Current Thoughts

Yes, it is very early and certainly tentative. And yes, there is much more negative news to come over the next few months. But for weeks now, we have detected some positive rumblings from China. And with each passing week, the rumblings seem to be getting louder. Nothing more than restocking you say, after raw material inventories have run down? Yes, a definite possibility and a point we have considered. Yet, we have now seen several different indicators suggesting something more at work. Too early to be sure but potentially significant.

 

Lets start with the obvious, the stock exchange indices:

 

Figure One: CSI 300 Composite (Shanghai Exchange)

+18.3% YTD

Figure Two: Hang Seng China Enterprises Index

(Chinese H shares listed on the Hong Kong Exchange)

-5.5% YTD

 

In an ocean of negative news, we consider these two indices to be quite interesting.

 

Next is the Baltic Dry Index, a measure of shipping rates for dry bulk commodities such as coal, iron ore, and potash. This index is very much a measure of China’s activities in these commodities.

 

Figure Three: Baltic Dry Index

+70.0% YTD (That’s correct!)

 

A widely used proxy for change in China’s GDP is domestic electrical power generation. This indicator rose month over month in December, the first time since July.

 

 

Figure Four: Percentage Change in Electrical Power Generation in China

                                            Source: CLSA Securities

 

Also, the headline Chinese Purchasing Manager’s Index (PMI) rose in January for the second straight month. Still, in negative territory for sure, but at least going the right way, which suggests stabilization.

 

Figure Five: Chinese PMI

                                                     Source: CLSA Securities

 

And finally, following a 20% YOY gain in new loans by Chinese banks in December, the following story today really caught our attention. Note that “domestic banks offered a record 1.2 trillion Yuan of new loans last month, representing almost a 50 percent gain from a year earlier.” In a centrally planned economy when the banks are told to lend, obviously they do.

 

On February 5, 2009, Bloomberg News reported the following story:

 

“ICBC Offers $36.9 Billion Loans in Jan. in Response to Stimulus

By Luo Jun

    

Feb. 5 (Bloomberg) — Industrial & Commercial Bank of China Ltd., the nation’s largest, said it offered 252.1 billion Yuan ($36.9 billion) of new loans in January in response to the government’s stimulus plan to avert an economic slowdown.

 

The bank lent 69.3 billion Yuan to power grid, railway, roads, and hydroelectric power projects, and 135 billion Yuan in discounted bills to small and medium-sized companies, the Beijing-based firm said in an e-mailed statement, without giving comparisons. New loans to individuals, including mortgages, amounted to 16 billion Yuan.

 

China dropped lending quotas and unveiled a 4 trillion Yuan stimulus package in November to maintain economic growth and counter the global financial crisis. Banks have responded by raising lending targets and focusing on railways, roads, power grids and other infrastructure projects with stable returns. Domestic banks offered a record 1.2 trillion Yuan of new loans last month, representing almost a 50 percent gain from a year earlier, the China Securities Journal said yesterday.

 

ICBC aims to advance 530 billion Yuan of new loans in 2009, about the same as last year, the 21st Century Business Herald reported today. The bank plans to complete 45 percent of the loan target in the first quarter.

 

ICBC attracted 271.2 billion Yuan of deposits in January, equivalent to a quarter of the total increase in 2008, according to today’s statement.”

 

 

All in all, an interesting collection of data points suggesting some positive news flow on the Chinese economy by mid-year. We do not expect China to save the world, but if they just succeed in saving their own economy, this will be a very positive step for everyone.

 

Michael

 

 

 

 

 

 

 

 

 

 

 

 

 

 

It seems to us that you can’t have it both ways.  Falling commodity prices and a retraction in credit lines will simply lead to a major cutback in commodity project development.  We entered into this global downturn with a large number of projects that were delayed due to cost escalation, shortage of equipment and skilled manpower.  Now the situation, in terms of new supply, has only been made worse.  From oil, iron ore and copper to platinum, the project delays and cancellations are now coming daily.  The last time the commodity industry froze capex, in 1998, it took nearly five years for it to return with any confidence.  The recent five year bull market in commodity prices did not see large-scale capacity additions with the exception of iron ore.  Typically, once a project is deferred it takes much longer to get re-started.  So while not relevant for today, tomorrow or next month, once we return to a vision of global growth the raw material supplies will simply not be there.  Simply put, we are sowing the seeds today for the next bull market in commodities 1-2 years hence.  So while commodity stocks are out of favour at the moment, you can’t have it both ways.  Great investment opportunities will present themselves over the course of the next few months.

 Read the full story here: http://test.kitimatlng.com/code/navigate.asp?Id=32

Here are some additional thoughts.

