Dear Global Investor:

As the potential for growth slows in the US, Europe and other developed regions, emerging markets are increasingly important because they continue to offer substantial potential for outsized gains.

To emphasize our commitment to coverage of developing economies around the globe, we’ve given the reins of The Global Investment Strategist to a new chief strategist with the breadth and depth of experience required to take the newsletter to the next level. His name is Benjamin Shepherd and his credentials are impressive.

Not only does Ben Shepherd bring to the table a decade of investment savvy and emerging markets experience, but he’s also a recognized exchange-traded fund (ETF) and mutual fund expert. Ben has an extensive background analyzing funds, their management and investment strategies.

Ben also is chief strategist of the new Benjamin Shepherd’s Wall Street, born from his years learning from famed investment guru Louis Rukeyser and subsequently serving as editor of Louis Rukeyser’s Wall Street and Louis Rukeyser’s Mutual Funds. Ben’s new publication generates a steady stream of stock, fund and bond recommendations driven by a long-term view emphasizing common sense over the short-term tumult of the markets.

Along with these duties, Ben finds time to regularly contribute to Personal Finance, the flagship advisory service here at Investing Daily.

I think the energy and analysis Ben brings to The Global Investment Strategist will exceed your expectations. I am excited to see him implement a strategy that goes beyond the usual foreign markets and throws a spotlight on often-neglected investment opportunities in Africa and other fast-growing niches. He will tirelessly scour the map to find the most profitable plays for you.

As always, your feedback is welcome. Here’s wishing you many happy, global returns.

John Persinos
Managing Director
Investing Daily

 

When many investors think of Africa, images of refugee children and warlords often come to mind. However, you should put away any such preconceptions. This “forgotten continent” is now one of the world’s hottest emerging markets.

Africa has become surprisingly peaceful, as several long-running conflicts wind down and democracy takes a tentative hold. These trends are attracting a growing number of foreign investors to the continent.

According to the International Monetary Fund, Africa’s gross domestic product (GDP) is expected to grow by nearly 6 percent from 2012 to 2015, overtaking Asia’s expected growth rate of about 5 percent during this period and reaching USD2.6 trillion by 2020.

The map below shows projected global GDP growth by country from 2011 to 2020. The redder the area, the faster the growth:

GDP Hot Spots

Source: The Observatory of Economic Complexity

Moreover, Africa also has the fastest-expanding labor force in the world. Today, its home to more than 500 million people of working age (15 to 64), a number that’s expected to exceed 1.1 billion by 2040, which would make Africa’s working age labor force larger than either China’s or India’s.

Mineral resources have always been a key determinant of Africa’s fate, drawing both conquerors and investors for hundreds of years. Below, we examine a trio of superlative Africa-related investments—two in the oil sector and the other in mining. One stock is promising enough to warrant its addition to our Long-Term Portfolio.

The Turning Tide

For centuries, Africa has suffered under a colonialist thumb. Beginning in the early 1800s, the English, Germans, French, Italians, Portuguese, Spanish and Belgians divided the continent among themselves, eager to exploit Africa’s rich mineral resources ranging from gold and diamonds to iron and coal.

By the 1960s, after continental Europe had been devastated by two world wars and almost innumerable regional conflicts, the tide of colonialism turned. In that decade alone, 33 independent African states came into existence. It was during this tumultuous period that “modern Africa” came into being, ushering in an era of seemingly endless wars and innumerable humanitarian crises as various factions struggled for political power and control of the continent’s vital resources.

That cycle of violence continued unabated for decades. Three years ago, roughly half of what were then 54 countries in Africa were either engaged in active conflict or had just seen the end of one. Two years ago, revolution engulfed North Africa as Egyptians, Tunisians and Libyans rose against oppressive authoritarian regimes.

However, the past year has witnessed a marked turn in Africa’s endless cycle of violence. As stable, essentially democratic governments have established control across the continent, today there are only four countries engaged in an active war. And most of those are chronic hotspots such as Somalia.

As peace has finally taken hold in this vast continent, investors are taking notice. Foreign direct investment (FDI) in Africa last year surged by 27 percent, more than in any other region in the world, with inflows of about USD80 billion. By 2015, FDI inflows are expected to top USD150 billion.

With some of the world’s largest reserves of bauxite and aluminum, vermiculite, manganese and zinc, Africa supplies an amazing array of industrial inputs critical to emerging economies. It should come as little surprise that most of that investment is focused on extracting Africa’s mineral wealth. Moreover, Africa is home to the lion’s share of world gold production (21 percent) and is believed to hold about 9.5 percent of global oil reserves.

