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SVB Silicon Valley Bank publishes a quarterly synopsis of VC investment trends. The February 2008 edition is now available. As a weekly reader of Investment Strategy Outlook, SVB Asset Management invites you to download this valuable report. (PDF, 798 KB)
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SVB Asset Management has recently published an overview of the strengths and weaknesses in the auction-rate securities market. We encourage you to download this valuable report. (PDF, 123 KB)
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Debunking the Currency/Commodity Correlation Myth
I would like to explore the theory that the rapid increase in commodity prices is not a result of global demand, but that commodities have risen mainly in USD terms. That is, commodities have not increased as much in relation to non-USD currencies. In fact, one could argue it's the devaluing dollar that has actually pushed commodity prices higher and if the dollar were to reverse course, the current trend in commodity prices would come down with the value of the currencies discussed below. This would cause a problem for the U.S., which currently needs a weak dollar, notwithstanding the official line from the administration. The weak USD means that U.S. exports continue to rise (they are up 10 percent in the last six months), and this has helped keep the U.S. economy afloat in the face of the subprime-driven housing slump.
Correlations between the different commodities and currencies should show if the relationship is strong enough to make the above argument. (For purposes of this article, I've compared five currencies and five commodities from the end September 2007 to the end of February 2008 in a manner described below.) Grains and agricultural products have been the last to join this trend, as the sacrilegious practice of burning food in the form of ethanol has caused feed prices to go up, increasing the price of beef and other livestock products. First, in checking the movement of the British pound, it was clear there is no correlation (this was expected), as the pound has been influenced by the more pressing problem of its own mortgage-housing subprime mess. The result is a 2.84 percent decline in value of GBP versus the dollar from the end of September '07 to the end of February '08, the time period used in the comparison. Notably, another currency typically associated with commodities, the Canadian dollar, only had a variance of 3.07 percent for the five data points chosen because there were trend-changing highs and lows for gold and the euro in the comparison (it moved sideways), but did move a total of over 16.03 percent from its highest point to its lowest point over the total time period. This example shows that statistics do not always illustrate the market volatility that actually occurs over time.
As mentioned, I used five currencies and five commodities for the comparison: the GBP and CAD already discussed above plus the euro (used by some Middle Eastern oil producers, including Iran, to write some contracts and price oil to threaten the U.S as another form of financial saber rattling); the Australian dollar (a very high percentage of its exports are in the form of commodities); and finally, the Japanese yen. The commodities were gold, oil, natural gas, wheat, and corn. The results were disappointing. The main conclusion: as currencies go higher versus the dollar, so do commodities. The trend is similar over the longer time period; otherwise, in the current situation with constantly changing risk appetites as subprime news hits the markets, the correlations do not work that well. During the comparison period, the euro rose 6.4 percent, the Australian dollar 4.83 percent, and the Japanese yen 9.63 percent. This does illustrate the Australian dollar was held down by the risk aversion fears, whereas the yen benefited from the same news, as we have often noted in SVB's daily FX updates.
The commodity increases were much higher in percentage terms and are a clear indication of what is driving global inflation. The Commodity Research Bureau's Index rose 23.7 percent over the comparison period, with natural gas leading (a rise of 45.7 percent), followed by corn (up over 39 percent), wheat rose 32 percent; gold rose 31 percent, and oil rose 24.75 percent. Livestock products were the laggards but will surely increase as the food stock prices filter through.
From the currency perspective, one can largely conclude there is a directional correlation between the currencies and commodities. If charts are superimposed under the prevailing market drivers (the subprime credit markets and the consequential change in risk associated with the news), gold, oil, the CRB Index, and the euro do move together — but not with the same magnitude. Also, the party trick of holding the yen chart upside-down (as it is quoted currency to dollar, not dollar to currency like the EUR and AUD) when superimposed over the others, works as well.
The conclusion is that the increase in commodity costs to non-USD currencies have strengthened over the comparison period is not as much as in U.S dollar terms. There is a directional relationship between currencies and commodities under the current circumstances, but to make the argument that there has been a decoupling of commodity costs away from dollars towards being priced in other currencies is not the case at least in any broad based way.
