Odey Asset Management LLP

Transcript of Crispin Odey’s Q4-10 Conference Call

Good morning and thank you for dialling in to my quarterly. I always feel happiest when
what others fear is what I want to happen. The truth, as we know, is that the future will quite
slowly move into the present and the immediate past dominates not only the discussion but
also the policy response, although probably too much so. At times of change it is not good to
be looking at the referee in order to understand how to get ahead and I love these kinds of
markets. We have got a very big book at the moment. The Odey European Inc Fund is 120
percent net long and we have a short bond book of about 40 percent. I remain committed to a
world which continues to recover, a world in which there is convergence between the
developed and the developing world, competitively, and one in which the crucial ingredients
of inflation, wages and interest rates are in favour of inflation and wages with interest rates
remaining low. Whereas at the present the developed world is seeing inflation coming
through ahead of wages both of which are running ahead of interest rates, ultimately, when
the developed world is competitive enough, I expect to see wages leading inflation, leading
interest rates.

It is a world which demands that policymakers hold their nerve and obviously this is going to
be one of those years where actually the recovery comes through but there will be quite a few
people asking for interest rates to be raised quickly. Also we will see some people still
arguing for some kind of denouement where actually debt is priced properly at 50 cents. I
hope that the policymakers will resist the first; and I don't think that three years into this
recovery, where policymakers have decided essentially the only way in which the dollar is
worth 50 cents is maybe because that dollar has been inflated away, I don't think we can turn
away from the path that we chose two or three years ago.

In terms of the fund and where we are, page 2 just gives you a bit of the numbers. I think
what is interesting for all of you is that since the low point of August 31st, OEI itself has seen
something like nearly a 30 percent rise and the question really is, have we gone into a
different world because that is the world in which the bond market has basically turned round
and it is a world in which we have moved away from the narrow confines of the emerging
market growth story to actually looking much more broadly at the developed markets. For
me, looking back last year, I kind of put it into a context of the last two years. Obviously in

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2009 in February/March time we really did change our portfolio quite markedly and bought
in to a lot of value stocks.

The chart on page 3 (actually it is wrong in the sense that it is showing September highs for
about mid-February 2010) shows the September highs of 2009 which is the previous high to
that. In 2009 we bought into a lot of companies where the pricing would never be a recovery
and we saw many stocks rise by 10 times through the lows that we were buying into and from
that September high through to August we saw those same shares fall by 30 percent and
Barclays is one, and Avis again another. What did that mean for the portfolio? It really
meant that last year it was always very heavy because actually the value stocks were rerating
downwards again, having probably had too high a spike in the immediate period from March
2009 to September. What has been very nice since the lows of August is that I have argued
that these value stocks are now properly yielding 6 to 7 percent again, they are on about eight
or nine times the earnings and they are no longer hurting the portfolio. What you can see,
therefore, is the portfolio has lightness to it. It tends to mean that in an up market we tend to
be out performing by 1.2 percent, 1.4 percent, and then in down markets only being hurt by
about 80 percent of the hit. That is important when you are running a big book as I am doing
- it still doesn't militate; obviously, if you think the market is going to fall apart you wouldn’t
have the positions I am running. I am saying that everything that I’m looking at still says to
me you should be very long equities at this point. So, I want to have a portfolio that has those
characteristics.

