First Eagle Global Fund Up In Q1 Letter
In the first quarter of 2014, the MSCI World Index rose 1.3%, while in the U.S. the S&P 500 Index increased 1.8%. In Europe, the German DAX Index increased 0.04% and the French CAC 40 Index rose 2.2% during the quarter. The Nikkei 225 Index fell 9.0% over the period. Crude oil rose 3.2% to $102 a barrel, and the price of gold rose 6.5% to $1,284 an ounce by quarter-end. The U.S. dollar fell 2.0% against the yen and it remained relatively unchanged against the euro.
Our ongoing concern regarding weakness in the global financial architecture means we are alert to second order effects from the artificial suppression of interest rates. As we previously discussed, one of the key sources of disequilibrium in the global financial system has been the Chinese government’s effort to tightly manage their exchange rate below fair value, thereby accumulating vast amounts of dollar reserves. Yet in recent weeks, China’s exchange rate has actually weakened. We fear that the currency’s moves reflect a softening in the Chinese economy beyond what policy makers expected. It is possible that the Chinese government worried that recent wage inflation was going to start to impinge on margins, profitability and economic growth. Furthermore, evidence of a slowdown in urbanization-related growth is manifested by the recent weakness in copper and iron ore pricing.
If our hypothesis about China is correct, it reinforces the notion that the core problem in the world financial architecture today is that neither the countries with a current account surplus, nor the current account deficit economies, can handle the equilibrium exchange rate or, conversely, the rise in interest rates that would be required for capital to be priced fairly. The political consequences would be too great.
A big driver of growth in China over the past decade has been fixed asset investment, and some amount of that manufacturing capacity would not have been added in the absence of a discounted exchange rate. The implication is the Chinese may have hit a political constraint on how much rebalancing they can tolerate.
The flip side of that is the current account deficits in reserve currencies like the U.S. dollar have resulted in excess debt. The U.S. economy cannot handle rates rising to say, 4%, because it would impose too big a debt service burden.
Thus, we have a continuation of this global financial repression for the forseeable future. The root cause of the malinvestment and excess debt has been easy money, which has become a widespread problem among both developing and developed economies because politically, no one wants to have neither a stronger exchange rate nor a tighter interest rate policy than competing countries. Every government is trying to maximize employment.
The excess assets and debt from easy money policy means there is a real risk of deflation were we to reprice currencies and interest rates to higher, more natural levels. But in the current political environment, there is no appetite for deflation. Thus financial repres – sion is indefinitely sustained. If unconventional policy is left in place too long, the feared deflationary risk could evolve and become more inflationary in nature as expectations could become unhinged. Inflation is ultimately a monetary phenomenon. So far, there has been limited evidence of that.
In an environment where individual bargains are harder to come by and macroeconomic imbalances remain, we are comfortable with our cash position of around 20% but we are not eager for our cash levels to go too far beyond those levels as we don’t want to create a strategic allocation to a repressed asset that would outlast an ordinary bear market. The cash is deferred purchasing power that we would like to put to work under the right circumstances. It has built as a residual of a disciplined approach to buying and selling.
Some of our weaker performers in the second half of last year rebounded nicely during the first quarter. The largest contributors to performance for the quarter were AngloGold Ashanti, Newcrest Mining, Microsoft, HeidelbergCement and gold bullion. The gold rebound arguably reflected the spike in risk sentiment following Russia’s incursion into Ukraine, lower yields in the Treasury market and a moderation of ETF-related selling. Microsoft rose as the company chose a new CEO, who was formerly head of cloud computing. This choice may affirm what we’ve said all along: Microsoft’s strength is in its corporate franchise.
Top detractors during the quarter were Mitsubishi Estate, MS&AD Insurance Group, Wm Morrison Supermarkets, KDDI Corpo – ration and NKSJ Holdings. Wm Morrison is suffering from a more competitive retail environment in the U.K. with the expansion of hard discounters. In the case of Mitsibushi Estate and MS&AD, their weakness may reflect anticipation of more fiscal drag in the local Japanese economy as the consumption tax is set to be increased in April.
In this environment of low risk perception, we maintain our preference for defensive franchise businesses, but are willing to add asset-intensive companies in windows of relative distress. The core of our portfolio continues to be in what we feel are resilient busi – nesses with strong balance sheets and reasonable free cash flow yields. We still see high option value in cash despite its low yield. Our cash allocation should not be viewed as a negative directional view on the market, but rather a reflection of our patience during an environment of high prices. As always, we take a long-term view and focus on seeking to build a durable portfolio that mini – mizes capital impairments and compounds wealth over time.
We appreciate your confidence and thank you for your support.
First Eagle Investment Management, LLC
The performance data quoted herein represents past performance and does not guarantee future results. Market volatility can dramatically impact the fund’s short-term performance. Current performance may be lower or higher than figures shown. The investment return and princi – pal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Past performance data through the most recent month end is available at www.feim.com or by calling 800.334.2143. The average annual returns for Class A Shares “with sales charge” of First Eagle Global Fund give effect to the deduction of the maximum sales charge of 5.00%.
*The annual expense ratio is based on expenses incurred by the fund, as stated in the most recent prospectus.
There are risks associated with investing in funds that invest in securities of foreign countries, such as erratic market conditions, economic and political instability and fluctuations in currency exchange rates.
Investment in gold and gold related investments present certain risks, and returns on gold related investments have traditionally been more volatile than investments in broader equity or debt markets.
The principal risk of investing in value stocks is that the price of the security may not approach its anticipated value or may decline in value. All investments involve the risk of loss.
The holdings mentioned herein represent the following percentage of the total net assets of the First Eagle Global Fund as of March 31, 2014: AngloGold Ashanti 0.58%, Newcrest Mining 0.69%, Microsoft Corp. 1.82%, HeidelbergCement AG 1.34%, gold bullion 4.51%, Mitsubishi Estate 0.57%, MS&AD Insurance Group 0.68%, Wm Morrison Supermarkets 0.31%, NKSJ Holdings, Inc. 0.77%, KDDI