Global Market Comments
February 9, 2024
Fiat Lux
Featured Trade:
(FEBRUARY 7 BIWEEKLY STRATEGY WEBINAR Q&A),
(LLY), (FXI), (TSM), (BABA), (PLTR), (MSBHF), (SMCI), (JPM), (INDY), (INDA), (TSLA), (BYDDF), (NFLX), (META), (UNG)
Global Market Comments
February 9, 2024
Fiat Lux
Featured Trade:
(FEBRUARY 7 BIWEEKLY STRATEGY WEBINAR Q&A),
(LLY), (FXI), (TSM), (BABA), (PLTR), (MSBHF), (SMCI), (JPM), (INDY), (INDA), (TSLA), (BYDDF), (NFLX), (META), (UNG)
Global Market Comments
December 15, 2023
Fiat Lux
Featured Trade:
(DECEMBER 13 BIWEEKLY STRATEGY WEBINAR Q&A),
(BYDDF), (TSLA), (NEM), (UNG), (WMT), (TGT), (GOLD), (TLT), (JNK), (HYG)
Global Market Comments
October 25, 2023
Fiat Lux
Featured Trade:
(AN EVENING WITH THE CHINESE INTELLIGENCE SERVICE),
(FXI), (CYB), (BIDU), (CHL), (BYDDF), (CHA)
Global Market Comments
September 11, 2023
Fiat Lux
Featured Trade:
(MARKET OUTLOOK FOR THE WEEK AHEAD, or THE BIG PULL FORWARD)
(AAPL), (UUP), (TSLA), (USO), (BYDDF)
Somehow, the summer got moved this year.
For here it is September, and the stock market is behaving like it is only July. July was different from normal as well, going straight up almost every day when it is usually asleep. This year, July acted like May, when you’re supposed to sell and go away.
If you’re thoroughly confused by all of this, so am I. The historic cyclicality of the markets, the ebb and flow of share prices according to the calendar, has gone out the window. But then, what isn’t confusing these days?
I went to buy a green drink from Whole Foods on Friday and the counter was closed because of staff shortages. Whole Foods unable to sell a green drink?
I tried to climb the Matterhorn this summer but was told that the guides weren’t taking anyone up because of the extreme heat. The mountain was literally melting, dropping rocks on the heads of climbers. No climbing the Matterhorn in Switzerland? I went to the Dolomites instead where you climb ice-free shear rock faces.
I tried to get into the Pantheon in Rome this summer and was met with a five-hour line. The Sistine Chapel in the Vatican was worse. When I first went there in the 1960’s the place was empty. The fact is that Italy now has more tourists than Italians. Oh, and the pope is from Argentina.
Has the world gone mad?
What has happened is that there has been a great pull forward that took place in financial markets during the first half of the year. I’ve seen this before. When a conclusion becomes obvious, everyone jumps on the bandwagon and brings everything forward.
So from January to July stock markets saw the blatantly obvious future that inflation would fall, interest rates decline, the US dollar weaken, and commodities and precious metals would rise. That’s why the “Magnificent Seven” led.
What happens next?
Now shares have to wait until these predictions actually happen before they can move any further. Markets have moved as far as they can on faith alone. Next, we need facts. This could take weeks or even months.
I knew this was going to happen. That’s why I went pedal to the metal, full speed ahead, damn the torpedoes aggressive during the first half of the year and clocked a 60% profit. I expected that if you didn’t make a profit in the first half of the year, you wouldn’t have any profits in 2023 at all.
And the trade alert drought continues.
There isn’t a day that goes by when I am not asked if America’s $33 trillion national debt will destroy the economy, cause the stock market to crash, and bring the end of Western Civilization. The answer is no, never, not in our lifetimes.
The reason is very simple. Any dollar the government borrows today sees its purchasing power go to zero in 30 years. That’s where the massive Civil War debt went, that's where the WWI debt went, and that’s where the gigantic WWII debt went, some 105% of GDP. Today’s debt will similarly vaporize over time.
Who pays for this cataclysmic decline in value? US government debt holders, who similarly see their purchasing power disappear over time. It turns out that the ultimate avoiders of risk, investors in US government debt, not only don’t get paid for their cowardice, they lose their entire principal as well, at least in terms of purchasing power.