There is a paradox on page 5, I have put down some of the things that I feel are important
because last year, going back, we had three attacks to my view. We had first of all Greece,
we had May, we had August and we had November. We had Greece, we had Ireland and
then we had Spain and each time an entirely different viewpoint was in evidence which was
essentially bearing you back and saying, we are not out of this and not only are we not out of
it but actually we are going to have to unpick most of the last three years. I have just been
around a bit too long, it reminds me too much of Sweden in 1995 when we all believed that
Sweden was going to be no more. 15 years on we now hail Sweden as one of the few great
countries that have got through this crisis with no pain whatsoever and indeed is booming like
nowhere else. And so yes, we have had three attacks and there are many people out there
who believe that we are going to continue to see attacks on the euro and on the weaker
members. Where I am coming from is to say just as Spain, Ireland and Greece have suffered
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from being part of the euro when they had not been competitive and therefore they have had
the wrong exchange rate for the own blowups, so actually the converse of that is that
Germany has been part of the euro which has been very undervalued relative to where
Germany's position is in exports etc. What we are going to see is this change from the
impotence being felt by the Irish and the Spanish and the Greeks to impotence over the next
couple of years being felt by Germany because actually Germany's going to boom in a way
that we haven't seen. Now that is quite a statement because I have only been covering
Germany for 30 years but the fact is since the war with probably the exception of 1961/63,
Germany has never seen a consumer boom domestically.

But before I go on to that I think it is worthwhile talking to you about the UK because in a
way it embodies everything that I think the right policy response is. If we look at last year in
the UK, GNP grew by six percent. Inflation was 3.8 percent maybe 3.3 depending where you
looked, basically wages grew by 1.8 percent and interest rates were at 0.5 percent. Two
weeks ago BarCap came out and said they expected Sterling to rally because they saw interest
rates rising quite sharply this year because how can you have interest rates at 0.5 percent
when you've got inflation coming through ever stronger. My forecast is to say actually, they
are looking at it the wrong way round. If you're the Bank of England, and this is how they
look at it, they should be saying, look this is all to the good, what we want to see is wages
rising relative to assets. Actually, if we look at last year, yes we have got an easy monetary
policy but Sterling has been a reasonably strong currency, so the market is not scared by the
fact that we are running an easy monetary policy. On top of that, when we look at monetary
numbers, M3 showed no growth whatsoever. This is really just the increase in the velocity of
circulation of money. This is not dangerous and so for me the UK is in the right place and it
means that as a market I've been very happy to be invested in it, I don't think there are
tremendous risks.

I think today the interesting point is that the euro has the perception that it is all going to
break apart whereas actually my anticipation is that this year and next year are going to be
two years where the currency union shows that it can work. And why do I think that? It's
because I think that thanks to Germany having an exchange rate which is probably 20 percent
too cheap over the last year, actually German monetary policy is massively easy and German
growth is going to be much stronger than people have forecast. I know Tim Bond was
talking about this yesterday but again the difference between the economist and strategists
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and the fund managers is often that I have to paint the colours much brighter because I have
to convince myself that this is worth doing and it is also because I'm just partly more right
than other people, that has a massive difference in terms of performance I think.

The next few charts show you how easy German monetary conditions are at the moment. On
page 8, I'm talking about German exports, and just what an advantage they have had,
especially over Japan, over the last couple of years. Then page 9 shows you just the result of
that in terms of the boom that is coming through. What is interesting is just how
unemployment is at its lowest level ever and at a level that is synonymous with wage pressure
growing, it is exactly what we anticipate happening. You can see again that everything is
starting to point to consumer income expectations towards a domestic consumption boom.
Then the big question which is what drives me to be much more optimistic about the euro, is
again, as everybody has got an overvalued property in Spain for sale, but the fact is Spain,
over the last 20 or 30 years, since it joined the EU, its exports have gone from five percent of
GNP to 25 percent of GNP. As Germany becomes much less competitive against Western
Europeans as I believe wages grow, it becomes the centre for redirected economic activity
across anywhere where there is any spare capacity. I think the chart on page 11, on the right-
hand side, just shows you how quickly this is happening. Remember, in investment terms, it
is always the unexpected that catches you out.

