Value of Perfect Information

If you think that the upcoming energy shortage is going to be bad, it will pale in comparison to the next water crisis, so investment in fresh water infrastructure is going to be a recurring long term investment theme. (See my earlier efforts to get you into the water space by clicking here). One theory about the endless wars in the Middle East since 1918 is that they have really been over water rights. Although Earth is often referred to as the water planet, only 2.5% is fresh, and three quarters of that is locked up in ice at the North and South poles. In places like China, with a quarter of the world’s population, up to 90% of the fresh water is already polluted, some irretrievably so. Some 18% of the world population lacks access to potable water, and demand is expected to rise by 40% in the next 20 years. Aquifers in the US, which took nature millennia to create, are approaching exhaustion. While membrane osmosis technologies exist to convert sea water into fresh, they use ten times more energy than current treatment processes, a real problem if you don’t have any, and will easily double the end cost to consumers. While it may take 16 pounds of grain to produce a pound of beef, it takes a staggering 2,416 gallons of water to do the same. The UN says that $11 billion a year is needed for water infrastructure investment, and $15 billion of  last year’s  US stimulus package was similarly spent. It says a lot that when I went to the University of  California at Berkeley School of Engineering to research this piece, most of the experts in the field had already been retained by major hedge funds! At the top of the shopping list to participate here should be the Claymore S&P Global Water Index ETF (CGW), which has appreciated by 50% since I first brought it up. You can also visit the PowerShares Water Resource Portfolio (PHO), the First Trust ISE Water Index Fund (FIW), or the individual stocks Veolia Environment (VE), Tetra-Tech (TTEK), and Pentair (PNR). Who has the world’s greatest per capita water resources? Siberia, which could become a major exporter of H2O to China in the decades to come.

Between 2000-2005 soybean cultivation resulted in a small overall percentage of direct deforestation. Nevertheless the role of soy is quite significant in the Amazon. As explained by Dr. Philip Fearnside, “Soybean farms cause some forest clearing directly. But they have a much greater impact on deforestation by consuming cleared land, savanna, and transitional forests, thereby pushing ranchers and slash-and-burn farmers ever deeper into the forest frontier. Soybean farming also provides a key economic and political impetus for new highways and infrastructure projects, which accelerate deforestation by other actors.”

Recently, soybeans have become one of the most important contributors to deforestation in the Brazilian Amazon. Thanks to a new variety of soybean developed by Brazilian scientists to flourish in rainforest climate, Brazil is on the verge of supplanting the United States as the world’s leading exporter of soybeans. High soybean prices have also served as an impetus to expanding soybean cultivation.            Commentary by Rhett A Butler, Mongabay.com.

Prolonged dry spell may damage Soybean Production in U.S., Brazil, Argentina: 

 La Nina may hurt soybean crops in the U.S., the largest exporter, and South America, should it cause a “severe” drought between early August and February; likely curbing yields, Telvent DTN Inc. said.

“If La Nina shows up in August, yes, it could contribute to damage to the U.S. soybean crop,” said Bryce Anderson, chief agricultural meteorologist at DTN, a provider of market information to 700,000 clients across North America. “It can certainly be a feature that leads to a reduction in the crop size” in Brazil and Argentina, he said in an interview.

La Nina, characterized by colder-than-normal sea-surface temperatures in the Pacific Ocean, can change world weather patterns, affecting crop development. It can cause wetter-than- usual weather in Asia and below-average rainfall in parts of the U.S., Argentina and south Brazil. And more hurricanes in the Atlantic Ocean.   There’s a high probability for La Nina to develop during Brazil’s September-November planting season, the weather office said June 25.

“The  La Nina years are among the worst for grain and oilseed crops in Brazil,” Paulo Etchichury, head of San Paulo- based forecaster Somar Meteorologia, said in telephone interview.  Soybean planting in Brazil, the world’s second- largest producer of oilseed, may be delayed by dry weather caused by the La Nina weather pattern, the San Paulo based forecaster Soma Meteorologia  said June 23.

Output losses in the U.S., Argentina and Brazil, which make up 82 percent of global soybean output, may end a 13 percent slump in prices in Chicago this year. Prices declined this year because of record crops. Soybean output in Brazil rose 20 percent from a year earlier to 68.7 million metric tons during the crop that farmers finished harvesting last month according to the Agriculture Ministry, known as Conab.  Southern Brazil accounted for 37 percent of total production.

