2011 Archive - Mad Hedge Fund Trader

What?s up with BYD?

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

European Style Homeland Security

Diary

The English are feeling the pinch in relation to recent events in Libya, and have therefore raised their security level from "Miffed" to "Peeved." Soon, though, security levels may be raised yet again to "Irritated" or even "A Bit Cross." The English have not been "A Bit Cross" since the blitz in 1940, when tea supplies nearly ran out. Terrorists have been re-categorized from "Tiresome" to "A Bloody Nuisance." The last time the British issued a "Bloody Nuisance" warning level was in 1588, when threatened by the Spanish Armada.

The Scots have raised their threat level from "Pissed Off" to "Let's get the
Bastards." They don't have any other levels. This is the reason they have been
used on the front line of the British army for the last 300 years.

The French government announced yesterday that it has raised its terror alert
level from "Run" to "Hide." The only two higher levels in France are "Collaborate" and "Surrender." The rise was precipitated by a recent fire that destroyed France 's white flag factory, effectively paralyzing the country's military capability.

Italy has increased the alert level from "Shout Loudly and Excitedly" to
"Elaborate Military Posturing." Two more levels remain: "Ineffective Combat
Operations" and "Change Sides."

The Germans have increased their alert state from "Disdainful Arrogance" to
"Dress in Uniform and Sing Marching Songs." They also have two higher levels:
"Invade a Neighbor" and "Lose."

Belgians, on the other hand, are all on holiday as usual; the only threat they
are worried about is NATO pulling out of Brussels.

The Spanish are all excited to see their new submarines ready to deploy. These
beautifully designed subs have glass bottoms so the new Spanish navy can get a
really good look at the old Spanish navy.

Australia, meanwhile, has raised its security level from "No worries" to
"She'll be alright, Mate." Two more escalation levels remain: "Crikey! I think
we'll need to cancel the barbie this weekend!" and "The barbie is canceled." So
far no situation has ever warranted use of the final escalation level.

-- John Cleese - British writer, actor and tall person.

November 8, 2011 - Quote of the day

Quote of the Day

?There are more beauty parlors than there are beauties,? said the late CBS commentator, Andy Rooney. The same can be said about stock brokers. He also said ?I just wish insignificance had more stature.?

November 7, 2011: Quote of the Day

Diary

?I?m not a dove or a hawk on monetary policy, I?m an owl,? said Richard Fisher, president of the Federal Reserve Bank of Dallas.

Testimonial

Testimonials

A full double on my FXE puts means?a dancing girl for you. You deserve it! Raising a glass to the Greek Prime Minister as I type this. Thanks John. You rock!!
CK

Goodbye Steve Jobs, Hello Dividend?

Newsletter

Analysts continue to be stunned by the rate at which cash is rolling into Apple (AAPL). At current cash flows, the company?s hoard is expected to grow from $81 billion to $120 billion by next June, an increase of nearly $200 million a day!

So far, the company has resisted every entreaty to part with some of this dosh, either through a share buyback or a dividend. Now some are speculating that the passing of founder, Steve Jobs, and the succession of new CEO, Tim Cook, could lead to a loosening of the purse strings.

Let?s face it. Apple has had a great, decade long run. Hundreds of my readers, many of them Apple employees, are faced with the enviable problem that, having ridden the stock up from $4 to $400, they have too much of their wealth concentrated in a single asset. That is never a good idea from a risk control point of view. But every time I look for reasons to sell Apple, I find three more reasons to buy it. It?s a case of the grass being greener on my side of the fence.

Let me list just a few avenues for continued meteoric performance:

*As the Apple generation reaches the ranks of senior management, more Fortune 500 companies will begin to support their products. Thousands would love to quit carrying around a Blackberry for business and an incompatible IPhone for personal use, with the associated chargers. (note to self: short (RIMM) on the next rally).

*Despite this torrid growth, the stock trades at a discount to the S&P 500 at 12 times earnings.

*The Apple of today is essentially a spanking brand new, high growth company. The company?s only decrepit product is the IMac. The IPhone is only 5-6 years old, while the Ipad and Ap Store are only 1-2 years old and still in their infancy. The potential near term growth of these products is huge.

*IPhones only have a 5% penetration of the world market. Past market leaders like Nokia (NOK)? and Motorola (MOT) have reached market shares well into double digits.

*Apple is just scratched the surface in China, where it only has six official stores (but lots of fake imitators), and is already the premium product.? The growth opportunities there are massive. Everyone there wants an IPhone, and they are traveling to Hong Kong to get them.