There is a wonderful article in Barron’s this week entitled “Government Debt Needs to Be Repaid, And Other Myths About the Federal Deficit” by Paul Sheard which explains how all this works, which I quote below in its entirety.
“The U.S. national debt currently stands at $32.91 trillion, and 10 months into this fiscal year, the U.S. government has spent $1.6 trillion more than it has collected in revenue. Those intimidating figures animate political battles that can shut down the government and even bring it to the brink of default. But the meaning of this money isn’t as simple as it seems. Five myths in particular deserve straightening out.
The first is that the government has to borrow in order to spend and run deficits. It’s the other way around. The government creates money (injects it into the economy) when it spends and destroys money (withdraws it from the economy) when it taxes. The government taxes variously to correct for negative externalities, to redistribute income, and to modulate aggregate demand; “raising revenue” is just a cover story.
A related myth is that the government needs to repay its debt. “Debt” is a misnomer; government debt is just money (or purchasing power) in another form. A $20 bill is a liability of the Fed, which makes it a liability of the federal government. A $20 bill never has to be repaid; it just is. Fundamentally, Treasuries aren’t much different.
That government debt never needs to be repaid doesn’t mean the government can or should create as much of it as it likes.
Too big a pile of debt because of prior and ongoing budget deficits may be inflationary, as too much money chases insufficient goods and services. That will require some combination of monetary and fiscal tightening. A mountain of debt may indicate a government that is too big and intrusive in the economy for many people’s liking, an issue that can be fought out at the ballot box.
A third myth is that the Fed prints money when it does quantitative easing. The money-printing happens when the government runs a budget deficit; QE just changes the form of that money.
QE is really just a debt refinancing operation of the consolidated government—that is, the government including the Fed—whereby it refinances one form of debt (government bonds or guarantees) into another (reserves). QE changes the composition of the (consolidated) government debt in the hands of the private sector, but it doesn’t directly add one iota of new purchasing power. For every dollar the Fed “pumps into” the economy by doing QE, it “sucks out” a dollar of assets. Conversely, quantitative tightening just returns assets to private sector portfolios, expunging reserves in the process.
Reserves are like banknotes: The Fed can withdraw them, but it never has to repay them as such. It looks like the government has to repay Treasuries, but this is an institutional artifact. In extremis, the Fed could convert all outstanding Treasuries into reserves, and it could maintain monetary control by it, rather than the fiscal authorities, paying interest on reserves.
Japan is the poster child for a miserable-looking fiscal picture. Yet, the Bank of Japan, the pioneer of QE, owns almost half of the stock of outstanding Japanese government securities and, at the same time, since 2016 has managed the 10-year yield, with some leeway, to be “around zero percent.”
It is precisely because the government can create money at will that the modern monetary and fiscal architecture has been designed to put shackles on its ability to do so: The creation of an “independent” central bank within the government, the central bank not allowing the government’s account with it to go into overdraft, the central bank not buying bonds directly from the government, and governments issuing debt securities rather than leaving their deficits in the form of reserves all serve that purpose. But what the government taketh away, it can give back. Faced with the need, it could loosen those shackles.
A fourth, and related, myth is that banks could, if so moved, “lend out” the excess reserves created by QE. Banks can lend these reserves to one another but they cannot turn them into lending to companies and households in the broader economy.
It isn’t just the government that creates money. Banks do, too. A fifth myth is that banks are just financial intermediaries “taking in” deposits and “lending them out.” Not so. Banks create money when they lend. For an individual bank making a new loan, it may not feel like this, because the first thing borrowers do is spend their money. If none of that money flows back into the same bank, its reserves at the central bank will decline by the amount of the loan. It will then probably want to attract deposits to “fund” the loan, but doing so will just top up its lost reserves. Bank lending for the system is entirely self-funding (so long as none of the money created leaks into bank notes).
The U.S. economy currently produces about $27 trillion of goods and services annually, a little more than the amount of federal debt held by the public and the QE-embracing Fed. The money needed to sustain this giant prosperity-generating machine comes from the government running deficits and from banks extending credit, with the Fed’s activities linking the two. Political debates and decisions currently are based on a befuddled grasp of how this monetary system works. The stakes for society are too high for that.”
So far in August, we are down -4.70%. My 2023 year-to-date performance is still at an eye-popping +60.80%. The S&P 500 (SPY) is up +17.10% so far in 2023. My trailing one-year return reached +92.45% versus +8.45% for the S&P 500.
