The Pyramid of Real Wealth

‘All real wealth is in the ground and societies become prosperous only by exploiting that wealth,’ once wrote the King of the Pilbara, the great Lang Hancock. We keep coming back to that quote every few years to see how it holds up. It holds up pretty well. But what does it mean in the context of today’s Australia?

Well first off, there are very few commodities in the world that get more valuable if you leave them in the ground. The exception might be gold or oil. Producers with known reserves of scarce resources may prefer to manage the extraction of those resources in order to get the right price. Leaving it the ground when prices are cheap is a better financial decision.

But most commodities are just smaller parts of a bigger whole. You extract them, process them, and then ship them off to someone who turns them into a finished good. If you’re in the extraction industry – and quite a few Aussie stocks are of course – you don’t create value by turning the commodity into a finished good. You create value by getting it out of the ground as cheaply as possible.

A company can be a low-cost producer for a lot of reasons. It may have an easily accessible resource like BHP and Rio Tinto have had for many years. It may be close to infrastructure and have access to skilled but competitively priced labour. That helps too. Or it could just have ruthless cost-cutting management.

But despite the claims by politicians that a nation’s resource wealth belongs to everyone, it takes a really well-run company to pull things out of the ground and make enough on the venture to pay everyone a wage and shareholders a profit. People don’t do it for free. The politicians should keep that in mind next time they take the resources industry for granted.

However, we have not come to bury politicians today. You already know that most of them are dishonourable. What we’ve come to figure out in today’s Markets and Money is where Australia’s productive farm land sits in the hierarchy of global assets. Assuming the land turns out to be pretty valuable (a safe assumption) the next question is whose going to benefit from its productivity; shareholders, Australians, the government, or the Chinese?

By now you’ve probably guessed that our questions are motivated by the $700 million investment by Shanghai Zhongfu Group in developing a sugar industry for the East Kimberley and northern Australia. Authorities in Western Australia gave the investment the nod earlier this week. According to the Financial Times:

‘Shanghai Zhongfu Group plans to invest up to A$700m (US$728m) in the next six years in developing land in the far north and building a sugar mill that will produce about 4m tonnes of sugar cane and 500,000 tons of sugar crystal for export annually. The company will lease 13,400 hectares (33,100 acres) of government-owned land for periods of 10 years to 50 years.’

Day by day, we draw closer to an idea we floated over five years ago: lease the whole joint out to the Chinese for 50 years, let them run it with their own labour, and call it New South Shanghai. Proceeds from the lease would be evenly distributed among every Australian over the age of 16. Finally, the profits from the land would really belong to the people…and the people would be saved from having to, you know, actually get their hands dirty.

Since our suggestion is fraught with political over-tones, let’s stick to investments. Where does land belong in the hierarchy of asset values in today’s world? Well, that depends on what you think is going on in today’s financial world. But our position on this has been the same for the last five years: the collapse of a global credit bubble in which money and liquidity moves from the abstract to the tangible and from claims on real wealth to possession of real wealth.

That’s a mouthful, so refer now to another version of John Exter’s liquidity pyramid. We’ve been ‘unpacking’ the pyramid in The Denning Report. Any useful theory is useful because it has both explanatory and predictive power. Exter’s pyramid is especially useful these days.

In this version of the pyramid, you see that that there’s actually another pyramid on the other side! The pyramid on top is the one you see if you take the blue pill, enjoying the life of ignorance in a world where money is fake and asset prices are managed/manipulated by the Fed. The pyramid on the bottom is the one you see if you take the red pill.

The red pill pyramid, if you’ll pardon the mixed metaphor, is the real world where real things matter. More importantly, it’s where wealth is not measured in portfolio balances. In the pyramid of the red pill, wealth is measured in terms of calories, potable water, arable land, and hydrocarbons (oil and gas). Everyone actually lives in the red pill pyramid, but not everyone knows it.

Actually, everyone lives in both worlds, whether they know it or not. But some investors inhabit only the blue pill pyramid. These investors go along with the belief that all economic problems can be managed by wise authorities. These are the buy and hold investors who work at large institutions and can surf compulsory superannuation contributions to a comfortable salary.

There are a lot of interesting characters in the pyramid of the red pill. Some of them have made the mistake of believing that just because something is inevitable – the collapse of the US dollar for example – it must also be imminent. This can result in an investment strategy in which you own too many canned goods and not enough cash.

But our point today is that even Nation States know these two worlds exist. While China prepares for the big currency realignment of 2015, where the International Monetary Fund will re-weight the currencies that make up the Special Drawing Rights (SDR), it also makes plans for more sugar. There’s a bit of prudence in acknowledging we live in both worlds.

Australians will be chuffed that the IMF is considering adding the Aussie dollar into the small fraternity of currencies that are tracked in is Currency Composition of Official Foreign Exchange Reserves report (COFER). The short explanation of this is that there are enough foreign central banks buying the Aussie as a currency hedge that it will be tracked separately, along with the Canadian dollar, the Yen, the US dollar, the euro, the British Pound, and the Swiss franc.

Does this mean the Aussie dollar is now a global reserve currency? Not on your life. But it does mean that the Aussie dollar plays an important role in the world of the blue pill pyramid. Capital flows to it for whatever reason capital flows to it. In the blue pill world, capital flows make strength.

For individual investors, though, the strong Aussie doesn’t present any obvious investment angles, unless you’re a currency speculator, in which case you’re not an investor. Our suggestion would be to go all the way back to what Lang Hancock said many years ago. Real wealth begins in the ground and builds up from there. More on this next week.


Dan Denning
for Markets and Money

From the Archives…

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Molto Moderato
13-10-2012 – Dan Denning

Vote for an Honest Election: Democracy on eBay
12-10-2012 – Bill Bonner

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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3 Comments on "The Pyramid of Real Wealth"

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” Real wealth begins in the ground and builds up from there ” Yeh, but will never recognise it, especially the part about leaving some of it in the ground until the timing is right. For instance, we once were self sufficient with oil – say 80% when the Bass Strait fields were in song – yet we allowed Esso/BHP to pump and sell the stuff into world markets when there was no real money to be made from oil – say our assets were sold for an average of $10 a barrel for more than thirty years – Now… Read more »

It makes me wonder – don’t the Chinese already have enough land for sugar planting in their country? Why Australia? Why not Thailand, Vietnam, or even Malaysia?


people buy the aussie dollar only because Australia is rich in natural resources.

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