Contrarian Finance

In preparing my stock write-up of Petrobras, I realized that a significant part of the analysis there relies on one of my fundamental tenets of investing: The Battle of Demographics and Non-Renewable Resources. Finding a company or an industry where these two elements are in opposition to one another is a fantastic way to find stocks poised for significant long term appreciation.

In simple economic terms, demographics are the demand side of the equation, and resources are the supply side. Think back to Economics 101, the intersection of supply and demand is the basic determining factor in establishing a price. So if demand is growing, that will drive up the price unless the supply also grows. Of course if the supply is fixed, or better yet, declining, then prices have nowhere to go but up... way up.

Either one of these elements alone is sufficient to set up a company or industry for significant growth, but finding them in opposition just multiplies the effect. Let's break down a few specific examples so you can see what I'm getting at.

First, an example of demographics driving industry growth in isolation is the healthcare industry vertical. Aging populations in the United States, Europe and Japan are fueling the demand for healthcare products and services across the board. This will fuel long term growth for companies in this sector, but since companies have the ability to increase supplies (of drugs, of hospitals, of doctors) over time you'll only see gradual price appreciation. You may see brief spikes, after all it takes time to educate new doctors, but in the long run, I wouldn't expect massive gains to be had on the demand alone.

Now, let's consider oil. The total supply is fixed, because it takes a geologic age to make more oil. Which of course is what we typically mean when we're talking about non-renewable resources. Demand on the other hand is growing by leaps and bounds, thanks to never ending U.S. demand and the rise of India and China. So, in the macro sense, here we've got supply going down and demand going up. In other words, the question is IF we'll see $200 a barrel for oil, it's WHEN.

By the way, a great read on this topic, particularly where Saudi Arabia is concerned is Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy. It can be a bit dry at times, but the explanations the author provides of petroleum geology and mining are invaluable to anyone trying to understand the basic operations of companies in the sector.

Anyway, if we go back to the list of sectors, as defined by the Global Industry Classification Standard (GICS) by MSCI Barra, here are the ten top level industries:

• Energy
• Materials
• Industrials
• Consumer Discretionary
• Consumer Staples
• Health Care
• Financials
• Information Technology
• Telecommunications
• Utilities

You can probably spot my two personal favorites right off: Energy and Materials. That's because the resources are mostly non-renewable (fossil fuels, metals) and the demand is linked to both economic development and population trends. I prefer companies that actually own the underlying non-renewable assets, as opposed to services companies, because they are best positioned to capitalize on rising commodities prices.

Next up, I'll discuss Petrobras, which is perfectly positioned in the marco sense.

Full Disclosure: I own shares of Petrobras.