Email of the day on the global macro outlook
Comment of the Day

January 20 2014

Commentary by Eoin Treacy

Email of the day on the global macro outlook

Liked your weekly commentary today especially the summary on Gold.  I have made money on gold and I don't wish to chase that market again.  

Now you keep talking regulary about innovation and technology.   As you are probably aware you are in conflict with the Harvard University Economic academic's view of technology and innovation.  They hold we are well past the big innovation gains from technology especially IT technology.  In fact these bunch of academics seem to beleive these innovation benefits ended at the turn of the last century i.e. 2000.  There message appears to be that the last decade has simply delivered fancy hardware / software toys that have offered business no productivity tools.   Mums and dads may like these toys but for business they are just staff time wasters.

I do beleive medical science has much to offer mankind in the future.  However that picture is a bit cloudy also.   Utilizing any new innovations seems to be determined by price.   My son Keith (has a PhD in genetics worked for Merrill Lynch) now works for a medical services company running the cancer treatment businesses.  He is some what cautious on medical innovation.  He sees government unwilling to embrace new technology unless their is a demonstrated cost saving to the government.  As he points out this is not always easy to demonstrate.

We all know US medical Insurance companies are also capping not premiums but the medical services they will offer to their insured patients.   We also here in Australia see lots of pressure from government to cap the more expensive medical procedures.  This must ultimately slow innovation in medical science.   The largest shareholder in the company Keith works for is no other than KKR who own a bit over 50% of the business.

Fridays profit warning from Royal Dutch Shell seems to suggest at least some of the dumb money must now be looking closely at getting out of the "Fracking" business.  Let's see if the other big dumb money provider in BHP also throws in the towel on what I see as a very stupid business.  I am not environmentalist this is just about a reasonable return on capital.

I listened to a Economist speaking on oil on Bloomberg the other night. He had a cautious view on Oil prices saying its always priced at the marginal producers cost structure I.e the fractures cost as we all know.  The dumb money frackers must be getting increasingly sick of this profit-less business.  I know Iraq, Iran, Saudi Arabia etc, etc are not going ignore 1,000 years of hating and killing one another.  The Libyan oil fields now producing 200,000 to 300,000 barrels a day are not going to revert overnight to again produce 1.8 million barrels a day.  Try talking to an oil geologists how hard it is to get an oil well flowing again.  This is an extremelly challenging task.  Lastly the US embraces Iran nuclear industry and all is forgiven about the Bush Evil Empire statement.  Somehow I don't think it's that easy.   The oil business is challenging. 

You are right the RBA is on the sell side of the AUD.  As to the future level of the AUD local economists are very worried.  They fear when we shortly become a very large energy exporter the AUD will come under pressure to rise.  This will make most other local export industries uneconomic.  There was a comment on Bloomberg the other night from a US oil company that said the oil business is now too expensive and costly.   That LNG is the go and forget the US, go straight to Australia where it is cheaper and easier.  True I am not making this up.

Perhaps we can talk more about these big picture matters at the Sydney conference.

Eoin Treacy's view

Thank you for this thought provoking email which touches on a number of the issues I anticipate discussing with delegates at the upcoming Chart Seminar and Global Strategy session in Sydney. With only two weeks left before these events please contact Sarah Barnes sarah@ftmoney.com to secure you place.

From what I have read of the Harvard Economics team’s research, they tend to focus on the significant challenge of increasing processor speed as “gates” approach the width of a silicon atom. An acceptance of this limit helps to explain the urgency with which companies are investigating the potential of carbon nanotubes, graphene and other substances for the production of future generations of microchips.

When we speak of nanometres in chip design, considerations such as heat and energy efficiency move front and centre. ARM Holdings benefitted from the development of smart phones because its chips are energy efficient, so they were ideal for the iPhone. The company now generates more revenue from embedded processors than phones.

I agree that much of what we have seen in the development of social media is at least superficially a waste of time from the perspective of a manager attempting to maximise the productivity of their workers. However, taking that view would be to ignore the very real growth potential of the sector from a marketing and crowd sourcing perspective.

Moving on, the evolution of embedded programming is changing the way large expensive industrial machines are designed. The most obvious example of this has been in the production of autonomous drone aircraft which has improved beyond all recognition in the last five years. Elsewhere, Boeing’s Dreamliner is laden with processors that give real-time diagnostics. They are designed to help cut the time the aircraft is out of the air and to alert service personnel to potential issues before they become expensive repairs. These types of processors are finding their way into large industrial processes such as the electrical grid, power stations, pipelines, heavy industry and manufacturing. Therefore while the last decade has not seen the kind of innovation in the industrial sector one might have hoped for, the next decade is likely to be much more rewarding. The evolution of optics, rapid prototyping, robotics and other technologies represent complimentary productivity growth channels for heavy industry.

Historically, medical innovation has focused on being the first to do something while cost savings have come later as volume increased. Genetics, biotechnology and advances in materials science are fuelling the exponential growth curve of medical innovation that still very much in a developmental stage. This sector is also likely to benefit from some of the same innovations that are benefitting the industrial sector. Considering the immature stage of the market relative to the potential companies are still focused on being the first to do something, rather than perfecting methodology to reduce costs. However, as it develops, and we are talking decades not months, this will logically become less of an issue as therapies eventually become ubiquitous.

While healthcare cannot be described as an efficient market because of all the various vested interests and the requirement for customised care, the laws of supply and demand are still applicable. New technologies are initially expensive to produce but the cost generally tends to trend lower rather than upwards over time.  

Moving on to energy, at FT Money we have long defined the peak oil argument in terms of the rising cost of marginal production. The advent of unconventional oil and gas represents an abundant source of additional supply but at a higher cost on average than conventional supply. Therefore while a number of the issues you mention have contributed to somewhat higher than average pricing over the last few years, it is reasonable to expect pricing to trend back down towards the marginal cost of production over the medium term which for oil is probably in the $60 to $80 range. 

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