Not only one less plant potentially importing gas, but it will also provide an alternative outlet for Canadian gas which has always been hostage to the US market.

Of course, one LNG (liquified natural gas) plant by itself will not have a meaningful effect on the overall Canadian gas market. But things become interesting if this is the beginning of a trend. Presumably they have done the economic analysis and concluded it works.

It should have a positive impact on the Horn River shale gas play through lower transportation costs and higher prices in the Asian market, especially Japan. Kitimat seems well positioned to have economic access to these markets. And remember, the Horn River is located in the north east corner of B.C. so the Kitimat location is close to ideal. According to management, the potential size of the Horn River play convinced them to go ahead with the export plan. I think this decision, if it goes forward, will give added impetus to the E&P companies involved in the play.

Of course,a challenge will be native land claims regarding the construction of the required pipeline. And questions remain as to end markets, project economics and financing! Again, I am assuming that they have done the math. The estimated cost of the project is $3 billion and completion is planned for 2013.

 

Kitimat LNG also said that they could not secure committed supplies of LNG to justify an import facility. This would suggest that LNG is not going to be a threat in terms of new supply any time soon in North America.

I don’t want to read too much into this decision to “reverse” the project, but I think it is a significant development.

It’s also possible that there could be other such projects following behind this one. And it is my understanding that several LNG import facilities in the US are sitting idle much of the time because of a lack of supply. Perhaps they could be reversed too. If this sort of thinking spreads,it could have a profound impact on North American natural gas markets.

 

I was hoping the market would rebound in the afternoon but it actually sold off. Leads me to think that we have more pain to go in the very near term.

But unless we are going into a full blown recession, I have to think we are getting close to some kind of bottom. Too many good companies are getting trashed and valuations are now quite compelling looking out 1-2 years. Markets are rife with rumours of more funds being liquidated and having to sell. If there is a check list of ten conditions for a market bottom, we are probably at eight.

As the old adage goes, buy at the point of maximum pessimism. Hard to gauge but it sure is bleak at the moment. Many seasoned veterans of the market that I talk to say that this the worst market they have ever seen in their careers. Could it get worse? Probably it can. But I think the potential upside in good companies now outweighs what remains on the downside.

 

Also, China cut interest rates overnight and its a sign that the chinese authorities are prepared to act now that domestic inflation has slowed. While GDP growth has slowed from 10% plus levels, China still has enormous momentum.

So while this has been extremely painful, I think opportunities are presenting themselves to investors. While fx predictions are difficult at the best of times, I would expect the US dollar to exhibit renewed weakness. I was carefully adding to our gold weighting in big, liquid names today.

I also think the sell off in high quality oil stocks and trusts has been overdone and I was picking away at a couple today.

With valuations on many stocks where they are, now is NOT the time to sell. And if we freeze here, we will miss some great opportunities. Always trying to go against the herd, I think we shld be preparing now for the next upturn. The timing, of course, is always difficult and calling the exact bottom is near impossible. But short of a full blown depression, I suspect that we need to sharpen our pencils and get to work.

Yesterday we saw indiscriminate selling right across the whole resource sector. The market was rife with stories of more forced selling by hedge funds to reduce leverage. From my experience, this a symptom of a market close to reaching a bottom. I don’t know for sure when, but values are now at very attractive levels for a number of high quality assets. Examples include CPG-U, TOG, TCM.

Yes, it’s like trying to catch a falling knife but I think things are getting seriously overdone on the downside.

If one were to have fresh money and look it up for 1-2 years, I suspect the returns would be spectacular.  And of course, that’s the problem: finding the fresh money.

I have not witnessed this market action in all my years of doing this. Everything is getting tossed out, regardless of outlook.

I have learned that when you are close to a bottom, there is nothing obvious on the horizon to turn things around. We certainly seem to be there now.

I don’t know the timing of course and never will but serious values are now appearing. And what a time for industry takeovers.

The use of leverage (up to 30x!!) by hedge funds is making this unwinding far worse than the fundamentals would justify. I would suggest that we all need to be patient and just get through this and I suspect it is all going to happen quickly. This is not the same as 80-82 when CSB’s were sold yielding 19%.Back then, inflation needed to be broken before mkts could advance. Today, it’s the unwinding of leverage by many funds that really didn’t even know what they owned.

Are we there yet??? I don’t know the answer. But all I can tell you is that valuations are now becoming quite compelling. And we all know that there is a wall of cash out there.

So the widespread use of leverage is now presenting many great buying opportunites. We just have to be prudent and pick our spots.

Tough times, but opportunities abound for those investors with a one to two year time horizon.

- Michael Waring

 

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