Jeff Saut Presents: Texas Hold 'Em
As opposed to "Texas Hold 'Em," instead of playing to win one hand at a time, the strategy of "GO" is to sacrifice a "stone" here and there to win in the long run.
Editor's Note: The following article was written by Raymond James Chief Investment Strategist, Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.
"The Chinese state has finally confirmed what we have been saying for a number of months: they have announced that $8 billion of government money has now been authorized and allocated as seed money to begin constructing a state-held Chinese airplane company. Furthermore, the new company will be designed to stand as a competitor to America's Boeing (BA) and Europe's Airbus. What makes this a bit shocking is that the Chinese ruling party's commission was so bold that it admitted China still does not have all the technical expertise it needs to build such large planes, but not to worry, it said, that is why they had approved Airbus' request to open a new factory in China -- one that will build four giant A320 jumbo jets a month.
"As usual, the government has required that all modern technology in the Airbus plant must be transferred to the Chinese state. This new plant will yield a treasure-trove of missing technology to fill in the gaps in China's knowledge when it comes to building larger civilian and military planes. China has already pulled much technology from dozens of Boeing projects in the country -- enough to allow them to soon build their own small jetliners. They are accepting orders now for a small regional plane, with deliveries to start in one year."
-Adrian Van Eck
I reprise Adrian Van Eck's comments this morning because they speak to a point I have been making for the past few years whenever asked, "When will the Chinese stop buying US bonds?" Unwaveringly, my firm's response has been, "Whenever the Chinese no longer need the US!" Yet the thought process goes much deeper than that. We in the U.S. are playing the card game called "Texas Hold 'Em" whereby you win one hand at a time. The Chinese, however, are playing the board game called "GO." Now "GO" is played by two people alternately placing black and white stones on vacant intersections of a 19 x 19 rectilinear grid. A stone, or group of stones, is captured (and removed) if it is surrounded by the stones of the opposing color. As opposed to "Texas Hold 'Em," instead of playing to win one hand at a time, the strategy of "GO" is to sacrifice a "stone" here and there to win in the long run.
Think about these two different strategies and reread Mr. Van Eck's comments. Plainly, the Chinese are "importing" technology at a much faster rate than they could ever develop it on their own. We have seen this strategy time and time again whereby the Chinese only allow a high tech manufacturing plant to be built if the company's modern technology is transferred to the Chinese state. So while companies think they are winning "one hand at a time" by being allowed to build this or that plant, the Chinese are importing technology that would take them decades to develop on their own! Eventually China will be able to build Airbuses on their own and with China's much cheaper labor costs...well, you can figure out what is going to happen over the long run.
Said strategy is about to dawn on America's automobile companies in spades when China's "Chery" automobile hits US shores in the not too distant future. As Adrian Van Eck concludes, "If we were Boeing, we would cancel every program now running in China, because they are simply training those who would compete with and destroy them! And if we were one of the CEOs of giant U.S. firms who are following Boeing and sending them state-of-the-art equipment (ready to copy), I would understand that this announcement of China's plan to build big planes is a warning shot across the bow. Any of them could be next."
Like many companies, stock investors have also "rushed" into China to garner its envisioned riches. My firm, however, has resisted direct investments in China given our belief that there will eventually be a banking crisis since China is a "debt driven" economy (read: bank loans). Rather, my firm has tried to get at the China theme via "things" that they need... a.k.a., "stuff." That theme has been a home run for my firm's investment accounts since the prices for "stuff" (oil, gas, coal, timber, uranium, water, base/precious-metals, fertilizer, grains, cement, etc.) have risen exponentially over the past five years. Verily, China's demand for stuff has proven insatiable despite periodic worries about a potential slowing for its economy. Most recently, this demand has been reflected in Ocean Freight Rates as can be seen in the below chart. Manifestly, Dry Baltic Freight Rates are again reaching for all-time highs as China's appetite for raw materials continues to dazzle the world. My firm thinks this trend is unstoppable as hundreds of millions of people continue to enter the world's economy.
Last week my firm once again followed China's continuing demand for energy into the energy space with our recommendation on 6.7% yielding, outperform rated, NGP Resources (NGPC). Just listen to what the company does:
NGP is a financial services company organized to invest in small/mid-sized companies in the energy space. The company's focus area is in the targeted domestic exploration and production (E&P) business and midstream businesses that gather, process and transport oil and gas. It also evaluates investment opportunities in businesses such as coal, power, electricity, energy services, and alternative energy. Clearly this strategy is in-keeping with my firm's macro investment thesis, which is why we embraced NGP.
Given the fact that the Chinese use 1-barrel of oil per capita per year, versus the U.S.' 24-barrels per year, all that is needed is for Chinese demand to rise to 2-barrels per year for oil prices to stay perky. Is it any wonder my firm remains steadfastly bullish on energy?! We also remain bullish on base/precious metals, which is why we recommended 7% yielding BlackRock Real Asset Equity Trust (BCF) that trades at roughly a 9% discount to its net asset value. As well, my firm embraced OCM Gold Fund last week (OCMGX), which conveniently has a retail-investors' conference call with its portfolio manager scheduled for April 10th at 4:10 p.m.
Still, while China, India, Malaysia, Indonesia, Uzbekistan, etc. economies are booming, my firm can't seem to figure out if the U.S.' economy is slowing into recession, muddling, or reaccelerating. And, last week's economic statistics were of no help in this regard for while the housing numbers improved a touch, other figures went lacking. Indeed, the Leading Economic Indicators (LEI) have been down for two months in a row, the Association of Home Appliance Manufacturers posted nearly a 10% decline in shipments, retail sales (except autos) are anemic, the current mortgage-malaise is spreading, capex spending stinks, the U.S. trade deficit continues to widen, productivity is waning, the U.S. dollar is sliding, and most importantly, there seems to be a reduced "risk appetite" by investors. Consistent with this, my firm remains selective on new stock purchases. Obviously our recommendations to "bet" on increased volatility have reaped rewards for trading accounts, but even here we have reduced our bets on the upside surge in the Volatility Index (VIX) from 10 to 21. The quid pro quo is that my firm initiated trading positions in the SPDR Financial Index (XLF) last week with a 34.12 stop-loss point. Yet, while trading is fun and exciting, the real money is made in the investing account and here my firm remains pretty cautious.
The call for this week: As Barron's notes today, "Last week the Fed, after deciding not to fuss with interest rates, essentially confessed that it really didn't have a clue as to what tomorrow, much less next month, would bring, although it suspected that inflation was working its insidious way higher and the economy was losing some of its zip." So what did the Fed do in response? Well, it did what it does best and flooded the system with money as the M-2 money supply soared by $24.4 billion for the week ending last Wednesday. No wonder the DJIA closed up 3.06% for the week as the new liquidity seemed to find its way into stocks. But if the Fed is really concerned with inflation, why is it fostering inflation by printing more money? Could it be that the Fed is more worried than it is telling us about a slowing economy and the threat of deflation?
While my firm continues to think deflation is a bad bet, we are watching deflationary events closely. Still, inflation is our "call," which is why we continue to be overweighed in "stuff stocks," preferably ones that have a yield. My firm also like the idea of having outsized "cash" positions and continue to use Franklin Templeton's Hard Currency Fund (ICPHX) as one of our cash proxies.
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