@GSElevator – #1: A market sell-off is worse than a divorce. I lose half my money, but my wife is still around.
1. Quote Of The Week / 2. Buy It When They're Giving It Away / 3. China Tells Investors to Bet The House On Stocks / 4. Interesting Links / 5. Joke Of The Week
1. QUOTE OF THE WEEK
In China, bull markets aren't allowed to die without a fight, and the authorities are pulling out all the stops…
The People's Bank of China has already cut interest rates and eased reserve requirements, while the China Securities Regulatory Commission has relaxed collateral rules on margin loans.
However, not to be outdone, the Asset Management Association of China has issued a rather Confucian statement titled “Beautiful sunlight always comes after the rain”.
There are many ways of losing money in the markets, but the belief by retail investors that the authorities will always look after retail investors is probably the most certain. And retail investors account for between 80% and 90% of trading in Chinese stocks (there were more than 14 million trading accounts opened in May).
2. THE TIME TO BUY IS WHEN THEY GIVE IT AWAY
In the late 70s when New York City was flirting with bankruptcy, you could buy top Manhattan townhouses for $40,000 that are easily worth 1,000 times that today. The reason? Rental income barely serviced the maintenance costs. The shift from intense deflation to double-digit inflation only took a few years. Could it happen again?
Fast forward to the collapse in commodities in the early to mid-1980s. Assets purchased during the hyperinflation of the late 1970s were hemorrhaging losses and sold to cashed up investors at zero cost. Within a few years, these assets were again profitable. Around the same time, the soaring U.S. dollar was devastating U.S. exports. If you had walked into almost any CAT dealership, they would have given you the keys to a brand new CAT with no downpayment. Within a few years, pressure on exports had become so painful that the U.S. orchestrated a major devaluation through the Plaza Accord, which continued until the long dollar basing of 1991-1995.
So what are they giving away now?
Glencore recently sold the Cosmos nickel mine for AU$24.5 million. In 2008, Xstrata paid AU$3.1 billion for Jubilee Mines to gain control of Cosmos, which was the Perth-based company’s flagship operation. Last year, Glencore sold the secondary Sinclair project to Talisman Mining for $8 million plus a $2 million contingency. While full accounting is not so straightforward, in simplest form, the properties were bought and resold 7 years later at almost total loss. Xstrata, which was purchased by Glencore in 2013, acquired Jubilee when the price of nickel was around $32,000 - 2.5 times higher than where it now trades. Bloomberg recently noted that Rio Tinto Group similarly sold Mozambique coal assets last year that it bought in 2011 with the AU$3.9 billion takeover of Riversdale Mining. The selling price? $50 million.
It is interesting to note how little is being written about One Belt, One Road outside of Asia – here it’s big news but aside from periodical articles like this by The Economist, it’s hardly publicised by western media. China Development Bank notes that the number of cross-border projects underway in the Silk Road effort already amount to $980 billion. Reportedly, Asia’s infrastructure needs are close to $8 trillion by 2020.
A must read Op-Ed from the New York Times back in 2009 refers to China’s policy to use foreign currency reserves to finance infrastructure projects in the developing world as ‘Beijing’s Marshall Plan’. China benefits from such infrastructure, whether it is railways to ship copper from Afghanistan, or industrial parks to produce goods in Egypt.
In other words, there is a giant infrastructure investment boom just getting started in Asia and along the Silk Road. Wasn’t the whole commodity boom of the last decade based on infrastructure investment in China? Now, it will expand to all of Asia and beyond.
3. CHINA TELLS INVESTORS TO BET THE HOUSE ON STOCKS
Earlier this week a friend passed on an article headlined China tells investors to bet the house on stocks which describes a new policy to allow retail investors to collatoralise margin loans with real assets – mainly their house. Backing a liquid security with an illiquid asset is usually a bad idea.
In the article “Official Rhetoric – Hero of The Chinese Stock Market” from Issue 29 of Interesting Things I wrote that 60% of household wealth is held in property and 15% in stocks. The purpose of highlighting this was to suggest that a capital rotation from property to stocks would have huge implications – more dollars chasing the same market means higher prices. But houses aren’t liquid assets and you can’t live in a stock, so it is only investment properties – a much smaller proportion of household wealth – that can rotate to stocks. Allowing retail investors to buy the market on margin backed buy their house is an immediate solution to this problem. If this goes through hundreds of millions of people will be handed thousands of dollars they think they didn’t (and actually don’t) have to buy stocks.
It easy to get distracted by day-to-day volatility and forget that the purpose of a market is to provide a source of capital to companies. Chinese banks (the government) funding margin loans to retail investors to ‘liquidate’ their property and buy stock is actually a pretty effective way to capitalise companies.
According to Quandl data the Chinese market is worth 3.6 trillion (compared to 18.6 trillion in the U.S.) and if we assume that the market is mostly owned by domestic investors and it’s only 15% of their personal wealth, then their’s alot of firepower which can come online. Buying existing companies creates limited value but providing growth capital to new companies or existing companies could have a huge economic impact.
This is a pretty good idea if the market continues to rise. But in the last few weeks Chinese markets have fallen. A lot. And the Chinese government is having none of it – pulling all the levers to prop up the market. Bloomberg news was banging the table earlier in the week that the sell-off was gaining momentum as traders unwound levered trades. There’s undoubtedly some truth to this – my friend told me their desk got hit when a position gapped through a hedge funds margin – but it’s probably overhyped.
Policy makers couldn’t be more clear that they want stable and ascending markets. Let’s not forget China still has growth that the U.S. would crash the world for and a lot of scope to ease rates. It will be interesting to see how this plays out and there’s going to be a lot of noise over the next few weeks. But if I had to, I’d guess that markets will ascend stably.
4. INTERESTING LINKS
There’s a correlation between money, sex and happiness [Research Links]; Essential properties of the engineering mindset [Farnam Street Blog]; Chinese officials are sick and tired of the market going down [WSJ]; 215 Years of Global Multi-Asset Momentum [Research Links]; How companies really get valued [Marc Andreessen]; When to post a selfie [The Economist]; Why to invest with managers who eat their own cooking [Morningstar]; The evolution of a value investor [Talks at Google]; A winery that runs on Tesla batteries [Fortune]; A look back at Iceland gives a look forward for greece [NY Times];
5. JOKE OF THE WEEK