That brings my 15-year total return to +657.99%. My average annualized return has fallen back to +48.15%, another new high, some 2.50 times the S&P 500 over the same period.
Some 41 of my 46 trades this year have been profitable.
Beige Book Shows Consumer Spending Slowing, long a pillar of this recovery, as the last of the pandemic bonuses work their way for the system. It’s putting a dent in corporate profits and hints at a shrinking economy, contrary to recent economic data.
The US Dollar (UUP) is Soaring, thanks to “higher interest rates for longer” and a strengthening US economy. Asian currencies are at ten-month lows and central bank intervention is looking. The dollar shorting selling opportunity of the decade is setting up.
China Restricts Sales of iPhones (AAPL), barring sales to government agencies. It’s only a small nick in overall sales, but certainly casts of cloud over doing business in the Middle Kingdom. Some $200 billion, (AAPL)’s market cap has been vaporized.
Weekly Jobless Claims Dive, down 13,000 to 216,000, a seven-month low. It’s the fourth consecutive decline and not what the Fed wanted to hear.
Rate Hikes Will Drag on the Economy for at Least a Decade, as the Fed's $8.24 trillion balance sheet unwinds, according to the San Francisco Fed. The balance sheet was only at $800 million before the 2008 Great Recession.
Saudi Arabia and Russia Engineer Short Squeeze on Oil (USO), taking the price over $90 a barrel this year. Large production cuts announced in June will be maintained until yearend. Will Biden counter with a release from the Strategic Petroleum Reserve, or SPR?
Tesla’s Chinese EV Deliveries Rise 9.3% in August, thanks to aggressive price cuts. There is a two-month wait for the Model Y. Chinese rival BYD (BYD), with its Dynasty and Ocean series of EVs and petrol-electric hybrid models, recorded deliveries of 274,086 passenger vehicles in August, a jump of 57.5% year-on-year. China has the world’s largest car market.
My Ten-Year View
When we come out the other side of the recession, we will be perfectly poised to launch into my new American Golden Age, or the next Roaring Twenties. The economy decarbonizing and technology hyper-accelerating, creating enormous investment opportunities. The Dow Average will rise by 800% to 240,000 or more in the coming decade. The new America will be far more efficient and profitable than the old.
Dow 240,000 here we come!
On Monday, September 11, US Consumer Inflation Expectations are announced.
On Tuesday, September 12 at 8:30 PM EST, NFIB Business Optimism Index is released. Apple announced the new iPhone 15.
On Wednesday, September 13 at 8:30 AM, the Core Inflation Rate for August is published.
On Thursday, September 14 at 8:30 AM, the Weekly Jobless Claims are announced. ARM started trading after its IPO, which was five times oversubscribed. NVIDIA tried but failed to take over the chip maker.
On Friday, September 15 at 2:30 PM, the Producer Price Index for August is published. At 2:00 PM the Baker Hughes Rig Count is printed.
As for me, not just anybody is allowed to fly an aircraft in Hawaii. You have to undergo special training and obtain a license endorsement to cope with the Aloha State’s many aviation challenges.
You must learn how to fly around an erupting volcano, as it can swing your compass by 30 degrees. You must master the fine art of not getting hit by a wave on takeoff since it will bend your wingtips forward. And you’re not allowed to harass pods of migrating humpback whales at a low level, a sight I will never forget.
Traveling interisland can be highly embarrassing when pronouncing reporting points that have 16 vowels. And better make sure your navigation is good. Once a plane ditched interisland and the crew was found six months later off the coast of Australia. Many are never heard from again.
And when landing on the Navy base at Ford Island you were told to do so lightly, as they still hadn’t found all the bombs the Japanese had dropped during their Pearl Harbor attack in 1941.
You are also informed that there is one airfield on the north shore of Molokai you can never land at unless you have the written permission from the Hawaii Department of Public Health. I asked why and was told that it was the last leper colony operating in the United States.
My interest piqued, the next day found me at the Hawaiian state agency with an application in hand. I still carried my UCLA ID which described me as a DNA researcher, which did the trick.
When I read my flight clearance to the controller at Honolulu International Airport, he blanched, asking if I had authorization because he’d never seen one before. I answered that yes, I did, I really was headed to the dreaded Kalaupapa Airport, the Airport of no Return.