Over the past two years alone, China has offered to make more than USD100 billion of investments across the continent, almost half of which has been geared towards securing some sort of mineral. The Chinese have struck deals to mine iron ore in Guinea and Sierra Leone, copper in Zambia and gold in South Africa.

China also has struck oil and gas deals in Uganda, Niger and Madagascar. Most of the remaining investments have been aimed at developing infrastructure such as rails and roads (the country constructed a major highway in Zambia), seaports and electricity generation capacity, the latter necessary for the extraction and transportation of minerals. Less than 2 percent of that investment has been geared towards humanitarian purposes.

China isn’t the only country showing interest in Africa, as the US and Europe also begin to invest heavily.

While democracy in Africa is still fledgling, if it weren’t for relatively stable governments in countries such as Zambia, Botswana, Ghana and Cape Verde, all of that FDI wouldn’t be on the table. What’s more, the combination of stable governments and high FDI inflows are creating a rising consumer class in Africa.

We’ll leave African consumer and infrastructure plays on the table for another issue. This week, we examine three African resource plays.

Hydrocarbons Remain King

While London-based Tullow Oil (London: TLW, OTC: TUWOY) is a relatively small-time operator—last year it produced just 78,200 barrels of oil equivalent per day (boepd)—it has been a trailblazer in opening up African oil fields.

Tullow’s operations span the world, from exploration work in Guyana and Suriname to exploration and production in Bangladesh and Pakistan. However, 68 percent of the company’s oil reserves and 70 percent of its production are located in Africa. It became a major player in Africa with its 2004 acquisition of Energy Africa for the bargain price of USD570 million.

In 2006, Tullow began drilling its first wells in the Lake Albert region of Uganda, a country that had been largely ignored by Western oil interests. The venture met with immediate success, with five test wells striking oil and proving that a huge oil field existed in the region.

Tullow followed that success the following year when two deepwater wells off the coast of Ghana proved the existence of the massive “Jubilee” field, holding an estimated 600 million barrels of oil and 800 billion cubic feet of gas.

Earlier this year, Tullow sold one-third stakes in three of its most promising Ugandan exploration fields in the Lake Albert region to China’s CNOOC Ltd (Hong Kong: 883, NYSE: CEO) and France’s Total (NYSE: TOT) for USD2.9 billion. In addition to providing Tullow with capital, the deal also leverages CNOOC’s and Total’s experience in oil and gas production in countries with underdeveloped infrastructure. Production is expected to begin in Lake Albert early next year.

The partnership also established the basis for the three companies to invest as much as USD5 billion in the development of a regional crude transportation hub to move oil from the Lake Albert region to Africa’s east coast. The Ugandan government is also pushing for the construction of an in-country refinery to supply domestic gasoline demand that will likely be built by CNOOC and Total. While Tullow won’t be directly involved in the refinery deal, it will still benefit by supplying it with feedstock crude.

In addition to facilitating the development of a critical regional transportation hub, Tullow’s partnership with CNOOC could prove serendipitous on another front.

China is currently the largest buyer of Iranian oil but that trading relationship is becoming increasingly complicated by a wave of sanctions and a massive US Navy presence in the Persian Gulf. There are also the simmering tensions over Iran’s nuclear program that some geopolitical experts still expect to develop into full-scale conflict.

China has proven itself more than willing to do business with pariah states over the years—it needs resources and Chinese authorities aren’t too concerned with where they come from. But China needs consistent access to everything from oil and gas to tin and copper and if those supplies appear to be in danger, it will look elsewhere.

Consistency of supply is the primary driver of China’s massive African investments.

By partnering with CNOOC, one of China’s largest state-owned oil companies, Tullow is establishing a ground floor relationship with a government that can not only provide additional investment capital but could also become one of its major customers.

That transportation hub will provide vital support for Tullow’s expanding operations in Kenya’s Ngamia-1 field. Tullow also recently announced that it had struck the first known natural gas field off the coast of Kenya. In all, Tullow estimates that it could be sitting on reserves of as much as 530 million boepd in Kenya, although that has yet to be verified.

Tullow reported impressive performance for the first half of 2012, as earnings soared to USD546 million, an increase of 63 percent compared to the same period a year ago. That surge in profitability was largely thanks to increased production, which reached 77,400 boepd in the first half, as Tullow’s realized oil price per barrel fell slightly to USD110.70.

