. Whereas, going into 2008 institutions held the vast majority of the shares, today it is almost entirely individual shareholders including Bharti who owns over 10% personally.

Even though the share prices were devastated and the funds new to the sector lost their shirts, the company still had the cash and they were able to pick up some assets on the cheap during the crisis.

So the elevator pitch is this: Aberdeen International is the proxy for access to Forbes & Manhattan deal flow. The shares are trading at a steep discount to the value of their investment portfolio and you get the fee income, talent of the management and future prospects of the company for free.

The Portfolio

The portfolio in its entirety can be viewed by clicking here, but here are the highlights.

Allana Potash is a Canadian potash company focusing on the exploration and development of a previously explored Dallol potash property in the Danakil Depression, Ethiopia. The Danakil depression had small-scale potash production in the 1920′s and was extensively explored in the 1960′s with nearly 300 potash drill holes. The Company has a strong management with experience in potash industry and 43-101-compliant resources of over 100 million tonnes. We are bullish on agriculture and as the Potash mania seems to be underway once again this asset should increase along with their other potash assets.

Brazil Potash Corp. is a private company with its base of technical operations located in Belo Horizonte Brazil and a corporate office in Toronto, Canada. Its primary focus is on exploration and development of its significant potash properties in the state of Amazonas, Brazil. The Company is positioned to capitalize on the growing demand for potassium-based fertilizers in the agricultural sector in Brazil and globally. Initial geological, seismic and borehole surveys indicate that the basin has similar scale, geological properties, and is the same age as the Saskatchewan basin in Canada. Access to important agricultural consumers and the presence of two ports within the property boundary provide a competitive advantage to potash produced in this area relative to competitors. Potash is popular once again. We hope they either find a buyer for this asset or get it on an exchange before the mania runs it´s course.

http://www.brazilpotash.com.br

Avion Gold Corporation is a Canadian-based gold mining company focused in West Africa. The Company holds 80% of the Tabakoto and Segala gold projects in Mali. The longer term goal of the company is to ramp production to a 200,000 ounce run-rate in 2012. Avion has a skilled management team, with a focus on growth and consolidation within West Africa. It is too early to determine if this will be a big winner but West African gold mining has been a hot bed of takeover activity and the gold price will keep this company going until someone tries to take it out.

Crocodile Gold is a Canadian company with operating gold mines in the Northern Territory of Australia and a land package of over 2,500 square kilometres. They are currently producing from the Howley and North Point open pit mines and the Brocks Creek underground mine. Crocodile Gold has 3.09 million ounces of NI 43-101 compliant measured and indicated resources and 1.94 million ounces of inferred resources. The Company has an aggressive exploration program in place with a budget in 2010 of US$23 million. This is an exciting company which Aberdeen picked up on the cheap in 2008. This is perhaps the most attractive company in their portfolio and deeply undervalued at today’s prices.

http://www.crocgold.com

Vast Exploration is an independent oil and gas company, and a partner of Niko Resources Ltd. Vast is focused on the exploration and development of its principal asset, the Qara Dagh Block, in the Kurdistan region of Iraq.The Qara Dagh Block lies on trend with existing discoveries and is located in the prolific Zagros Fold Belt of Northern Iraq which contains several large fields including the super-giant Kirkuk field. This company is a Kurdish lottery ticket. We are planning a trip to go visit them and an exciting telecommunications company also operating in the region in the next few months. We are bullish, very bullish, on the prospects of the Kurdish region but the situation with oil and gas licenses remains up in the air.

Forbes Coal is a producer of high quality bituminous coal and Anthracite from mines in the Klipriver coalfield, near Dundee, in the KwaZulu Natal province of South Africa. The corporate objective is to organically increase production from both its Magdelena and Aviemore mines to capitalize on rapidly increasing demand from both domestic and export markets. F&M and Aberdeen took Forbes coal from inception to a public listing just last week.

Belo Sun Mining (previously Verena Minerals Corporation) is a Canadian based mineral exploration company with a portfolio of properties including gold and Alexandrite gemstones in Brazil. Belo Sun’s primary focus is on expanding and completing a feasibility study on its 100% owned Volta Grande Project in Para State, which hosts a 1.4 million ounce (Inferred) and 715,000 ounce (Indicated) NI 43-101 compliant gold resource. This is an early stage play but the geology looks good.

Sulliden Gold is a Canadian-based gold exploration and development company with assets in Peru and Canada. The Company is currently focused on developing the Shahuindo Gold Project, its flagship property in Peru. Led by a proven management and board with extensive mine building and operating experience, Sulliden is moving ahead with its goal of becoming a gold producer by mid-2012. Sulliden is a top-performing pick of the Frontier Research Report. Carlos has high hopes for the company and came away from a recent trip to the mine impressed with the company.

Castillian Resources is a Canadian gold and base metal mineral exploration and development company listed on the TSX. Castillian has the right to acquire a 100% interest in 993 claims covering 25,000 hectares in the Hope Brook Gold Mine Project located on the southwest coast of Newfoundland, Canada.