Getting into Kalaupapa is no mean feat. You have to follow the north coast of Molokai, a 3,000-foot-high series of vertical cliffs punctuated by spectacular waterfalls. Then you have to cut your engine and dive for the runway in order to land into the wind. You can only do this on clear days, as the airport has no navigational aids. The crosswind is horrific.
If you don’t have a plane it is a 20-mile hike down a slippery trail to get into the leper colony. It wasn’t always so easy.
During the 19th century, Hawaiians were terrified of leprosy, believing it caused the horrifying loss of appendages, like fingers, toes, and noses, leaving bloody open wounds. So, King Kamehameha I exiled lepers to Kalaupapa, the most isolated place in the Pacific.
Sailing ships were too scared to dock. They simply threw their passengers overboard and forced them to swim for it. Once on the beach, they were beaten a clubbed for their possessions. Many starved.
Leprosy was once thought to be a result of sinfulness or infidelity. In 1873, Dr. Gerhard Henrik Armauer Hansen of Norway was the first person to identify the germ that causes leprosy, the Mycobacterium leprae.
Thereafter, it became known as Hanson’s Disease. A multidrug treatment that arrested the disease, but never cured it, did not become available until 1981.
Leprosy doesn’t actually cause appendages to drop off as once feared. Instead, it deadens the nerves, and then rats eat the fingers, toes, and noses of the sufferers when they are sleeping. It can only be contracted through eating or drinking live bacteria.
When I taxied to the modest one-hut airport, I noticed a huge sign warning “Closed by the Department of Health.” As they so rarely get visitors the mayor came out to greet me. I shook his hand but there was nothing there. He was missing three fingers.
He looked at me, smiled, and asked, “How did you know?”
I answered, “I studied it in college.” Even today, most are terrified of shaking hands with lepers.
Not me.
He then proceeded to give me a personal tour of the colony. The first thing you notice is that there are cemeteries everywhere filled with thousands of wooden crosses. Death is the town’s main industry.
There are no jobs. Everyone lives on food stamps. A boat comes once from Oahu a week to resupply the commissary. The government stopped sending new lepers to the colony in 1969 and is just waiting for the existing population to die off before they close it down.
Needless to say, it is one of the most beautiful places on the planet.
The highlight of the day was a stop at Father Damien’s church, the 19th century Belgian catholic missionary who came to care for the lepers. He stayed until the disease claimed him and was later sainted. My late friend Robin Williams made a movie about him, but it was never released to the public.
The mayor invited me to stay for lunch, but I said I would pass. I had to take off from Kalaupapa before the winds shifted.
It was an experience I will never forget.
Stay Healthy,
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
The Airport of No Return
Father Damien
One hundred years from now, historians will probably date the beginning of the fall of the American Empire to 1986. That is the year President Ronald Reagan ordered Jimmy Carter?s solar panels torn down from the White House roof, and when Chinese Premier Deng Xiaoping launched his secret ?863? program to make his country a global technology leader.
? The big question today is who will win one of the biggest opportunities of our generation. Some 27 years later, the evidence that China is winning this final battle is everywhere.? China dominates in windmill power, controls 97% of the world?s rare earth supplies essential for modern electronics, is plunging ahead with ?clean coal?, and boasts the world?s most ambitious nuclear power program. It is a dominant player in high-speed rail, and is making serious moves into commercial and military aviation. It is also cleaning our clock in electric cars, with more than 30 low cost, emission free models coming to the market by the end of 2013. Looking from a distance, one could conclude that China has already won the technology war. Not if Tesla?s (TSLA) Elon Musk has anything to say about it. Our only serious entrant in this life or death competition is the Tesla Model S-1, which has been on the market now for a year.? At $80,000 per vehicle for the long range version that accounts for 90% of sales, production is now ramping up to a modest 40,000 units a year. My Model X SUV won?t be delivered until January 2015. Elon tells me that he plans to bring out a $40,000, 300-mile range ?Next Gen? vehicle by 2018, which will reach 500,000 in annual production. And they will all be 100% ?Made in the USA.?