“The market will continue to monitor the changes in the weather pattern and price in potential risks for losses to global output,” Peter McGuire, managing director of CWA Global Markets Pty. said by phone from Sydney.

Goldman Sachs Agricultural Index's Stairstep rise in response to La Nina fears.

“When you’re dealing with Mother Nature, you’ve always got those issues as far as the weather is concerned,” McGuire said.-Bloomberg Business Week

The critical time frame for US crops is August. The critical time for sowing South American crops is fast approaching:  This may explain the continued rise is shares of fertilizer stocks like Mosaic, Agrium, Terra Nitrogen and our favorites CF Industries and Potash. You can look for share additions to our model portfolio come early August.   Opposite Goldman Sachs Agricultural Index’s Stairstep rise in response to La Nina fears. -Stock Market Guru

South American rainfall month-to-date 7/28 10

Shorting the world’s most overvalued asset, the 30 year US Treasury bond, has got to be the big trade from here. The relentless whirring of the printing presses is so loud that they keep me awake at night, even though, according to Mapquest, I live 2,804.08 miles away. What will be unique with this meltdown is that it will be the first collapse in history of a bond market in a non-inflationary environment.

It is not soaring consumer prices that will execute the coup de grace to the long bond. It will be the sheer volume of issuance. The Feds have to sell nearly $2.5 trillion of debt to cover a massive budget deficit and refund maturing paper, easily the largest cash call in history. Bring in a double dip recession and a second, larger stimulus package, and those numbers ratchet up considerably.

Pile on top of that trillions more in offerings from states and municipalities that are bleeding white. By the end of 2010, total government debt from all sources will rocket to a staggering 350% of GDP. Throw in private debt requirements, like the rolling over of a trillion dollars worth of commercial real estate financing and your garden variety corporate offerings. The rush to borrow has started overseas too, with hundreds of billions of dollars more in Eurobonds floated by cash strapped sovereigns like the PIIGS. It’s clear that the bond markets of all descriptions are going to become very crowded places, driving rates irresistibly higher.

At some point, the world runs out of buyers, and the long bond yields will begin their inexorable climb from the current, ridiculously low 4.10% to 5.5%, 6%, and higher.  Even Moody’s is talking about a ratings downgrade for the US debt, not that we should give that disgraced institution any credibility whatsoever. The unfortunate camel whose back is on the verge of breaking is about to have sticks come raining down upon him.

I am a worshipper of the TBT, a 200% bet that long bonds are taking the Lexington Avenue Express downtown. I managed three round trips in Q1 covering the $46-$51 range before a flight to safety bid stopped me out in April. It has clawed its way back up from $34.80 to $37.15, compared to the $70 it traded at in 2008.  Falling interest rates have a silver lining in that the annual cost of carry for this leveraged ETF has dropped appreciably, from 10.5% to only 8.2%.

If short interest rates double from the current levels, a virtual certainty, so does America’s debt service, from the current 11% to 22% of the budget. This could happen as early as 2014. That’s when the sushi really hits the fan.

If I’m wrong on this and the 30 year yield surges to 3% in some sort of second Great Depression scenario, the TBT will drop down to the high $20’s. If I’m right, the final target could be as high as $200, when long rates top 13%. That’s where they were when I bought my first coop on Manhattan’s Upper East Side in 1981.  If you have a serious pair of cajones on you, take a look at the 3X short ETF (TMV) with its higher cost of carry.

A 20% downside risk and a 540% upside potential sounds like a good risk/reward ratio to me. If the TBT dips again in August, it might be time to take another bite from the apple.

The ultra bears were sent packing in recent days, thanks to a spate of economic indicators showing some unexpected strength. Take a look at the chart below for rail car loadings showing an unequivocal spike upward. I warned last week that there was some positive action in this area (click here for the piece), and the latest data confirms my belief that we are not going into another crash, or even a double dip, but merely a slowdown to a 2% annualized GDP growth rate. It also gives credence to my expectation that the stock market is not going to collapse, but merely move to the lower end of a long term 900-1,200 range in the S&P 500. You knew that when the media was blaring in unison about “death crosses,” stocks could only rally. But how much money do you want to put into a market where the characters of MTV’s “Jersey Shore” get to ring the opening bell?