They have a 100% interest in the Paramirim Gold-Copper project which covers 39,000+ hectares of a favorable belt for IOCG- and orogenic gold-style mineralization in Bahia State, Brazil.

In Tanzania, Castillian holds a 100%interest in the Kagera Project which comprises over 960 square kilometres in the highly mineralized Kabanga-Musongati Belt and holds a 100% interest in the Mangabal nickel-copper project in Goias State, Brazil acquired from Xstrata Nickel. In addition, the Company has rights to acquire 90% of the Achachucani (Pederson) deposit, an advanced gold exploration project in Bolivia which is currently under force majeure and holds 46 claims covering 960 hectares in the Klondike area of the Yukon. We would write off the Bolivian properties but they have drills turning on other projects. This is a company with several lottery tickets any of which could be a company maker. Very early stage.

Alder Resources is a Canadian TSX venture company focused on gold exploration in Colombia and in the Canadian Creek area of the Yukon Territory in Canada. They have an 80% interest in the La Montañita Gold Project situated in an area with a reported 100 year history of gold mining. It is located in western Colombia about 40 km from the city of Medellin. It’s properties are in an area where locals have been successfully mining with hand tools for the last 70 years. The company intends to analyze the potential for a bulk tonnage open pit mine. Management believes the host rock, scope and mineralization style are comparable to the nearby Gramalote deposit. The Gramalote deposit is held by a joint venture between Anglogold-Ashanti and B2Gold Inc. and hosts a NI 43-101 compliant estimated inferred mineral resource of 74.4 million tonnes at an average grade of 1.00 g/t gold for a total of approximately 2.4 million ounces of gold. The Gramalote property is less than 40 km from the La Montañita Project.

The Canadian Creek exploration property comprises approximately 11,860 acres of prospective gold, copper, and molybdenum. It is located 50km southeast of the Underworld Resources Inc (UW-V) owned “White Gold project” on the south side of the Yukon River sandwiched between the Kaminak exploration ground and the Western Copper’s Casino Deposit. These two projects sparked the largest land rush in the Yukon in years and the newly recognized area has been named the White Gold District.

Aberdeen also has another exciting private copper and gold company, Temujin Mining , located in Mongolia. We are very bullish on both Mongolia and gold. Drilling started on their three 100% owned concessions in the Ouy Tolgoi belt last month. Given the resources found in the same belt over the last several years, this company alone could dramatically increase the value of Aberdeen.

Management

We already mentioned Stan Bharti who is the Chairman and driving force behind the company. We spoke at length with the President and COO David Stein who impressed us as an honest young and aggressive financier. Stein has a degree in economic geology and worked as a securities analyst for Cormack Securities before joining Aberdeen. It was clear he was brought in to help the company gain some attention in the financial community and to try to get the story out. The CEO is George Faught who has a long track record as a resource company CFO. The younger Stein is the aggressive ¨Mr. Outside¨ to Faught´s backstage ¨Mr. Inside¨. Faught seems to have the quiet gravitas and experience whereas Stein seems like he has the bit in his mouth and is going to do all he can to close the gap between the NAV and the share price. Meanwhile there is no doubt that Bharti and his team at F&M are really the driving force behind the company.

Valuation

As of the last reporting period NAV was CAD 1.12 per share. The shares are presently trading at less than .45. Of that CAD 1.12 , 80 cents is the investment portfolio while the remaining value is a legacy gold royalty worth just over two million dollars a year as well as just over two million dollars of cash. However, the company has been buying back its shares and the investment portfolio has increased significantly with the listing of Forbes Coal and the run up in the shares of Sulliden, Crocodile and others. The valuation does not include the value of the Temujin project in Mongolia. We suspect the NAV is greater than 1.25 a share today.

So where are the risks? First this is a resource house and although they do roll up their sleeves and take an active role in the portfolio companies, the geology will determine the ultimate value. Secondly, this is a very small company and could remain under the radar for a very long time. Management is in a tough position. They need more capital to grow but don’t want to raise any money while the shares are selling at such a steep discount to NAV. They have to sell existing holdings to free up cash for the next deals. The share price in the short term will hinge on Stein and Bharti´s ability to get he word out. We suspect that if Crocodile, Sulliden or Forbes Coal gets taken out by a large player it will shine a positive spotlight on F&M and Aberdeen.

Recommendation

Aberdeen International is a STRONG BUY at CAD .45 and a BUY up to .55. If the shares pull back because long suffering shareholders give up on it then we would be backing up the truck under CAD .40.

Vulture Update

We were pleasantly surprised by all the interest we received in our Southern Cone Vultures. A lot of behind the scenes activity is going on figuring out how to best structure everything without getting crosswise with the various Caesars our diverse group has to mollify. If you have not yet received more information by the time this hits your inbox you will shortly. We are excited about this opportunity and we are keenly aware of the need to shift some cash into productive real assets. Stay tuned. It will be worth the wait.

End Quote

“There is no means of avoiding the final collapse of a boom brought on by credit and fiat monetary expansion. The only question is whether the crisis should come sooner in the form of a recession or later as a final and total catastrophe of depression as the currency systems crumble.”

Ludwig Von Mises