So what are my conclusions from all this for Germany and again for our portfolios? It is
really that Germany goes from having the lowest inflation rate in Europe around one percent,
to within two years having the highest. I haven't put in here very much about the corporate
tax rate and the effect that might have on profits in Germany because if you talk to any
German they will tell you that there are a 1000 ways in which you can still hide profits but
the fact was the tax rate came down only in 2008. The laffer curve hasn’t really been given a
chance to work. What we do know is instead of the tax rate of 50 percent on profits there is a
tax rate of 30 percent on profits and in much the same way whereas the top rate of taxation
used to be over 60 percent it is now 40 percent, so everything has actually changed over the
last 10 years in Germany. The only question is, can they hide profits? The truth is, as I
mentioned in one of my reports, that the Germans spend more money on cut flowers than
they do on equities. So there is a real problem with profitability coming through into German
companies the Germans themselves don’t own them! Historically, profits get commuted into
wages quite quickly, but if they do get commuted into wages quite quickly, it does mean
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people’s forecasts for GNP growth and for inflation in Germany are far too low. On top of
that, you have got to understand in line with the rest of the developed world we have seen a
marked fall off of in capital spending in the private sector over the last 15 years. Basically,
depreciation was 9 percent of sales 15 years ago; today it is 6 percent of sales. If we even
saw Capex rising back to those levels that would be the equivalent of adding another 15
percent to our GNP forecast for the next 3 to 4 years in Germany, and given that we have got
a 3 to 4 percent growth rate, it is going to be hotter than hell. What are the chances of that?
They are quite high because why are the Chinese so intent on raising the reserve
requirements? It is because China having been this great deflationary force in terms of wages
is now suddenly starting to look at any labour saving devices and that is when capital
spending really comes through.

I'm pretty optimistic as I say that the boom in Germany is going to go to the domestic sector;
that it is probably going to lead to everyone having to raise forecasts for GNP not only for
next year but the year after. The question is that, historically, Germany, at this point in the
cycle, would have been raising interest rates sharply, they would have allowed the currency
to rise and they would have been turning wage increases into cheaper holidays abroad. This
time around because they are part of the euro suddenly they find they can't avoid becoming
richer.

Now there may be some way in which there is some accommodation on the interest rates side
because if you look at a lot of the problems in both Ireland and in Spain, they really relate to
the banking sectors there and the margin that they are charging on mortgages, which is kind
of libor plus 4 or plus 6% over the 60 percent over the 25 year life of a mortgage. The
problem is at the moment with interest rates as low as they are is that none of these banks are
getting any benefits from the endowment effect of cheap deposits and therefore there is a
sense in which actually, strange as it may seem, in the midst of a depression in Ireland and
Spain, a rise in interest rates up to two percent may be countenanced as being actually
attractive not only for Germany but also for those countries.

What does that mean? It means that given that the expectation is that the euro is going to
play a wider part and that certainly there is no expectation of interest rates rising there, that
actually I am more positive on the euro against the dollar. I'm more positive generally as you
can see.
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What are the risks to this? The risks go back to the fact that people remain amazingly
depressed. Over the Christmas period I was reading Scott Fitzgerald's life and what struck
me as amazing is that the great Gatsby was out of print from 1933 onwards to the end of his
life in 1940, just because people didn’t want to read about the roaring 20s - they just wanted
to read John Steinbeck. But the point is that the risk today relates to the fact that government
has had to undertake an enormous public policy program in order to stabilize the financial
markets and this means that they don't see how important it is for private enterprise to exist
and to work. We have seen various different underminings of the rule of law but one would
hope, and that is why I would argue Cameron is a great thing, that there is an understanding
that growth will come from the private sector and not from the public sector. But the truth is
that is always a dangerous thing because remember - in the world that I’m looking at - I do
believe ultimately that inflation will come through and will change things.

The second risk is that interest rates rise too quickly and choke off this recovery. Always
keep in mind wages, inflation and interest rates. After the crisis and excess that we have had
before the crisis we need real interest rates to remain very much negative for a long time - for
two to three years - and that is why you do need to have bold policy makers. I think it is
important that we keep up the dialogue with them to make sure that they are not slipping
there. Ultimately as I said, I think the whole nature of what we have been in for the last three
years means that you have to make a division between the depression which demanded that
we save the financial system and caused very few casualties in terms of a competitive basis in
the real economy and inflation which I think will cause some very interesting new
developments and will induce the first recession that we will have really since 2000/2002 and
could be much more like the 70s.