Given Tullow’s steady increase in production over the past several years and its heavy investment in expanding its capacity—it expects to make about USD2 billion in capital expenditures this year—the company can withstand most dips in oil prices. The company’s solid first-half performance this year is testament to this fact.

Tullow also enjoys a tailwind from its proximity to Asia, where oil demand continues to rise despite the slowdown in China. Over the past 30 years, Asian oil demand has more than doubled. In many countries such as Indonesia, Thailand and Korea, oil demand growth is averaging more than 5 percent annually. That’s a huge and growing market for Tullow’s crude and one that Africa is ready and willing to supply.

The newest addition to our Long-Term Portfolio, Tullow Oil rates a buy up to GBP1,450 on the London Stock Exchange. It can also be purchased in the US under 11, but London is the preferable trading venue because of liquidity concerns.

A more speculative play on African oil resources is Africa Oil Corp (Toronto: AOI).

Africa Oil, focused on identifying potential oil baring land, owns significant exploration acreage in Kenya, Ethiopia, Mali and Somalia.

Once the company identifies a promising resource area, it partners with other companies to actually develop the resource. For example, Africa Oil currently operates a 50 percent partnership with Tullow Oil in developing several tracts of the promising Ngamia-1 field in Kenya. It has also partnered with Horn Petroleum (Canada: AOI) to develop its properties in Somalia.

Given the preponderance of finds there over the past several months, East Africa has become one of the globe’s hottest oil prospecting territories. Holding more than 74 million acres of exploration territory in the region—including tracts in close proximity to recent major strikes—Africa Oil is positioned to be a major player in the East African oil boom.

So far, Africa Oil’s Block 10BB in its Kenyan holdings has been proven to hold oil and block 13T, which sits adjacent, is showing encouraging seismic data. The company plans test wells in the near future for Block 10A and is completing seismic studies on its remaining holdings. However, given their proximity to Ngamia-1, all blocks are expected to pay off to varying degrees.

In Ethiopia, the situation is a bit more speculative as geologic studies there remain underway. Nonetheless, mature wells are located near two of the blocks, an encouraging sign.

Test wells on the company’s Somali holdings have shown the presence of oil and gas but have so far failed to flow. Additional test wells are planned over the next few years.

Finally, the company’s Mali holdings are a special case, in the wake of a coup there in March. The country’s security remains unstable, as rebel groups demand the secession of an independent state. Government forces are working to reestablish stability but have yet to make headway. These troubles have prevented Africa Oil from accessing ts exploration tracts in the country.

While Africa Oil’s current holdings are generally promising, it only gets paid if oil is found and there’s a willing buyer. As a result, the company has been operating at a loss for several years and has been primarily funding itself through partnerships with other oil outfits.

That said, the company’s promising tract holdings and its geographic location in the heart of an oil boom position it for lucrative deals down the road. Africa Oil Corp is a speculative buy under CAD11.

If You Dig It

A lot more comes out of the ground than just oil and First Quantum Minerals Ltd (Toronto: FM) digs it.

First Quantum is one of the world’s fastest-growing copper producers, exploiting resources in Finland, Australia and Peru, and Zambia and Mauritania in Africa. It’s also a significant gold producer and it’s entering the nickel mining business with the imminent opening of its Enterprise mine in Zambia, a country in which it already has substantial operations.

Through its Kansanshi Mining subsidiary, First Quantum owns 80 percent of the Kansanshi copper mine in Zambia, Africa’s largest. Since opening in 2005, the mine has on average produced about 20,000 tons of copper and about 10,000 ounces of gold per month. Production is expected to increase, as the company completes improvements and expansions to the mine.

First Quantum also is in the process of constructing a smelter strategically located near Kansanshi and its planned Sentinel copper and nickel mine. The smelter is expected to create an annual cost savings of between USD300 million and USD500 million per year for First Quantum, which is already one of the lowest-cost copper and nickel producers in the world.

First Quantum’s shares have been under pressure over the past year, as global economic worries (particularly the slowdown in China) dampen industrial metals prices. While those worries aren’t completely unjustified, they’re also overwrought at least as far as China is concerned. Taking the long view, the stock’s depressed price represents a buying opportunity.

First Quantum’s recent push into the nickel market should prove extremely profitable, particularly if it is able to use an open-pit method at Enterprise. Indonesian recently announced an export ban on nickel, a key ingredient in stainless steel, which is expected to cut global nickel supply by as much as 15 percent. That should result in a rapid drawdown in global supplies, particularly since China will have to return to the market, pushing up prices and boosting First Quantum. First Quantum Minerals Ltd is a great long-term buy under CAD25.