Monday, January 01, 2007

Missed oppotunities

Year-end is usually a time for reflection. I’m planning a more quantitative look at my portfolio this year, but as always, numbers don’t tell you the whole story. In this post, I want to take a look at some of the missed opportunities in 2006. In a way, it will serve as a road map for my investment approach in 2007.

Many themes related to commodities did well in 2006. My attention was mostly on precious metals and secondarily on oil, gas, and base metals. Some of the other themes I was aware of but didn’t capitalize on were uranium, water and food.

Uranium
I wrote about the big picture in uranium in April. I had a small position in International Uranium (IUC.to) but sold too early. Cameco (CCJ) is the 800 lb gorilla in uranium mining. In October, there was a flood at its Cigar Lake mine which accounted for 24% of the world supply. The subsequent scrambling for supply sent prices of both uranium oxide and junior uranium miners to the stratosphere. You can read more here.

Food and water
Water (clean water, to be exact) is often taken for granted but it’s actually one of the most precious resources. For example, the water supply problem in China is well documented (Google search: china water crisis). Within US, water rights in the southwest have been a thorny issue for decades. I was very aware of the investment promise of water stocks through the articles at Summit but didn’t act on it last year. My wife does own some Aqua America (WTR) in her account. The easiest way to add exposure is probably through the Powershares Water Resource ETF (PHO, + 20.7% this year). I’ll also be looking at foreign utilities like Veolia (VE) and Suez (SZE) that did very well this year.

Agricultural products are very much related to water because of the amount of latter needed to grow the former (link). When I check the quotes for Bunge (BG), Anderson (ANDE) and iShares Brazil (EZA), I again kick myself for not following up on at least some of the ideas.

China
The second big area I didn’t fully capitalize on was the Chinese market. I was very bullish on China and FXI (Xinhua/FTSE China 25 ETF) in my first long blog entry at the start of this year.

At the time, the Chinese market (measured by the Shanghai stock index $SSEC) was the worst major world market during the preceding three years, declining from a high of 2200 to a bottom must below 1000. $SSEC closed 2006 at 2675.

I exited FXI in May which meant I missed much of the parabolic spike at the end of the year. In December, I bought straddles on FXI (A straddle is a call and a put at the same strike price. It profits when the underlying stock moves above or beneath a given range. It’s a way of long volatility.), as I thought the parabolic move was unsustainable but was also aware of the tendency of stocks that have done well in the year to maintain that momentum at the end of the year (because sellers want to wait till the new year to book gains). FXI continued to appreciate and I closed out the calls just before Christmas to make the whole trade profitable. It turned out I was too early again, had I waited one week those calls would have doubled again.

There were some positive developments related to China recently.
- CalPERS approves investments in China
- The Carlyle group buying into Chongqing commercial bank If you recall from “Fahrenheit 9/11”, Carlyle group was the private equity fund with Mid-Eastern investors and big-wig advisors that included Bush 41, John Major and Jim Baker. This is quite consistent with China’s push to develop the interior.
- The most recent news that “added fuel to fire” was the new Chinese tax law that lowered tax burden for domestic companies from 33% to 25%.

However, I don’t think any of these factors fully explain the spike we have witnessed here. More likely, the rise in $SSEC as well as other Asian markets was due to the flow of hot money/global macro funds. One telling sign is the rise of the Thai Baht and Malaysian Ringgit since October.

About the Renminbi
The value of Renminbi (or Yuan) has been a big sticking point in sino-american relations. Many claim that the Yuan is 30% under-valued which may well be true. Steve Saville looked at the history of Yuan valuations and was quite dismissive of the recent “rise”. I don’t quite agree with his arguments as the exchange rate pre 1994, and in the 80’s at least, was no more than figments of official imagination. Black market rates then were much higher, whereas today’s black market rates are close to the official rate. But that’s beside the point. I’m of the opinion that China will have controlled “revaluation” of 5% per year for the next five or six years. The non-deliverable forward (NDF) contracts have predicted RMB exchange rates very well. Current 1-yr contracts point to a rate of 7.42 Yuan to the dollar.

As for the saber-rattling by Schumer and company (I’m referring to the 24.5% tariffs here), one commenter at Mish’s blog put it this way: “It’s like aiming a shot gun at my foot and saying ‘If you don't do as I say, I am going to shoot!!’” Seriously, I think the sino-american relationship is much more symbiotic than most people give it credit to. I’m not saying that America is getting the better end of the deal, but I do think the status quo will be kept longer than many think possible. For now, I’d sooner believe that China is buying US stock futures than it dumping US$.

Ok, I'll wrap up by saying that I expect uranium, food, water and China continue to be important themes going forward. The problem with missing an opportunity is that you don’t know if you should enter right away or wait for a pull-back. I think it depends a lot on your own conviction of the trend. Personally, I’m not going to chase here as I’m still wary of the froth in global markets but your take may vary. I’ll continue monitoring these sectors and probably revisit them at the end of Q1.

I do hope I have given you some investment ideas for the new year. Remember to do your own research, good luck and be safe!