Page 13 is the gilt market and it shows you relative yields and that we have broken the up
trends in bonds. Bonds look like they are on the way down, interest rates on the way up, I
don't think anyone doubts that. The question then is does that undermine the case for
equities? Partly no because equities are very much cheaper than gilts have been. Equities
have been priced off a depressionary world and not the inflationary world and this is a very
typical period, which doesn’t feel that different to 2003 to 2007. It means though that as we
are seeing in the emerging markets where interest rates really need to go up sharply there is
then pressure on financial assets to the extent that equities are very expensive. They are
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expensive but not where we are. I am the one who believes that inflation will be higher in
Germany than it will be in the UK in two years’ time.

In terms of the currency when we put this chart in on page 14 you can see the euro looked
like it was breaking down, today it has broken up to 135 now. Currencies have become much
more difficult over the last two years having had a really great time in 2008. The more
important point here is just one of convergence. I anticipate that inflation rates in emerging
markets will be that much higher than inflation rates in the developed markets but the
beginning of this year has highlighted it: investors, having been very narrowly focused on
emerging markets themes last year in the equity markets, have, even since Christmas,
broadened that and that has been very helpful for the fund which is up 5 percent since the
beginning of the year.

As these inflationary pressures come through, is the portfolio prepared? What is interesting is
our attitude has not really changed very much and my strategy hasn't changed since the
beginning of 2009. Most of the work that the researchers have been doing here has really
been to take into account: how do you prepare for a world in which input prices are rising and
where we have to differentiate between the winners and losers? On page 16, I just show you
a very quick and dirty way in which I see the winners and losers coming through.

On the left hand side is a branded company; it can therefore charge 20 percent more than the
unbranded company on the right hand side. In this case I'm going with food manufacture
selling into retail space. You can see that the branded guy spends 11 percent but it allows
them to charge 20 percent more. They make a 9 percent margin and thanks to that they make
a 3 percent margin, which is pretty well the manufacturing return which is the same return the
own label manufacturers makes. The capital employed in both instances is exactly the same.
The cost of goods is 65 percent for the own label manufacturer but it is 65 of 120 for the
branded guy so it is actually more like 51 percent for the branded and 65 for the own label.

The funding of the company's capital is typically again, the branded guy, remember he is
making a 12 percent return on sales; typically he has 20 percent equity and 10 percent debt.
The own label manufacturer, he has about 100 percent gearing. He has got 15 percent equity,
15 percent debt; he has always found it difficult to produce free cash flow. What happens
when there is 20 percent rise in the cost of goods? Very easily done, import prices rise. On
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that 65 percent the branded guy is fine because as you remember it is 55 percent of sales so it
is an 11 percent rise that he has got put through to keep his margins. The own label guy has
to increase prices by 13 percent to keep his profit margin at 3 percent. But of course, in both
instances they now have an increase in their working capital requirement, one of 11 percent
and the other 13 percent. The problem is, they go to their bank manager to say look we need
11 percent more or 13 percent. When it comes to the 11 percent, it is reasonably easy to do;
the guy has got an existing facility, 10 percent of sales. He is going up to 21 percent of sales
but it is covered by 12 percent margins, so two times covered, yes, we will give you that. The
own labelled guy on the other hand it is pretty nasty because it is 13 on 15. It is up to 28
percent, he has only got a 3 percent margin and the bank says, I don’t know if I'm going to do
it.

Why is it so important? Because actually during this next phase that is when you see the
winners and losers, this is when the inflation causes the actual recession.

