You ain’t seen nothing yet

You ain’t seen nothing yet

I trust that our readers have had a pleasant and relaxing Easter holiday.

Today, I will be covering several topics, Easter Eggs, defence, the water industry and politics in turn. I expect most of you have enjoyed receiving or giving the traditional Easter Eggs in the last few days, albeit at a slightly higher price, possibly suffering a little shrinkflation along the way. Well as they say ‘you ain’t seen nothing yet’.

The spot price of cocoa beans had been jogging along around US$1,700 per metric ton for years and suddenly it has hit several multiples of that figure. The current price is around US$10,000. I expect you have read that this is all due to ‘Climate Change’ but that is far from the truth. It seems ‘Climate Change; has now replaced ‘Brexit’ which three years ago was the excuse trotted out for any complex problem the user did not understand and had been brainwashed to believe.

The true fact is that while crop failures and adverse weather is repetitive over the years, the main reason is the nature of the supply. Almost 70% of world cocoa production comes from West Africa, nearly a half from Ivory Coast alone, with Nigeria, Togo, Cameroon and Ghana other suppliers. While the El Nino impact (quite naturally) has led to drier conditions in West Africa, the main problems are structural. The growers are not large corporations, as you would find with the Palm Oil sector, but a myriad of small farmers. These are just one step up in the hierarchy from subsistent farmers. Like UK farmers, they have historically suffered from poor pricing. Indeed, they barely make a living and have not been able to invest in the plantations. Cocoa trees have a productive life of about 25 years, but the crop declines rapidly in later years and disease resistance increases significantly.

Moreover, the historic way of finding new land for planting with slash and burn is much more difficult due to the environmental lobby.

Add in the dry conditions and you have a significant decline in yield which has now led to the sharp price increase. You might ask why this has not yet been fully reflected in chocolate prices, including this year’s Easter eggs. The answer lies in the way that the big Chocolate companies buy their cocoa. This is through the futures market (buying forward at expected prices at the time), so it will probably take several months, if not a year or so to come through. There are no easy ways to invest in this agricultural sector, again unlike Palm Oil, where there are quoted companies, there are some ETF’s that give coverage for investors but if you love chocolate, then have a good stock as prices will continue to rise.

Defence stocks continue to outperform. I have been a strong holder of Bae and we now see others like Babcock, Qinetiq and Cohort following in their wake. We could see a prolonged bull market in this sector, which of course is precluded from being held in the fashionable ESG funds.

The war in Ukraine and the Russia- Iran – N Korea axis, China/ Taiwan plus weak Western governments suggests there are a lot more threats to come. The change in warfare playing out in Ukraine will require lots more investment in technological warfare, drones being an example. I would suggest Ukraine has similarities with the Spanish Civil War, where new tactics and equipment were perfected for the coming World War 2.

There has been a lot of misleading hot air about the problems at Thames Water, where there is an £18bn debt problem at a time when consumers are rightly concerned about discharge of sewage into water courses at times of excess precipitation. The bad management changed in 2017 when ownership changed. Previous management geared up the business and paid increased dividends and bonuses from the borrowed funds, this was a mistake. They imagined that water businesses had a reliable income stream and could stand higher levels of debt. This ignored the need for investment to cope with changes in water run-off. Coincidentally, the ownership had passed largely overseas.

The current owners have not continued with that greed or in short termism, but faced with the need for substantial investment they will not put more equity investment in unless prices to consumers are increased by around 40%. The regulator has said no, hence the crisis. Thames Water may go bust or be nationalised. Anyway, prices will go up. How did this mess happen? Greedy, mainly overseas shareholders, a regulator asleep on the job and international pricing comparisons that leave UK water charges at the bottom end of the international table.

One important factor that you will not read about is the vast increase in rainfall run off due to huge rises in urban development. It is no surprise that this has happened to Thames, where population growth has been very big. Builders get a few section106 requirements for new traffic roundabouts and the like, but are allowed to channel the extra run off into water channels that have not been improved in a century. No wonder Thames water cannot cope with the discharge of water and the increased effluent. Very poor long-term thinking here and the taxpayer will have to pick up the big one way or another.

Lastly, I turn to politics with all the talk about when the General Election will be. I am not really interested in the timing; it is the implications that are important. in my last article I explained the several reasons for low growth in the UK economy, I do not see any chance that any constructive measures will be taken whichever party forms the next government. Th polls suggest that Labour is probably going to win a huge majority. No surprise here after the revolving leadership and relative incompetence of the Conservative government, I say that knowing how distracting the pandemic and the Ukraine war has been. Lots of money spent (mainly borrowed) and largely unappreciated by the population. Moral here is that handouts to maintain a living standard are never appreciated.

So, the most voters will turn to Labour just for a change of power, but Labour will be totally hamstrung by the high borrowing levels to do anything to satisfy voter’s high expectations of change. The honeymoon period will undoubtedly be short and a majority of circa 200 as forecast will certainly lead to party divisions between left of centre ideas and a leadership that says ‘we can’t’. Big majorities and an impoverished opposition are never good for democracy and will further lead to the public’s distrust of politicians. Although some months off, the best indicator of how things are panning out will be the exchange rate, which for most investors will mean a bit more inflation and perhaps higher interest rates than expected and a portfolio orientation towards overseas currency earners. Just watch that exchange rate two years from now.

If you would like to discuss your current investments or future plans we would be happy to schedule a call – Contact details for the CFM team are here and my contact details are:

E: barrie.newton@capitalfinancialmarkets.co.uk
T: 07977 784167

Barrie Newton, April 2024