It’s here. Jeremy Grantham, chairman of GMO LLC of Boston and a well-known money manager whose clients have included U.S. Vice President Dick Cheney and 2004 presidential candidate John Kerry, has finally released his latest quarterly letter, along with a “special topic” letter to boot. The following are some notable excerpts:

U.S. Stock & Housing Markets

Where does this leave me? Believing that asset prices will come down to fair price and below by about 2010, a belief I have held since 1999. This means about a 10% to 15% decline in the S&P by then (to about 1100) and a similar percentage decline for EAFE; about another 10% decline in U.S. housing and perhaps a 40% decline in U.K. housing, which is likely to take quite a while longer than 2010 to bottom out. Critically, overruns on the downside for all asset prices after a bubble breaks are much more the rule than the exception!

Commodities

The prices of commodities are likely to crack short term (see first section of this letter), but this will be just a tease. In the next decades, the prices of all future raw materials will be priced as just what they are: irreplaceable. Oil, for example, will never again be priced on the marginal cost of pumping a marginal barrel from some giant Saudi oil field, as has been the practice for most of the last 100 years of oil production. Real cost is always replacement cost and oil, a precious feedstock for chemicals and fertilizers, simply cannot be replaced. Using marginal cost as a substitute was ignorant and conducive to wasteful consumption of scarce energy resources. It also enabled us to put our collective head in the sand and ignore the growing need for an enlightened long-term energy and climate policy.

Relatively quickly, in 100 years or so, we will run out of oil, underground water, and most non-fully-renewable resources. At current rates, we will do it very, very fast. A major complication now, though, is that we have been brainwashed by repetition to reject this whole idea as irretrievably pessimistic and defeatist, and just well… thoroughly un-American.

Summary & Recommendations

Due to a combination of spectacular mismanagement by the authorities that resulted in very excessive and dangerous speculation and very bad luck in the timing of commodity problems and over-rapid expansion of China, the fundamental global outlook is substantially worse than expected. These problems lower long-term asset values by a little and increase the chances of deeper overruns and perhaps a faster trip to the lows. Our advice until now was very simple: take as little risk as possible except for emerging markets. Now it is even simpler: take as little risk as possible.

The more complex issues, as always, involve timing. Both emerging markets and commodities (especially oil) have a creative tension between the negative and risky short term (1-2 years) and the attractive long-term (5-10 years) prospects. In the short term, slowing world economic growth combines with credit, currency, and inflation problems to dominate the outlook and offer poor prospects for emerging markets and commodities. Longer term, the reverse is true and they look like the assets to own. But for those who can keep some of their powder dry, there are likely to be much better investment opportunities in a year or two (or three) than we have seen for 20 years. Our motto should be:

Don’t be brave, run away.
Live to fight another day.

You can access both Grantham letters via the GMO site here.

Sources:

“Meltdown! The Global Competence Crisis”
GMO Quarterly Letter, July 2008
Jeremy Grantham
GMO, August, 2008

“Living Beyond Our Means: Entering the Age of Limitations”
Letters to the Investment Committee XV
Special Topic, July 2008
Jeremy Grantham
GMO, August, 2008

This morning, I read a piece by BusinessWeek associate editor Susan Berfield, who wrote that legendary oilman T. Boone Pickens, Jr., has been investing in water, or “blue gold,” as it’s known to some. Berfield wrote yesterday afternoon:

If water is the new oil, T. Boone Pickens is a modern-day John D. Rockefeller. Pickens owns more water than any other individual in the U.S. and is looking to control even more. He hopes to sell the water he already has, some 65 billion gallons a year, to Dallas, transporting it over 250 miles, 11 counties, and about 650 tracts of private property…

“There are people who will buy the water when they need it. And the people who have the water want to sell it. That’s the blood, guts, and feathers of the thing,” he says.

Why would the “Oracle of Oil” take a special interest in water when there’s other resources he could turn a profit from? Berfield explained:

In the coming decades, as growing numbers of people live in urban areas and climate change makes some regions much more prone to drought, water—or what many are calling “blue gold”—will become an increasingly scarce resource. By 2030 nearly half of the world’s population will inhabit areas with severe water stress, according to the Organization for Economic Cooperation & Development. Pickens understands that. And while Texas is unusually lax in its laws about pumping groundwater, the rush to control water resources is gathering speed around the planet…

Into this environment comes Pickens… So far he has spent $100 million and eight years on his project and still has not found any city in Texas willing to buy his water. But like many others, Pickens believes there’s a fortune to be made in slaking the thirst of a rapidly growing population. If he pumps as much as he can, he could sell about $165 million worth of water to Dallas each year.

Source:

“There Will Be Water”
Susan Berfield
BusinessWeek, June 13, 2008

This weekend, Bloomberg reporter William Bi reported that legendary investor Jim Rogers is bullish on Chinese shares and currency. China’s stock market, the world’s fourth largest, surged from 2005 to 2007, but has plunged as much as 39% this year. According to Bi, Rogers told a seminar in Beijing on April 26 that:

“All my new money goes to commodities and China. All the panic looks like a bottom. I have bought in the last four to five weeks. I’ve been buying shares in China for the first time in a long time.

The Bloomberg reporter wrote:

Rogers said he bought shares related to tourism and education, which “in China will continue to be a major industry.” Other investments include those of airlines, water companies and agricultural producers, he said.

“China has a huge agricultural problem,” Rogers said. The “government is doing everything it can to revive the agriculture industry.”

The co-founder of the Quantum Fund with George Soros also spoke positively of the yuan (or renminbi), China’s currency. Rogers predicted the currency could eventually rise to 2 yuan per dollar, and said:

“Don’t sell your renminbi, because it will go a lot higher in the next 20 years.”

According to Bloomberg, the yuan has gained more than 4% against the greenback in 2008, after climbing 7% last year.

Source:

“Investor Jim Rogers Buys Chinese Shares as Market Hits ‘Bottom’”
William Bi
Bloomberg, April 27, 2008