? General Motors? (GM) pitiful entrant in this sweepstakes, the Chevy Volt, has utterly failed to reach the firm?s sales targets. It is, in fact, a hybrid that runs on battery power for the first 40 miles, when a weak conventional gasoline engine takes over to deal with ?range anxiety.? Still, I receive constant emails from drivers who say they absolutely love the cars, with many still driving around on the original year old tank of gas. And at $39,000, with dealer discounts and tax subsidies, it IS cheap. This is all far more than a race to bring commercial products to the marketplace. At stake is nothing less than the viability of our two economic systems. By setting national goals, providing unlimited funding, focusing scarce resources, and letting engineers run it all, China can orchestrate assaults on technical barriers and markets that planners here can only dream about. And let?s face it, economies of scale are possible in the Middle Kingdom that would be unimaginable in America.
The laissez faire, libertarian approach now in vogue in the US creates a lot of noise, but little progress. The Dotcom bust dried up substantial research and development funding for technology for a decade. A ban on government funding of stem cell research, for religious reasons, left us seriously behind in that crucial field. An administration that believed that global warming was a leftist hoax, coddled big oil, and put alternative energy development on a back burner. While China was ramping up clean coal research, President Bush was closing down ours. Never mind that the people supplying us with 2 million barrels of crude a day from the Middle East are trying to kill us through whatever means possible, and are using our money to do it. But Americans are finally figuring out that we can?t raise our standard of living selling subprime loans to each other, and that a new direction is needed.
Mention government involvement in anything these days and you get a sour, skeptical look. But this ignores the indisputable verdict of history. Most of the great leaps forward in US economic history were the product of massive government involvement. I?m thinking of the transcontinental railroad, the Panama Canal, Hoover Dam, the atomic bomb, and the interstate highway system. All of these were far too big for a private company ever to consider. If the government had not funneled billions in today?s dollars into early computer research, your laptop today would run on vacuum tubes, be as big as a skyscraper, and cost $100 million.
I mention all of this not because I have a fascination with obscure automotive technologies or inorganic chemistry (even though I do). Long time readers of this letter have already made some serious money in the battery space. This is not pie in the sky stuff; this is where money is being made now. I caught a 500% gain by hanging on to Warren Buffet?s coat tails with an investment in the Middle Kingdom?s Build Your Dreams (BYDDF) four years ago. I followed with a 250% profit in Chile?s Sociedad Qimica Y Minera (SQM), the world?s largest lithium producer. Tesla?s own shares have been the top performer in the US market in 2014, up over 400%. These are not small numbers. I have been an advocate and an enabler of this technology for 40 years, and my obsession has only recently started to pay off big time. We?re not talking about a few niche products here. The research boutique, HIS Insights, predicts that electric cars will take over 15% of the global car market, or 7.5 million units by 2020. Even with costs falling, that means the market will then be worth $225 billion. Electric cars and their multitude of spin off technologies will become a dominant investment theme for the rest of our lives. Think of the auto industry in the 1920?s. (TSLA), (BYDDF), and (SQM) are just the appetizers. All of this effort is being expended to bring battery technology out of the 19th century and into the 21st. The first crude electrical cell was invented by Italian Alessandro Volta in 1759, and Benjamin Franklin came up with
the term ?battery? after his experiments with brass keys and lightning. In 1859, Gaston Plant? discovered the formula that powers the Energizer bunny today.
Further progress was not made until none other than Exxon developed the first lithium-ion battery in 1977. Then, oil prices crashed, and the company scrapped the program, a strategy misstep that was to become a familiar refrain. Sony (SNE) took over the lead with nickel metal hydride technology, and owns the industry today, along with Chinese and South Korean competitors.
We wait in gas lines to ?fill ?er up? for a reason. Gasoline has been the most efficient, concentrated, and easily distributed source of energy for more than a century. Expect to hear a lot about the number 1,600 in coming years. That is the amount of electrical energy in a liter (0.26 gallons), or kilogram of gasoline expressed in kilowatt-hours. A one-kilogram lithium-ion battery using today?s most advanced designs produces 200 KwH. Stretching the envelope, scientists might get that to 400 KwH in the near future. But any freshman physics student can tell you that since electrical motors are four times more efficient than internal combustion ones, that is effective parity with gasoline. Since no one has done any serious research on inorganic chemistry since the Manhattan project, until Elon Musk came along, the prospects for rapid advances are good. A good rule of thumb is that costs will drop by half every four years. So Tesla S-1 battery that costs $30,000 today will run $15,000 in 2017 and only $7,500 in 2021. Per Kilowatt battery costs are dropping like a stone, from $1,000 a kWh in the Nissan Leaf I bought three years ago to $365. kWh in my new Tesla S-1. In fact, the Tesla, is such a revolutionary product that the battery is only the eighth most important thing. The additional savings that no one talks about is that an electric motor with only eleven moving parts requires no tune-ups for the life of the vehicle. This compares to over 1,000 parts for a standard gas engine. You only rotate tires every 6,000 miles. That?s because the motor runs at room temperature, compared to 500 degrees for a conventional engine, so the parts last forever. Visit the Tesla factory, and you are struck by the fact that there are almost no people, just an army of German robots. Few parts mean fewer workers, and lower costs. All of the parts are made at the Fremont, CA plant, eliminating logistical headaches, and more cost. By only selling the vehicle online, the expense of a huge dealer network is dispatched. The US government rates the S-1 as the safest car every built, a fact that I personally tested with my own crash. Consumer Reports argues that it is the highest quality vehicle every manufactured.