*There was always a fear of what would happen to Apple stock after Steve Jobs was gone. That is now behind us. In the wine bars around the company?s futuristic Cupertino, California headquarters at One Infinite Loop, I am hearing that Steve left behind enough new product ideas, improvements, upgrades, and direction to keep Apple forging ahead for another five years. The vast, interlocking, synergistic ecosystem he envisioned is still maturing.

It all reinforces my view that Apple shares will reach my long term target of $1,000 sooner than anyone thinks. It is already trading places with Exxon (XOM) as the world?s largest company and most profitable company on an almost weekly basis. At $1,000, Apple would boast a market value of $930 billion, accounting for 7.5% of total US stock market capitalization, and 40% of NASDAQ.

What if multiples expand, as they should? Take Apple stock up to its past peak multiple of 36, and the company would be worth $2.8 trillion and rank 5th in the world in GDP, more than France, and just behind German. Wow!

Goodbye Steve Jobs, Hello Dividend?

October Nonfarm Payroll Surprise Points to Market Upside

Diary

The October nonfarm payroll came in at a pedestrian 80,000, compared to 158,000 in September, a rate that is somewhat less than what matches population growth. But it is the numbers behind the numbers that will deliver the big market impact. The headline unemployment rate came in at a nosebleed 9.0%.

August and September were revised up a whopping 102,000. This is final proof that the recession that the market was discounting over September and early October was never there, a point which I have been arguing about vociferously. The recession was only in the stock market.

What was particularly fascinating was the massive decline in the long term unemployed, by 366,000, the largest since records began in 1948. This took the expanded U-6 unemployment rate, which includes discouraged workers and those whose benefits have expired, from 16.5% down to 16.2 %. I have never seen anything like this, and have no idea what caused it. But the overall message about the economy has to be good.

October saw a pop of 104,000 in hiring by the private sector, partially offset by a loss of 24,000 government jobs, a continuation of what will be a decade long trend. Gains were seen by business and professional services (32,000), leisure and hospitality (22,000), and health care (12,000). Further losses of 20,000 were seen in construction. Since the beginning of 2010, an impressive 3 million jobs have been created by the private sector.

Another sobering statistic buried in the raft of figures was that, of the 80,000 hired, a shocking 42,000 were of people who were taking on second full time jobs! This is additional evidence that the only way that minimum wage workers can support families is by working 16 hours a day at two jobs. Even still, that only gets you earnings of $33,280 a year, pretax, and will certainly be more ammunition for the ?Occupy Wall Street? crowd.

Taken together with a sudden decline in weekly jobless claims to 397,000, and improvement in other employment data, an improving jobs market emerges out of the mist. They suggest an employment picture that has stopped deteriorating, is stabilizing, and beginning a modest upturn. These are economic conditions far better than the financial markets are currently discounting, and are consistent with the 2.0%-2.5% GDP growth rate that I have been sticking to all year.

At the beginning of the year I have been asserting that the economy was growing at a 2% rate, not 4%. Now I have to convince people that it is growing at 2%, not zero. This difference equates to about 300 points in the S&P 500.

Take this data, and throw it in with fading turmoil in Europe and a budget Supercommittee surprise, and you will have a springboard for the S&P 500 to break through upside resistance at the 200 day moving average.

Trade Alert- (JEF) Update November 6, 2011

Trade Alert

Trade Alert-Update regarding the alert on November 4, 2011. As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price. This is your chance to ?look over? John Thomas? shoulder as he gives you unparalleled insight on major world financial trends BEFORE they happen. Read more

Trade Alert - (JEF) November 4, 2011

Trade Alert

As a potentially profitable opportunity presents itself, John will send you an alert with specific trade information as to what should be bought, when to buy it, and at what price. Read more

Report From Australia

Newsletter

SPECIAL AUSTRALIAN ASSET CLASS REVIEW

I am writing this report on the ferry boat from Sydney to Manley, where I will attend a gathering of Australia based hedge fund managers to absorb their collective wisdom. I have deliberately taken the slow boat,? so I have the time to give this report the depth it deserves. The Australian swim suit model sitting next to me will just have to wait and enjoy the scenery.

When I first came here in 1976, women were not allowed into the pubs, and drinking was the national pastime. Today they still drink like fish, but the prime minister is a woman, Julia Gillard, although probably not for long. It?s proof that if you live long enough you get to see everything.