— Laurence Hayward, Senior Advisor, SVB Silicon Valley Bank's Global Financial Services
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Tech Giants Still Shopping
The U.S. economy may be in the doldrums, but big tech companies still have the money and the incentive to acquire start-ups with useful products. Experts note that during stock market downturns, valuations are depressed, which in turn creates buying opportunities for companies with cash. Cisco — which has acquired some 120 companies in its history — is making seven to 10 acquisitions per year. Microsoft has purchased about 20 companies per year for the past several years, opting to buy technology that enhances its existing products. Explains Peters Suh, president of Vodafone Ventures Ltd., "We need [start-ups] who can help us do things at a faster velocity." (VentureWire)
Consolidation on Horizon for Drug Supply Firms
Companies that supply the world's drug companies with services and equipment may soon be in for a huge shakeout. Cost-conscious drug companies may start narrowing their lists of suppliers and likely pressuring many to merge. Consolidation provides two major benefits: small companies can gain access to a worldwide sales force and distribution, and large companies can expand their portfolio of products and services by joining forces. In fact, many drug companies would rather buy from a well-known supplier rather than from a start-up they can't count on to survive. (Boston Globe)
China Talks about Accountability
China's State Food and Drug Administration said checks of pharmaceutical ingredients made in China are ultimately the responsibility of countries that buy them. The agency said it is cooperating with the U.S. Food and Drug Administration in the regulator's investigation of deaths and illnesses possibly related to the anti-clotting medicine heparin sold in the U.S. by Baxter International Inc. The heparin case highlights regulatory gaps that are more significant now that drug companies purchase ingredients globally. (Wall Street Journal)
VCs to Work with Government
The federal government has picked three venture capital firms to take promising energy technology ideas from national laboratories and turn those concepts into companies. Under the Dept. of Energy's Entrepreneur in Residence program, each venture firm will be paired with a specific national lab. The firm will choose an experienced entrepreneur to spend several months at that lab, examining the facility's research into alternative energy or energy efficiency. After identifying the most promising idea the entrepreneur will create a new company with the help of the VC firm. (San Francisco Chronicle)
VCs Advise Conservative Spending
Venture capitalists at the Dow Jones VentureOne Summit conference voiced their concerns about a coming lack of liquidity, telling their portfolio companies to conserve cash in the midst of limited exit opportunities. The dearth of exits will require companies to raise bigger rounds in order to prepare for what will likely be a tough year. "It'll be slow, steady company-building," said Christopher Rust, general partner at U.S. Venture Partners. "There will be a flight to quality both by LPs in the venture industry and entrepreneurs to sources of capital." Some believe the industry will shift to more early-stage funding where the better valuations make more attractive investments. (VentureWire)
'Buy When There's Blood in the Streets'
A study published in the Academy of Management Journal, found that deals struck at the beginning of a merger cycle (in the first 15 percent) tend to do well, measured by the acquirers' share performance against that of the market. This year is shaping up to be a dismal year for deal-making, as M&A volume has dropped 37 percent in the U.S. according to Dealogic. The trend is a result of the private equity being taken out of the equation because of the credit crisis, but it is also because executives become paralyzed when the markets turn turbulent. However, studies show that early movers who make acquisitions in the beginning of a consolidation wave find their stock up an average 4 percent relative to where the shares would ordinarily trade. (New York Times)
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March 3, 2008
American Evita?
Tomorrow voters in Texas, Ohio, Rhode Island, and Vermont will have an opportunity to render an opinion on the extraordinary career of Senator Hillary Clinton. The pundits say it is "do or die" for the Clinton campaign. At similar junctures in the recent past, democratic voters hesitated to close the deal for Obama. Faced with two very attractive alternatives, perhaps they are reluctant to shut down either one. We can't help but wonder if Hillary's barrier-breaking candidacy helped open the door for Obama's barrier-breaking candidacy. Sometimes it feels like 1968 with Gene McCarthy setting the table for Robert F. Kennedy. Somehow, Hillary's "clean Gene" role has morphed into her playing Hubert Humphrey to Barack's RFK. It's a strange irony if Senator Clinton's inevitability has been undermined by a young, articulate man that appears to connect with voters in a special way — a reflection of 1992.
