The challenge current investors face is that sovereign debt default via inflation/currency debasement obviously doesn’t create any new wealth but it certainly reallocates it amongst economic participants, and it is a process that takes place largely unnoticed until it is too late for most.

1. Agcapita Update
May 23, 2012

2. Agcapita Update
INVESTMENT THEMES - RISK, RETURN AND VALUE IN
WESTERN CANADA
The challenge current investors face is that sovereign debt
default via inflation/currency debasement obviously doesn’t
create any new wealth but it certainly reallocates it amongst
economic participants, and it is a process that takes place
largely unnoticed until it is too late for most.
Sadly, that is the entire point of the ongoing zero-interest rate
policies - to quietly expropriate as much scarce capital as
possible for the benefit of bankrupt but politically influential
sectors of the economy - particularly in finance and real
estate.
Where do you invest in such a world - a world of negative
real interest rates, bloated central bank balance sheets and
solvency challenged governments? I do not intend this letter
to be a definitive answer to that question by any means,
rather a quick overview of some ideas which we believe are
worth consideration.
There are still pockets of good risk-adjusted returns to be
found in the developed world despite the relentless overall
deterioration in western growth fundamentals - or perhaps
due to the dogmatically Keynesian mindset of our monetary
and fiscal authorities, because of them. I hope it does not
come as a surprise that for the diligent researcher there are
ways outside of gold to go long monetary malfeasance while
obtaining some growth exposure and perhaps a margin of
safety as well.
Consider the value of commodity-linked returns in a
politically stable part of the world - western Canada.
Commodity production assets, or more generally commodity
linked cash flows, have interesting inflation hedging
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3. Agcapita Update (continued)
characteristics, can be useful tail risk hedging tools never be ignored, as I believe it is a key differentiator
(farmland) and when located in Canada provide of returns. Just ask investors in Sino-Forest or YPF to
linkage to emerging market growth and tight supply name just two recent demonstrations of this principle.
dynamics without emerging market risk. In addition,
agriculture and energy have another useful quality in Private Equity (“PE”): Canada has some of the best
volatile times - highly inelastic demand curves. PE returns globally (particularly smaller transactions):
For those unfamiliar with western Canada’s 10 years 5 years 3 years
commodity endowment, it is a region with less than
Canadian PE 14.2% 16.8% 7.2%
10 million inhabitants but is the epicenter of one of
the world’s most impressive concentrations of real US PE <250mm 3.4% 4.2% 0.1%
assets. Its approximate global reserve rankings (or TSX 3.9% 4.1% -2.5%
production rankings in the case of beef, timber and
wheat) are as follows: At the most basic level western Canadian PE returns
are linked to commodity prices and the consistently
Potash - 1 higher and more stable rates of growth that have
Oil - 2 been occurring in this market. However, there are
Uranium - 3 some additional factors driving returns as well:
Timber - 5 Firstly, there is a strong supply of small & medium
Wheat -6 enterprise deal-flow in western Canada due to
Gold - 7 high levels of entrepreneurship (roughly speaking a
Beef - 10 “SME” is a business with less than 100 employees
Natural Gas - 20 or an enterprise value of less than $10 million). SME
penetration in the west is almost 30% higher than the
The advantage of producing the commodities that Canadian per capita average.
the emerging economies need and importing the
manufactured goods they make is significant -
per 1,000 pop
western Canadian growth rates have averaged twice
those of central Canada over the last decade. So for Canada 70
investors looking for commodity linked returns with Saskatchewan 91
political safety - western Canada is a good choice. Alberta 92
BC 81
Why the reference to political risk? When seeking to
generate commodity linked returns political risk can Ontario 68
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4. Agcapita Update (continued)
Secondly, the number of Canadian baby boomer subject to two discounts: 1) the discount of heavy
retirees has been increasing rapidly and is projected to WTI prices and 2) the discount of WTI to global
reach more than 40% of the working age population prices. Conventional heavy oil represents a relatively
by the late 2010s. It is no secret that baby-boomers inexpensive oil BTU and we believe spreads will
continue to be an influential cohort and in retirement compress over time, enhancing returns to heavy oil
will have a significant effect on the pricing of assets, production assets. In addition, we are experiencing
just as they did during their key investment years, historically low natural gas (“NG”) prices. The
except now they are entering liquidation mode. The perverse effect of low NG prices is to force operators
effect on the private equity market is simple - retiring with high levels of NG in their production mix to sell oil
baby boomer entrepreneurs must sell their numerous production assets to raise capital. This in turn tends
SME businesses which should create both deal flow to creates oil production deal flow - even though oil
and downward pressure on cash multiples. Phrased cash flows are robust.
another way, PE returns should improve.
Natural Gas: For the extreme value oriented
Saskatchewan Farmland: Since the beginning investor with a long-term horizon, NG assets with
of 2007 Saskatchewan farmland has appreciated large reserves and low production levels necessary
at a rate of over 12% per year due to increasing to maintain leases represent a low cost-of-carry
agricultural commodity prices but much more long position. Our analysis leads us to believe that
because of a large price discount to fundamentally for this purpose such a position has distinct cost,
identical land in the neighboring province of volatility and return advantages over traditional long
Alberta. In fact, the differential between the rate NG futures exposures or investments into operating
of appreciation of similar land in Alberta and companies. Assuming that the market will find a way
Saskatchewan is over 50% with Saskatchewan to exploit one of the most inexpensive BTUs in world
farmland generating substantial “margin of safety” (North American NG) then we should expect prices to
returns as the long-term price parity with its recover over the medium to long term as these BTUs
neighbour is restored. On a fundamental price per are eventually pulled into other markets - perhaps
bushel of yield basis Saskatchewan stills trades at a in the form of feed stocks (ethylene & propylene),
material discount to global averages, a diminishing finished goods (fertilizers) or LNG. Obviously this is
legacy of regulatory barriers to capital that have not an investment with a view to an immediate return
disappeared for domestic investors. but for value investors who believe in the long-term
strength of the energy markets surely something
Conventional Heavy Oil: When investing in worth considering.
conventional heavy oil in western Canada, you are
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