We are moving into a period when I think stock picking is going to be very much more
important than it has been in the past and that is because in an inflationary world there are
winners and losers. I remember when I started in the city, even though we were at the very
beginning of the bull market – and we have not seen any real bull market since 1982 - the fact
is people's portfolios had few stocks that had gone up 10/12 times and many stocks which
were the same as they had been in 1965. This shows you very simply the differentiation
between the good and the bad in a reasonably capital intensive industry. In light of this on
page 17 I'm showing you the stuff that James Hanbury has done; we have done similar stuff
on our own: we are looking all the time at which stocks are going to be most affected by
inflation coming through. If those companies which essentially have got long lines of supply
and slow capital turn, how often are they repricing their products? Obviously a guy may be
absolutely in the right place: for example, the machine tool guy: his capex is going through
the roof, he prices the contract on 1 January and delivers on 1 October and costs go up, input
costs rise; then he finds he is not the guy who's making the money, it is the guy who's taking
delivery in October. So in many, many instances what it highlights is that it is far better not
to be producing cranes at this point in time.

It also means some businesses are the most beautiful businesses because the inflationary
pressures that are being witnessed by most people which are obviously wages, energy and
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food (if they are not being felt by the companies that we are invested in), they have the ability
at that point to put up prices because inflation is going through the roof without actually
needing to. That comes through in March and that is when stock picking really comes into its
own.

Where does this leave one? Essentially I remain convinced that we are in a really quite
normalized recovery built on very fragile foundations but one where I think the authorities
understand the problems. I think that after all the volatility that we have seen over the last
three years I think that we are going to see much less volatility. I think that what I detect
amongst most of my clients, certainly amongst you lot, is a willingness to take more risk. I
thought you would start to do that last year but actually you have taken a bit longer. I do
think that the aspect of stock picking is going to come through, I am pretty optimistic. It
doesn't mean that we aren’t going to have some difficult times but what was helpful and
interesting was we had 3 moments of hits last year and certainly in May I unfortunately did
the wrong thing, cut the book vastly, but what we saw was in the first instance there was a
float back to the bunds and a qualitative life and by November the bond markets were
breaking down in the developed world even as there were crises in some of these peripheral
companies and peripheral bond markets. The way in which I have been looking at the world
for the last three years is that I think the policymakers have got a strategy which can get them
out of the problems of the last three or four years and I think they are going to pursue them.
The answer is there are going to be many people who are wanting to trip them up but I am on
the side of the policymakers here. I think it provides an opportunity for all of us to make
some money and that is pretty crucial.

I think that obviously I have to get worried as the year goes on that we may see some
inflationary pressures getting out of control. I think one of the points that one has got to
make is that for the last three years there has been precious little capital spending - precious
little capital spending in the last 10 years, but almost nonexistent in the last three years - so
there are bottlenecks developing. You get a lot of comment at the moment about speculators
driving up commodity prices but the truth is what has happened over the last three years is
that margining of anybody in the commodity market has become much more aggressive so
that you have to put up a lot more money in order to play in those markets which has made
them much thinner and unfortunately as a result in a way they are not really telling the
producer the real facts of how little spare capacity there is out there.
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So I do anticipate this year is going to be one of those years where there will be scares about
a lack of supply. It is going to be very important that the authorities hold their nerve.

Thank you very much and let’s talk in three months’ time.

IMPORTANT DISCLAIMER
© 2011 Odey Asset Management LLP (“OAM”) as the issuer has approved this publication which is for private
circulation in the UK only to, and/or directed in the UK to persons who are professional clients or eligible
counterparties for the purposes of the FSA’s Conduct of Business Sourcebook and it is not intended for and
must not be distributed to Retail Clients. It is for information purposes only and does not constitute an offer to
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guaranteed. No responsibility can be accepted for any consequential loss from the use of this information. The
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fluctuations in investments that have an exposure to currencies other than the base currency of the Fund. OAM
is authorised and regulated by the Financial Services Authority (“FSA”). The Fund is not a recognised
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