Today, the Commerce Department reported that June new home sales, at 330,000, were up a blistering 24%. So is the crash in residential real estate over? It’s off to the races, right? Wrong! Much of the gains were cancelled out by whopping great downward revisions which caused April to shrink from 504,000 to 422,000, and May to shrivel from 300,000 to an unbelievable 267,000, a 60 year low. Every time I update my prediction that home prices are either going south or nowhere for a decade, my inbox gets flooded with angry emails from real estate agents around the country and other industry apologists screaming that I am missing record home affordability and historic low 30 year mortgage interest rates. Over the weekend I received an assist from Barrons (click here for the link), which highlighted an unexplored angle in the real estate crisis. The coming demographic curve predicts that there will be a shortage of those aged 35-49, prime first time home buyers. At the same time, there will be an oversupply of those over 50, like me, who are looking to downsize their housing requirements. The net effect is for national home ownership that peaked in 2004 at 69% to fall as low to as 64% by 2015, its 1993-94 bottom. The flip side is that renters will soar from 32.8% to 36% during the same time period. Needless to say, this is terrible news for house prices. It also explains why low end multifamily housing, where newly formed young families and immigrants reside, is one of the few sectors of the housing markets showing a pulse. If you want more depth on this politically sensitive issue, please read my notorious piece on “The Hard Truth About Residential Real Estate” by clicking here.

A favorite ploy of poorly managed school districts in California is for the teachers to simply give all their students “A’s”. That way the state and federal money keeps rolling in, and demanding parents can be assured that their over protected children are performing. That seems to be what is happening with the stress test given to European banks, the results announced on Friday, which most passed with flying colors. French banks were found to be the healthiest. Only 7 out of 91 banks in 20 countries were sent to the markets to raise more capital. One German bank flunked the test, one from Greece, and five from Spain. Having been a banker in Europe myself for a decade, I can tell you first hand that they have never been big on transparency. The test assumes that banks will be able to maintain a minimal 6% tier one capital ratio, even after another economic or sovereign debt crisis wipes out $700 billion in new losses. Healthy banks generally have 10% capital ratios. Many analysts suspect that the European Union reverse engineered the test, setting the standard by calculating the lowest capital ratio that would pass the most banks. Eyebrows were further raised when the German banks refused to disclose their sovereign debt holdings, which are believed to already carry huge losses. Still, there has been a sigh of relief in the global capital markets, as credit spreads tightened all week. Add one known, scratch one unknown. The news is considered good enough to allow the rallies in US stocks and the Euro a few more days of life. We’ll find out for sure when the next round of disclosure comes our way in two weeks.

The boarding of a Turkish ship by Israeli commandos and the international brouhaha that it sparked has thrown a searing spotlight on that emerging nation. Several hedge fund friends and now a few readers of this newsletter in Istanbul have urged me to explore this intriguing nation further. So I thought I would use this otherwise slow news day to do exactly that.

I first trod the magnificent hand woven carpets of the Aga Sophia in the late sixties while on my way to visit the rubble of Troy and what remained of the trenches at Gallipoli, a bloody WWI battlefield. Remember the cult film, Midnight Express? If it weren’t for the nonstop traffic jam of vintage fifties Chevy’s on the one main road along the Bosporus, I might as well have stepped into the Arabian Nights. They were still using the sewer system built by the Romans.

Four decades later, and I find Turkey among a handful of emerging nations on the cusp of joining the economic big league. Q1 GDP grew at a blazing 11.4% annualized rate, second only to China, exports are on a tear, and the cost of credit default swaps for its debt is plunging. Prime Minister Erdogan, whose AKP party took control in 2002, implemented a series of painful economic reform measures and banking controls which have proven hugely successful. Since the beginning of this year, Turkey’s ETF (TUR) has outperformed BRIC poster boy China’s ETF (FXI) by a whopping 11.8%.

Foreign multinationals like general Electric, Ford, and Vodafone, have poured into the country, attracted by a decent low waged work force and a rapidly rising middle class. The Turkish Lira has long been a hedge fund favorite, attracted by high interest rates. With 72 million, the country ranks 18^th in terms of population and 17^th in terms of GDP, some $615 billion. It has a near perfect population pyramid; with young consumers greatly outnumbering expensive retirees (click here for more depth in my “Special Demographic Issue”).