They call this the lucky country for very good reason. It is surfing the crest of a decade long resource boom to prosperity. Virtually everything it produces in size, including iron ore, coal, and gold, have seen enormous price increases over the past decade. The cities of Sydney and Brisbane are vibrant and bustling. The department stores were besieged with women buying hats for the upcoming Melbourne Cup, the country?s premier horse racing event. Talk to people and they are optimistic and upbeat about the future. It is all very refreshing. Only a people with Australian levels of self-confidence and brass will be told that construction of their bold new opera house in Sydney was beyond the reach of modern engineering, and then go ahead and build it anyway.

My Favorite Australian

In Brisbane, I saw a lot of kids racing hot new expensive imported cars. When I remarked to a local that there must be a lot of rich parents here, he replied ?It?s not the parents, it?s the kids who are making the money.? By working a ?21/9? schedule, which means working ten hours a day for 21 consecutive days at a distant mine, and then getting 9 days off, a 20 year old here can earn A$200,000 a year. Now, workers in other industries want a larger piece of the pie. Australia is one of the few countries in the world where you actually see strikes. Indeed, the antics of the Qantas union, the national airlines, made traveling to and from the country challenging at best.

Hey, Junior, Can I Borrow the Car?

The boom has fundamentally remade the Australian economy. Over the last 15 years, mining has jumped from 4% to 10% of GDP and management services from 10% to 15%. At the same time, manufacturing was pared back from 15% to 10%. That enabled the country to more easily absorb the blow when China took over the world?s low end manufacturing industry, which has caused so much damage in the US.

Today, services of all descriptions account for 69% of GDP, which gives it a crucial buffer against the extreme volatility in commodities prices. But it is not immune. During the 2008 crash, shares in mining and energy giant, BHP Billiton (BHP), the country?s largest company, and the third largest in the world, collapsed by 80%. Competitor, Rio Tinto (RIO), plunged by 90%. As much as Australians are complacent in their belief that they are immune from the world?s problems, that is anything but the case. A dependence on foreign oil imports of 80% presents another big risk.

Much of today?s prosperity can be traced to groundbreaking reforms of the financial and tax system in 1983. These enabled the country to replace colonial ties that were severed when Britain joined the European Community in 1973 with trade relations with neighboring Asia. It was a natural and inevitable geographic realignment. China now absorbs far and away the largest share of exports, followed by Japan and South Korea. Australia is also host to 120,000 foreign students, mostly from Asia, further adding to the newfound muscle in the service sector.

Although Australia has been running large current account deficits for 50 years, the shortfall has been more than made up of large foreign capital inflows. Most recently, China has attempted to take large minority stakes in several firms, especially in the resource area. This will accelerate in coming years to the extent that Australians permit it. A capital shortage in the country there is not.

Today, Australia ranks 10th in per capita GDP at $39,764, behind the US at $46,810 (7th), but well ahead of China at $7,544 (94th).? You can expect those numbers to converge in coming years, with America continuing its fall and the Land Down Under rising. A debt to GDP ratio at an enviable 22% has made Australia one of the few to maintain its triple ?A? credit rating. GDP growth has averaged a blistering 3.6% rate for the past 15 years.

Another Favorite Australian

If there is a dark cloud hanging over this economic miracle, it is a rampant property bubble. Prices have doubled or tripled since 2003, and homes now sell for a sky high seven times average annual earnings. The post-crash US is seeing homes selling at multiples of three to four. Houses can be bought for as little as 5% down, and many individuals have been pouring excess savings into multiple real estate purchases.

There are a whole host of tax subsidies that favor home ownership. Liberalization of real estate purchases by foreign investors has further thrown the fat on the fire, attracting massive Chinese buying. House prices are now rising at triple the inflation rate. These are all signs of coming trouble that can only end in tears. But point this out to newly enriched Australians, and I get the same chill I received from Americans in 2005.

Which leads us to the question, ?What to do about Australia?? If you are Australian, it is easy. Sell your home. Take the money and run. This is the easiest cash you have ever earned, and you are unlikely to experience such a windfall again. Rent, don?t buy. As Americans proved so amply, the home ATM doesn?t stay open forever.

A continuation of home price appreciation at these rates is a mathematical impossibility. Once prices stop going up, the hot money will exit post haste. And like real estate markets everywhere, there is a ton of liquidity on the upside and none on the downside. It is your classic ?Roach Motel? market. You can check in, but you can?t check out

Will this cause a subsequent crash in the Australian banking sector? That is unlikely. The industry received a firm rap on the knuckles during the 1998 Asian financial crisis. As a result, the country today has one of the most conservatively run banking systems in the world. Leverage is a miserly 10:1. It is highly concentrated, with just four majors, the Commonwealth Bank of Australia capitalized at A$80 billion, Westpac Bank (A$65 billion), Australia and New Zealand Banking Group (A$56 billion), and National Australia Bank (A$55 billion),? accounting for the bulk of transactions. By comparison, libertarian America has 14,000 banks. Still, they will get slapped around a bit. Going into the autumn swoon, Commonwealth?s shares were off 25% from their 2010 peak.

