Investing in tangible or paper assets

Tom Dyson - Tue 04 Jul, 2006

...Under paper, we put stocks and shares, bonds, currency and cash. Under tangibles, we find hard assets like land, gold coins, factories and oil tankers...

  
 
- The investment world can be divided into two broad categories: paper and tangibles.

- Under paper, we put stocks and shares, bonds, currency and cash. Under tangibles, we find hard assets like land, gold coins, factories and oil tankers.

- Hard assets have intrinsic value. You get what you pay for. When you drop a silver bar on your toe, it hurts. Paper is just paper. It may represent a claim on an asset or a share of cash flow, but it has no tangible value.

- That’s why they attach an interest rate or a dividend to paper investments. The return compensates investors for their trust.

- There are periods in which investors prefer paper investments. These are in times of prosperity and good faith. Investors have confidence in the financial system and expect no trouble from their creditors.

- The prices of stocks and bonds go up. Interest rates fall as investors accept less compensation for holding paper investments.

- At other times, investors lose their faith in paper when hard assets perform better. Interest rates rise, dividends rise and paper gets cheaper.

- These cycles tend to last around seventeen years. For example, the 1980s and the 1990s were paper years. The late 60s and 70s were hard asset years. The post-war years from mid-1940s to mid-1960s were paper years.

- The pattern appears to follow a generational cycle. Sure, the statistics are a little flimsy, but if you think about it, the generational idea does make sense: After a market crash, it takes a generation to clean out the skeptics and usher in a new class of bullish investors.

- As legendary investor Jeremy Grantham explains...

- "It is absolutely no coincidence the great speculative bull markets of the 20th century occurred [when they did: 1929, the late 1960s, and 2000]. The fell exactly where you’d expect they would.

- "Why? Let me describe the nature of a [stock market] bubble: First a real bubble needs above all to get rid of the old fogies. So you can’t have a bubble five years after a bust. A bubble needs to rotate serious investment professionals out of their jobs..."

- Recently, I explained the generational cycle to an investment club in London and suggested the next decade would favour hard assets.

- The thing was, many of the people I presented to were approaching retirement age. Several people told me they agreed with the idea in principle, but they couldn’t wait a generation for their hard asset investments to pay off. They wanted income instead. As I explained earlier, income is more closely associated with paper assets.

- There is a solution. I call them "tangible assets that sweat."

- A factory is a tangible asset that sweats. So is a piece of property – if you can find someone to rent it. You don’t want to own these assets. They take too much time and expertise to manage.

- You can buy tangible assets that sweat through the stock market instead. This way you get the capital gain from owning a hard asset at the right time in the cycle, plus you get the income benefit of a paper investment.

- I recently uncovered my favourite example. Located in the ports just south of Vancouver, this is one of the simplest businesses I have ever come across. They unload coal from trains, pile it up on the dock and then reload it onto ships. The coalmines pay the company for this service, based on the price of coal.

- So as the price of coal rises – as I expect it will for the rest of this decade – this simple firm will make more and more money.

- The key is there is no viable way for this coal loading business to expand. So after they’ve covered their expenses, they pay all the profits back to shareholders. Using the most recent figures, they currently pay an 11% return to shareholders.

- I wouldn't say there is an abundance of firms out there like this one, but there certainly are more. So if you're after an income-from- commodities investment, pay close attention to companies whose revenue relies directly on a commodity price, companies that transport a commodity, and companies that provide services to the mining industry.

- You might just find the perfect share for your retirement...


Regards,

Tom Dyson
for The Daily Reckoning