Still, Turkey is not without its problems. It does battle with Kurdish separatists in the east, and has suffered its share of horrific terrorist attacks. Inflation at 8% is a worry. The play here long has been to buy ahead of membership in the European Community, which it has been denied for four decades. Suddenly, that outsider status has morphed from a problem to an advantage.

Growing economic power brings political influence with it. The last year has seen Turkey broker settlements in the Balkans and facilitate the Iranian uranium swap with Russia. Some analysts claim this new flexing of diplomatic muscle has a pronounced Islamic, anti American bent. Remember, Turkey refused transit rights to US forces during the invasion of Iraq.

The way to play here is with an ETF heavily weighted in banks and telecommunications companies, classic emerging market growth industries (TUR). You also always want to own the local cell phone company in countries like this, which in Turkey is Turkcell (TKC). Turkey is not a riskless trade, but is well worth keeping on your radar.

 ’Is China the Next Dubai’  Absolutely not!

NAPOLEON WAS RIGHT -China is a sleeping giant!

 ”Build it and they will come”, works in Hollywood; worked for Hollywood in the Golden Years, but does not always work in Adam Smith Capitalism. It does however work in a Command economy! As in Stalin’s Russia, ‘build it’ and they will be led- kicking and screaming- if need be. Soviet Union built a mighty industrial nation until the intricacies of the micro-chip -a society based on computer software and information exchange did them in.     We shall see if the Chinese -long a people known for ingenuity and invention have been paying attention.
This command -this hybrid economy does not play by Adam Smith rules. The Chinese are halfway through transformation from agrarian to urban industrial base.This week the IEA said that China had surpassed the US in energy consumption for the latest year calculated (2009). Their manifest destiny beckons. They now have the currency reserves to accomplish their task and the  political will power:  embarking  on  massive capital spending as the main driver to domestic recovery. 

Granted capital spending ratios are near historic peak. Capital Investment to GDP not unlike: West Germany 27% in 1964, Japan 36% in 1973, South Korea 39% in 1991. None of these peaks however, was anywhere near peak economic growth. In each instance, individual and corporate wealth continued to grow for years if not  decades. China at 50% Capital to GDP,  presents a daunting figure but comparable to the build out in the old Soviet Union; which continued to progress, if not prosper [ Re: average citizen.]  fifteen or more years after the heyday of the 1960′s.
Yes, there will be bumps along the way; but remarkably few so far in China since the Tiananmen Square tragedy. Most Chinese eschew political rancor, they strive to be professional, urban consumers, intellectuals: who, if so blessed, married with an apartment -maybe one day a car!  Urbanites have become  the consumate consumers of high-end European luxury goods.       Migrant workers, socially upwardly mobile, retain ties with distant relatives and family -working for a better day of personal prosperity. They represent the best elements of post-war U.S. & Japan in their growth phases. All under the auspices of a Central Polit Bureau that uses a more strigent version of the social model that has worked so well in Singapore for a generation. All dissention is quietly discouraged, promptly, and censored from view.
Of course the government “cooks the books” on occassion -no differently than any other nation. All have the need to obfuscate; to paint pleasing pictures for the populace and potential investors. Note the constant, often blatant reversals in official numbers from our own Bureau of Labor Statistics.
“Raise the Yuan! Let it free-float!” Be careful what you ask: The Chinese may let the Yuan rise in truth. Augmenting its burgeoning industrial juggernaut with a post-industrial financial haven, drawing capital and commodities from around the world to one of the few oasis’ of growth. For now any appreciation of Yuan to Dollar will be gradual over the next year.  Growth is still likely to slow, near term, as economies around the world continue to struggle. Combined domestic concerns over less than full employment and possible labor unrest over low wages, trump international considerations. The jury is still out as to whether the domestic economy has turned the corner to generating sustained economies of scale. Odds are it will by 2015.
Just remember, China  has $2.3 trillion in currency reserves!  $2.3 trillion! Marty Zwieg says, “Don’t fight the tape!” [or the $2,300,000,000.]
Speaking of internally generated economies of scale:  the populace does like to gamble and is returning to Macau in ever increasing numbers: I will have to add Steve Wynn’s company[earnings alert!]and China Southeast Airlines to watchlist.

Conjoined twins above: Shanghai suffered bear market (-27%) since April, while senior index Hang Seng only a correction. Below: Shanghai shows signs of sustainable rebound.

MACD and Momentun swings are positive for a turn in the tide.