For me, the highlight of Grant's investment conference in New York this week was Jim Chanos' speech on the bubble in China. He said 60% of China's gross domestic product (GDP) comes from construction... "It's one very large construction zone." Chanos says more cranes dot the skylines now than a year ago (reminiscent of Miami leading up to the real estate crash), despite empty cities, empty malls, and empty airports. He's seen this firsthand.
Chanos described this as a credit-driven boom. Local governments form "Local Government Funding Vehicles" (LGFVs) to lend money to developers. These LGFVs are off-balance-sheet liabilities. Think of them as the Chinese version of special investment vehicles (SIVs) – the investment companies Wall Street banks set up specifically to invest in mortgage securities, which lay at the center of the 2008 credit crisis.
The central Chinese government is trying to stop this lending (it actually raised interest rates a quarter point before Chanos' speech). Its April efforts to cool development only lasted three months. A few days ago, the central government estimated 26% of these LGFV loans are duds and 50% will be problematic.
China bulls point to a great urban migration to support China's booming real estate market. Chanos says it's a myth. Already, 900 million Chinese live in cities. Only 400 million live in rural areas. If many more Chinese migrate to cities, nobody will be left to farm. And those who are migrating are from the lowest socioeconomic class. Chanos says the majority of the urban developments are affordable to only 3%-5% of the population.
China will reach its tipping point when the government tries to cool the market, Chanos said. He predicts it will trigger a "great wall of foreclosures." The second tipping point is China's politics. China only looks at Western investors as a source of capital, not true partners. Chanos recommended reading a book called Mr. China on the topic. It's about a U.S. man who moves to China to start a private-equity fund. He lost almost all of his money.
Finally, Chanos pointed to China's uncanny ability to regularly hit GDP numbers... GDP drives economic activity, not vice versa. It's just like tech companies' earnings in 1999-2000 – when, through the wonders of accounting magic, all the high-flying tech stocks hit their earnings targets with scary frequency. He also said the books are cooked at almost every Chinese company his firm has researched, making it a "short seller's dream." Remember, this is one of the best forensic accountants in the world (he discovered both Enron and WorldCom), telling you Chinese accounting is crooked.
Jim Grant cut Chanos off at only one question, so I couldn't ask mine... "When are you going to cry 'uncle'?" Chanos' short-China position has been painful. It's difficult to short the biggest growth story in the world, which also happens to have the world's largest foreign reserves...
Frank Byrd, of Fielder Research & Management, gave a well-thought, clearly explained talk on why we're currently seeing inflation. Frank said before the "great inflation" of the 1970s, the economy looked deflationary – just as it does today. Unemployment was rising, and CPI was slowing. Factories had lots of unused capacity, so they couldn't raise prices. Then, capacity utilization tightened quickly and the Fed raised rates. It was too late. CPI tripled within two years.
So, how do you play inflation? Definitely don't buy bonds. And Byrd argues stocks are generally a losing proposition. Stocks dropped 40% between 1973 and 1974. The time to buy stocks was in 1975 after inflation expectations have changed. Byrd loves gold. He said, "If you're bearish in gold, you're bullish on fiat currencies." I don't know anyone in his right mind who would take that trade.
I found a video of Frank Byrd giving basically the same presentation to Columbia Business School earlier this year. It's 30 minutes, but I recommend you watch the entire thing. Understanding the inflation that will rock our economy could save your portfolio. Watch the video here.
Yesterday's plunge in precious metals triggered one of Jeff Clark's favorite sell signals. Two weeks ago, Jeff predicted the correction in metals and recommended buying puts on Newmont Mining, a giant gold miner. That trade is already up 85%. But this latest move down means it's time to add exposure. Jeff recommended another option trade that will soar if metals break down further (a near certainty according to Jeff's indicators). He believes this trade will quickly return 150%. To learn more, click here. And you can still sign up for Jeff's Short Report at a generous discount until Thursday.
New highs: Coca-Cola (KO), Chimera Investment Corp. (CIM).
Light mailbag today... Where's the outrage? The accusations? We're always happiest when the bile piles up in the inbox: feedback@stansberryresearch.com.
"I'm sorry I'm so dense, but I don't understand what is the recommended way of using the portfolio and how you assess it's yearly performance? If quarterly you build an all new portfolio (admittedly with some overlaps), does that mean a recommended strategy would be for us to adjust our portfolio quarterly? But, then, by the end of the 4th quarter the portfolio might be quite diffrent, so wouldn't be comparable to the one the year before. I simply don't get how we use the new quarterly portfolios, short of buying an entire, new portfolio each quarter and hold each for a year, which, of course, would be impractical for most people. Please get me on track." – Paid-up subscriber Sam Dysart
Goldsmith comment: We create a new S&A 16 portfolio exclusively for our Alliance members every quarter because that is the best way for us to benchmark ourselves against the S&P 500. As for how to use it, that's really up to you. As you noted, many of the positions overlap from quarter to quarter, so you could update your portfolio without much trouble. Or you could simply buy one and hold for the year. Either way, we're sure you'll be pleased with the performance. The portfolio we compiled in October 2009 is up 23% in the past 12 months, compared with the S&P 500, which is up 10% in that period. For a full explanation of the S&A 16, click here. (Note: You can only access this if you're an Alliance member).
Regards,
Sean Goldsmith
New York, New York
October 20, 2010