Commonwealth Bank of Australia (CBA)

For the rest of us who don?t own Sydney homes with spectacular Pacific views or enormous farms in the outback, the question becomes a little more complicated. Because of a heavy reliance on commodities, Australian financial assets of every description have become a call option on the growth of the global economy. When growth is healthy, Ausie assets outperform on the upside. Look no further than the Australian dollar (FXA), one of the world?s few remaining high yielders, which nearly doubled against the US dollar after financial assets bottomed in March, 2009.

This is why hedge funds have fallen in love with Australia, and why you hear me singing ?Waltzing Matilda? in the shower whenever global markets are in ?RISK ON? mode. Good times bring massive buying of Australian stocks, currency, and every kind of commodity. During bad times you want to throw all these things out the window. The dark side to this interest from hedge funds is much greater volatility in all things Australian, including the lady sitting next to me. Notice that when ?double dip? was on the table during the summer, the Ausie dollar cratered 15% in a few weeks.

Another consideration to keep in mind is the China card. During this trip, I have been constantly queried about the risks of a ?China crash.? Put those concerns out of your mind, China isn?t going to crash. Slow down, yes, crash, no. The Midde Kingdom growing at a more sustainable long term rate is a good thing for investors. I will go into the why?s and wherefores in a future country report.

Suffice to say that a China with a $5.5 trillion GDP growing at 7% in the future will generate far more GDP and final demand for Australian resources than one with a $1 trillion GDP growing at 10%? ten years ago. In fact the annual GDP increase today is almost as much as the country?s entire GDP a decade ago, and is also much larger than the $300 billion in new GDP the US will create this year at its own arthritic 2% growth rate.

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China Isn?t Going to Crash

Australia also has a tailwind behind it which others lack: immigration. This is why America consistently grows 1%-1.5% faster than Europe year in and year out. American fertility rates are close to the replacement rate at 2.1, while those in European countries have plunged to as low as 1.2. They are just not making Europeans anymore as fast as they used to.? Australian fertility rate are still up at 1.8 times, and they supplement that with large waves of inward immigration, primarily from Asia.

Having visited this country for 40 years, the change in the makeup of the population is very noticeable. There were no sushi restaurants in Brisbane in the early seventies. Today I am spoiled for choice. And as I constantly pound the table about in my demographic research pieces, higher fertility and immigration create young, faster growing economies, and make far better investments than old slower growing ones with a lot of benefits to pay out. Oz is a perfect example of this.

So what?s the play here? If you are an Australian there are some intriguing opportunities. They used to say that you should buy your age in bonds. Australia is one of the few countries in the world where this is still valid. If you are 70 years old, that means keeping 70% of you portfolio in local bonds and 30% in equities. That guarantees interest from fixed income instruments and reduces the volatility of your income stream as you go into retirement. If you are 30, it means putting 70% of your portfolio into growth equities, and 30% into more sedentary bonds. At your age you will outlive any of the momentary 50% declines that occasionally wrack these securities. Whatever your portfolio allocation, you are really in the sweet spot because most Australian stock and bond alternatives are offering relatively higher returns than elsewhere.

Foreign investors have the luxury of sitting back and waiting for those rare windows that open offering great investment opportunities. If we go into recession next year, as I expect, both the Australian stock markets and currency should see declines of 30% or more from current levels. That would be a great time to load up on long term positions in the resource, energy, and precious metal sectors. You can either index through an ETF like the (EWA) or going for the highest weighted resource stocks in the index, (BHP) and (RIO), which trade like water. You should be able to get great prices that will lead to multiyear gains when the ?RISK ON? trade returns. One thing is certain. When the music starts playing again, the same gorgeous girls keep getting invited to the ball, cycle after cycle.

Until then, a position in Australian government bonds, now yielding 4.54%, might be worth a shot. An economic slowdown will send prices for this paper through the roof. Just make sure you hedge out your Australian dollar exposure when you do so. You don?t want to be putting money into one pocket, only to take it out of the other.

As for the exact timing on all of this, when you need to be running a ?RISK ON? or ?RISK OFF? portfolio, I?m afraid you?ll just have to keep reading the Diary of a Mad Hedge Fund Trader.

Well, the ferry is just tying up now at the Manley dock, the stevedores tossing the heavy ropes on to the pier, and it is time to bring this missive to a close and give my Sheila the attention she so richly deserves.