Indeed, the Tesla S-1 is already the most registered car in America?s highest earning zip codes. Oh, and did I tell you that the car is totally cool? Hence the need for government subsidies to get private industry over the cost/production hump. Nissan, Toyota, Tesla, and others are all betting their companies that further progress and economies of scale will drive that cost down to below $100 per kWh. That will make electric cars cheaper than conventional hydrocarbon powered ones by a large margin. The global conversion to electric happens much faster than anyone thinks. In a desperate attempt to play catch up, President Obama has lavished money on alternative energy, virtually, since the day he arrived in office. His original stimulus package included $167 billion for the industry, enough to move hundreds of projects out of college labs and into production. However, in the ultimate irony, much of this money is going to foreign companies, since it is they who are closest to bringing commercially viable products to market. Look no further than South Korea?s LG, which received $160 million to build batteries for the Volt. The IRS currently gives buyers of electric cars a $7,500 tax credit on their federal return. California buyers get an additional check for $2,500, and get zero emissions commuter stickers which permit single drivers in HOV lanes. Fortunately the US with its massively broad and deep basic research infrastructure, a large military research establishment (remember the old DARPA Net?), and dozens of still top rate universities, is in the best position to discover a breakthrough technology. The Energy Department has financed the greatest burst in inorganic chemistry research in history, with top rate scientists pouring out of leading defense labs at Los Alamos, Lawrence Livermore, and Argonne National Labs. There are newly funded teams around the country exploring opportunities in zinc-bromide, magnesium, and lithium sulfur batteries. A lot of excitement has been generated by lithium-air technology, as well as much controversy. In the end, it may come down to whether our Chinese professors are smarter than their Chinese professors.? In 2007, the People?s Republic took the unprecedented step of appointing Dr. Wan Gang as its Minister of Science and Technology, a brilliant Shanghai engineer and university president, without the benefit of membership in the communist party. Battery development has been named a top national priority in China. It is all reminiscent of the 1960?s missile race, when a huge NASA organization led by Dr. Wernher von Braun beat the Russians to the moon, proving our Germans were better than their Germans.
Consumers were the ultimate winners of that face off as the profusion of technologies the space program fathered pushed standards of living up everywhere. I bet that?s how this contest ends as well. The only question is whether the operating instructions will come in English?or Mandarin.
For the first time in three years, China (FXI) has cut its prime lending rate by 50 basis points. The timing caught many analysts by surprise, as such move was not expected until the lunar new year in early February. Perhaps recent data showing collapsing exports prompted the Mandarins in Beijing to hurriedly move up the timetable.
The Middle Kingdom?s action is one of the most important developments in financial markets this year, since it represents a major sea change, and is hugely positive for the global economy. It could signal a coming year of additional incremental interest rate cuts and bank reserve reductions designed to keep the country above the ?red line? GDP growth rate of 8%. Observers were also stunned by the magnitude of the cut, 50 basis points, compared to the usual 25 basis point move seen by the People?s Bank of China.
I have been comfortably out of Chinese equities for more than a year, vowing not to return to the mainland until interest rates fell. Now the worm has turned. It may be time to take another look at companies like Build Your Dreams (BYDDF), which has risen by 50% since my undercover visit there last month. Other names like China Telecom, China Mobile, and Baidu (BIDU), are also starting to look interesting.
We Want Lower Interest Rates!