Carl Bernstein, a Clinton biographer (the far right might say hagiographer), paints a picture of someone he truly admires and wants to succeed. But the journalist in him cannot ignore the Nixonian attributes: the enemies list, the flexible relationship with legal niceties, and the frequently recast persona. Ultimately, he bemoans his conclusion that she "misrepresented not just the facts but often her essential self."* As a journalist, Bernstein's view must be taken with a grain of salt grown from our knowledge of his own professional experience. Maybe for Carl Bernstein, every politician seems Nixon-like.
Political historians may cringe at the comparisons to Indira Gandhi, Golda Meir, Margaret Thatcher, and Benizir Bhutto, arguing that Senator Clinton does not come close to the stature of these women. They are, of course, forgetting that those powerful reputations were established after they held the top job, not before. Equally off base is the "third term for Bill" analysis, positioning the campaign as a reprise of a long-held southern tradition for term-limited husbands that put "Ma" Ferguson of Texas and Lurleen Wallace of Alabama in the governors' mansions in 1925 and 1966, respectively.
Forbes' list of the world's most powerful women in 2007 contains 50 Americans (Hillary is number 25), but only four are in government service. Of the 50 foreigners, fully 10 are heads of state. Considering the leaders of nations with problems and challenges as diverse and complex as Germany, Chile, the Philippines, Ireland, and Liberia, it seems clear that Americans have been ignoring 50 percent of the talent pool for too long. Whatever the eventual outcome tomorrow, it's obvious that at least one glass ceiling has been shattered in this primary season. Although she may find it difficult or impossible to appreciate in defeat, attracting high caliber women to the field of politics where aspirations for the White House are expected, is a substantial legacy for anyone.
Beans, Wheat, Oil, and Gold!
No, this is not some medieval incantation, but, rather, a portfolio strategy for the next bubble. The curious notion about these investments is that they do not pay interest, have earnings, or even a management team. They are inert from the perspective of human ability to influence quality and to a great extent quantity. We are all price takers in this market. Calpers recently decided to invest up to 3 percent of their $240 billion in commodities. Maybe they are worn out from their "investor activism" and prefer to try their hand at changing the weather. Oh, yes, for the record: gold is up 53 percent, oil 68 percent, and soybeans and wheat 108 percent since January 2007.
A relentless pounding of bad news drove markets lower last week. The main diffusion-type purchasing manager survey indexes are continuing to fall with Chicago dropping to 44. The Michigander confidence index fell to 70, a level not seen since 1992. To cap off the terror in the markets, Chairman Bernanke got beat up in Congress for not doing a better job of protecting poor unsuspecting mortgage applicants from the rapacious lenders. He responded that he would do whatever it takes to avoid a recession. This may have satisfied the politicians, but it was not the reasoned and balanced view one might expect from a central banker. In the ensuing panic, the DJIA dropped 304 points and treasuries rallied as yields fell an astounding 30 to 40 bps across the curve. Buyers of the newly minted 2-year bond were richly rewarded with a handsome 71 bps gain for a mere two-day holding period.
End Note
William F. Buckley, Jr. died last week. One of his many contributions to political and philosophical discussion was the program Firing Line. I started watching the show as a teenager (no video games in those days), and I wondered if he invented that speaking style or if it occurs naturally in some region. (It wasn't until years late when I met Ann Peabody, head of Protocol for David Rockefeller at Chase Manhattan Bank, that I learned that Buckley's style had roots in a certain New England wealthy patrician-ism.) People say that the show was the precursor of the modern political talk show. For me, it's difficult to see the connection between the relaxed verbal jousting on Firing Line and the moronic shout fests we have today. Today's programs have much higher ratings, of course. But then, there are not that many people with the post-graduate vocabulary required to comprehend Buckley's acerbic witticisms.
— Jim Anderson, Editor
* Carl Bernstein, A Woman in Charge, Knopf, 2007
Investment Strategy Outlook is published each week to highlight issues we hope you find relevant and topical. The views expressed in this newsletter are solely those of its authors and do not reflect the views of SVB Asset Management, Silicon Valley Bank, or any of its affiliates.
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