norm lamarche - q3 2011 commentary | front street capital

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Front Street Capital

NORM LAMARCHE - Q3 2011 COMMENTARY
It is very disconcerting to see the governments bickering in times of trouble. Unfortunately, its human nature to take it as close to the wall as possible, before putting measures in place that should have been initiated months beforehand. In many respects, the current market bears a striking resemblance to the 2007-2009 fiasco, in which the factions in the U.S. politics dragged the fiscal and monetary fixes later than the market and the economic world needed. The longer they wait, the greater the stress, and ultimately, the greater the economic scar tissue thats longer lasting. In Europe today, the EU countries have been living through similar feelings as the American government and the American tax payers felt back in 08. At the time, it seemed ridiculous to have to
FUND MANAGER

Norm Lamarche

bail out the big U.S. banks, after they profited handsomely by taking on extreme risks and poor lending, all in the pursuit of growth, profitability, and bigger bonuses. Bailing them out seemed unfair to the average taxpayer. But in the end, they realized that they couldnt survive without them and bailed them out. Europe is going through a similar set of feelings this year. Why bail out Greece, when they mismanaged, lied and cheated within the Euro? When they work fewer hours a week, have more holidays and retire at a younger age than the Germans? There is a growing realization today, that notwithstanding those views, the alternative (to not bail out Greece ) is a worse one. Now the devil is always in the details and we havent seen anything yet, other than the intent to ring-fence as much as possible the private sector (banks). The other frustrating reality with the current Euro issue is that were now dealing with multiple governments. Not only do they share some commonality, but also they have strong diverse views and must report to their own constituents. Not an easy task indeed. Having said all that, stability is required and will likely come forward. We expect a lot of cheap liquidity to be made available to the EU governments and to the Banks. Greek debt has to be written down to more manageable levels. What will the world look like if the Euro is able to manage its sovereign debt issues?

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06/11/2011

norm lamarche - q3 2011 commentary | front street capital The economic world is not as bad as the media portrays it to be. However, it certainly doesnt mean that it cant get worse from here. The longer this plays out, the more difficult it could get. Real consumption and investment decisions are currently being postponed until greater clarity prevails. America also needs to contend with its own set of austerity measures in a very politically hostile environment. A challenging big picture indeed, likely throwing big headwinds our way. However, not all is bad. In fact, we find some reasons to get excited. The thrust of our investments are in sectors that continue to be really busy. There is a renaissance going on in the global energy sector, particularly in North America. The change could be as powerful to the North American economies as the internet revolution was on the way we conduct business. The benefits would not only be economic, but potentially geopolitical as well. The chart below shows the price of natural gas in the U.S. compared to the price that the Europeans and the Asians are paying.

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If the discrepancy was short-term driven, for technical reasons, it wouldnt matter much. In this case, it is secular driven and long lasting. America has a competitive advantage as it relates to energy. Cheap energy may just save America!

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06/11/2011

norm lamarche - q3 2011 commentary | front street capital For Americas industrial segment, its chemical industries, fertilizer industries, its transportation sector, its power industries, all are big consumers of natural gas, all have a tremendous competitive advantage, worldwide. Dow Chemicals notes that cheap North American gas saves them $2 billion a year. They and other industrial consumers of natural gas are investing dramatically in the U.S. today. Natural gas prices will likely remain quite subdued for a long period as a result of the massive new shale plays that have been made possible with new technologies. Infrastructure will need to be built to support it. In a growing demand and volumes environment, capital spending in infrastructure is following. Investments in pipelines, gathering line, midstream facilities, fracking units, etc. Natural gas for export markets is also a new reality (unthinkable only five years ago). North America was very busy five years ago, building LNG (liquefied natural gas), receiving terminals to allow for imports of gas into the continent. Today, they are not only left under utilized, but industry is now looking at converting them into export facilities! The energy sector, particularly the services sector, is running hard and is very profitable. This technological revolution in the energy patch is turning America into the low-cost energy basin and giving its economy an edge to its manufacturing sector. The energy infrastructure space in the U.S. is bottlenecked and capital is flowing into it for expansions. Natural gas is extremely cheap and will likely stay there for a long time, which means, that for whomever consumes it, they have a world-class advantage, relative to Europeans and Asians. We think energy will save America! These massive shale plays (oil and gas) are expansive and cheap! But they are very labour (energy services) intensive. Hmm, just what America needs! Jobs, cheaper energy, and a need to build massive infrastructure to support it. In volatile capital markets like these, the smaller to mid-cap stocks take a bigger back seat and underperform their larger counterparts. Operationally, the companies are generally fine and their balance sheets are OK. Avoiding groups that have large debts really paid off for us back in 08-09. Its a theme with us today as well. We are definitely in an era of government retrenchment. That shouldnt surprise us. It will indeed be a drag on world growth. That also shouldnt surprise us. Interest rates will remain ultra low for longer, especially during periods of instability. Price declines in the market have been overdone and investors will likely remain quite anxious about putting on the risk trade, until they see a way out of Europes sovereign debt crisis. While painful to watch, we have remained focussed on our key themes.

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06/11/2011

norm lamarche - q3 2011 commentary | front street capital This energy revolution, for example, is happening today, notwithstanding the global macro picture. It will create greater economic activity, additional jobs, more wealth, greater U.S. energy production, a reduced reliance on foreign imports, a cleaner environment, lower energy prices, greater domestic consumption, a competitive advantage for industrial America, capital investments, a better fiscal situation, improved trade balances, and a potentially improved geopolitical balance of power! All of which will cost the taxpayer NOTHING because industry will do it themselves for profit. Americas best policy today should be to just GET OUT OF THE WAY. Norm Lamarche

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06/11/2011