When I first bought shares in the Chinese electric car manufacturer, BYD (BYDDF) (or Build Your Dreams) in 2009 on the heels of Warren Buffet?s 10% investment, it looked like a total home run. The stock soared from $1.50 to $11, given me a paper return of 730%.
Undercover, I Totally Blend
Last year, the stock started to roll over, retracing all the way back to my cost. I called the company?s Los Angeles office, but the line was disconnected. I tried the New York office, but my call was never returned. An email I sent their headquarters in Shenzhen, China went unanswered. I even had a friend in the Chinese government make some inquires, and he told me the company wasn?t seeing anyone.
That?s it! Off with the gloves. No more Mr. nice guy. I did what I usually do when a company I follow won?t talk to me. I fly to their headquarters and break into the facility.
It was easier than you think. I simply pulled up to the main gate in Northern Shenzhen and told security that I was a friend of Mr. Buffet and was there to see Mr. Li. They waved me through and went scurrying to find the appropriate Mr. Li. I knew full well that in a company of 100,000, at least 10,000 had to be named Mr. Li, and by the time they figured out that there was no Mr. Li, I would be long gone. It worked like a charm.
This Could Be Your Next Car
At this point, my editor is saying, ?You did what!?? Indeed, my staff worries about my antics from time to time, fearing the dole if I fail to return from one of my adventures. But the nine life limitation that cats face doesn?t seem to apply to me, so I just keep on going.
I then set off and roamed the factory floors freely, stopping workers wherever I could and asking about conditions. The great thing about this approach is that the man on the assembly line, in R&D, and the girl in accounting are totally unfamiliar with management?s sanitized view for public consumption, and haven?t been professionally trained to lie. As a result, I was able to get a first class read on the state of the company.
E-Taxis
When I met with the Shenzhen venture capital community in the days before, the rumors were rampant. When founder and CEO, Wang Chuanfu, launched his assault on the global car market three years ago, expectations were high. He promised investors, like Berkshire Hathaway?s Charlie Munger, that BYD would soon become the world?s largest car manufacturer. He ramped up production from 500,000 vehicles to 800,000 in 2010, anticipating a huge demand for the company?s conventional cars and hybrids.
But quality issues persisted, and the resale rate to past BYD car owners fell to zero. Sales peaked at just over 500,000, leaving the company with a huge inventory of unsold vehicles. Profits collapsed. Mercedes was brought in to provide technical assistance, but has so far been unable to improve sales. Was BYD going under? Was Warren Buffet pulling his investment? Speculation was rife.
One salesman told me that the information blackout was ordered not due to any financial problems, but because the company was releasing its new, all electric Model E6 the following week. This car is much larger than other electric cars, gets an amazing 186 miles per charge, and will be offered for sale for $39,000 after government incentives.
If true, this would be a revolutionary, highly disruptive advance. BYD plan to export the car to the US as soon as possible. It has already been test driving a fleet of ?E-Taxis? on the streets of Shenzhen for the past 18 months, with much success. If the company cans delivery on the vehicle, Wang Chuanfu might realize his ambitious goals after all.
China currently subsidizes energy prices, with gasoline available for about $3.50 a gallon, or 10% lower than US prices. That means a smaller cost advantages for alternative car producers. That disadvantage could disappear during the next oil price spike. Government subsidies will also eventually have to disappear because they are too costly.
Finally, after two hours of scouring the grounds, inspecting the physical remains of their crash tests, inspecting the assembly line, and peeking through windows, I was ready to go. There once was a day when I could have been put in front of a firing squad for doing something like this. But the People?s Republic has grown soft in its old age, and I figured that, worst case, I would just get kicked off the grounds. Not, so for my Chinese staff, however, who were sweating bullets and begging me to leave.
So what are investors to take away from this? For a start, you run out and buy tsunami afflicted, beaten down Nissan Motors (NSANY). If BYD can squeeze 186 miles out of its batteries, so can Nissan, and there is already talk that the second generation all-electric Leaf will reach that target. That will eliminate the ?range anxiety? afflicting current owners with their 80 mile limitation.
As for BYD itself, the story is a little more complicated. At this share price, you are essentially getting a world class multinational lithium ion battery company with the car company thrown in for free. If the car division continues to sputter along, you can expect modest appreciation in the shares. But if the E-6 becomes the next big car of the future, the stock could go ballistic and potentially make a new high, delivering investors a multi bagger.
Whoa, That Was Close
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