April Gold Fever

One of the biggest moves in April was by gold, which was up 11.4% in April, or 31% YTD. Although I confess to being a bit of a closet goldphile, we don’t have any gold exposure in the fund as yet. For those who think the gold price rise seems overdone in the past few weeks, take a look at the chart below of gold price vs Dow Jones Index. At the peak of gold fever, 1 ounce of gold was the equivalent of 1.3pts on the Dow, however at current prices; 1 ounce of gold is the equivalent of 17pts on the Dow. That’s a long way to go to previous peak, either that or Dow has to retrace by around 85%...Putting it simply, the downside definitely looks worse for Dow than gold!

On the other side, the best parity to gold is so far, interestingly, the Thai SET index, which is almost at parity to gold price. I.e. 1 ounce of gold will buy 0.9pts on SET index. Which will outperform, SET or gold? I’m still thinking about this one…but if gold hits $1,000/oz will the SET be at < or > 900 pts. Tough one that, but looking at the trend in chart below, it seems to be heading for parity of 1.0, i.e. if you want to outperform gold, you better buy SET…hey! I’ve just solved my conundrum over lack of gold exposure, buy Thai instead!

As central banks scramble to diversify their US$ exposure (and in particular, if we look at Asian central banks’ reserve backing, very little tends to be in gold), we can continue to expect further US$ weakness against Asian currencies. As such, one way to avoid ‘going down with the dollar’, is to remain highly invested in order to get as much of the benefit of potential for Asian currencies to rise further. If we look at North Asian currencies (Korean Won and Taiwan Dollar), these currencies are still around 25-35% above pre-crisis levels vs US$ whilst South East Asian currencies are northwards of 50% higher than pre-crisis levels.

April remained a hectic month for us, with over 54 meetings in three countries. Interestingly, we found gems where we weren’t expecting and duds where we were expecting to find gems. My trip to Taiwan was a little disappointing, especially given the attractive valuations there relative to the region and historically. It was not helped by aggressive run up in quite a few of the stocks we had arranged to visit thanks to President Chen Shui-bian’s comments on the potential for country to open to Chinese tourists for the first time. Still, we will continue to monitor to look for opportunities there.

The most interesting comparison for me this past month was between Korea and Taiwan. Both countries are potentially on the verge of war (South and North Korea are theoretically still at war) and both are extremely reliant on tech focused investments, i.e. exports. Ironically, despite an inextricably linked economy between Taiwan and China, the population there seems to be much more polarized to a reunification move then the Koreans. However, with the younger generation being much more supportive of a reunification, this issue seems resolvable. It’s just a matter of time.

One of the more confounding facts to me is that with the general obsession of Asians over brand names, valuations for companies with strong brands continue to trade at large discounts to peers listed in more developed countries. Instead, investors in Asia tend value companies growing sales at 30% but with a 10% margin higher than a company whose sales is growing at 10% but with a 30% margin. With today’s volatility in cost of production (due to volatile material and energy costs), a 5% increase in cost of production could reduce margins by half for the first company whilst it would have only a 16% reduction in margins for the latter company.

However, I do not believe this will continue to hold long term. With a younger generation who do not have memories of the bad old times, the habit to save for a rainy day is not as well ingrained. With generally easier access to credit, consumers are increasingly focusing more on buying ‘branded goods’, one of the reasons the ‘affordable’ luxury segment is one of the fastest growing segments in the fashion world. These are also some of the reasons why more than half of the stocks in the portfolio have strong brands, either globally or in their respective markets. Currently, our two largest positions manage or own global brand names, and are trading at 50-100% discounts to global peers, whether on PER or DCF basis. As awareness on the resilience of brands continue to increase, valuation discounts between these companies listed in Asia against peers in more developed countries should start to narrow.

As we start moving into May, after strong recent run ups in markets, we are taking a more cautious stance. The generally slower summer months for the stockmarkets are in our view perfect opportunities to pick up some stocks which have run up strongly recently, but that may see a pullback over the next few months as short term excitement gives away to longer term reality.

Kicking off the fund

It has been a busy month for us indeed since the successful launch of our fund on the 28th March. Since January, we have visited 112 companies shortlisted in our value filter listed in Thailand, Indonesia, India, Singapore, Hong Kong/China, Korea and Malaysia. We hope to hit our one hundred and fiftieth visit by the end of April with continuing visits in both Thailand, Taiwan and Philippines.

We have seen a lot of undervalued companies, most of whom are cheap for a particular reason, either due to corporate governance issues, conflicts of interest, unethical business practices or poor structure of the industry they operate in. However, for every five to six companies we have seen, we have found one which has either made it into our portfolio and if not, then onto our watch list. Suffice to say, I have been very pleased with the overall results from our initial screen and could not hope for a better start.

For our initial investments, our focus has been mainly on investments on companies with strong brand names with global or commanding domestic market presence and whose share price is currently trading at deep discount to the intrinsic value of the company or the value of the brand. Our largest position is currently invested in a global brand portfolio management company with a stable of 33 own brands and 11 long term exclusive licenses in the affordable luxury segment, the fastest growing area in the fashion business currently. With share price trading at less than half of the intrinsic value of the brands as valued by external valuers and a steep discount to global peers, this investment epitomizes our investment philosophy.

For our initial round of visits, we have tried to focus on a bottom up basis on companies in countries without any prejudices, relying purely on our selection method to identify potential investments for us. So far, I have been extremely pleased with the outcome of the screens and have been pleasantly surprised, such as in Malaysia, where we have initiated a position in a company with a world class brand name in the stationary business at a price which values its brand at practically zero. Even more extreme, in Singapore, we have also accumulated a position in a retailer of high end luxury watches, which at current price, values the company only on its inventory, and at a 20% discount at that. Think of that as the equivalent of walking into a very well known retail shop, buying a watch at a 20% discount to their cost and getting the shop and the brand name thrown in with your purchase! That’s what I call value!

In Korea, we were particularly impressed by the number of small cap names with commanding positions either domestically or globally. However, the difficulty in valuing these companies (accounts were generally not consolidated and the tendency for Korean corporate to invest in non-core businesses) did make it difficult to compare against other businesses in the region. Corporate governance issues remains a problem with dividend payout ratio barely exceeding 20% in almost all the corporates we saw, regardless of whether they had 20% of their market capitalization in cash or were heavily indebted. Nevertheless, the absolute attractiveness of investments in Korea means that our exposure in Korea remains one of our largest in the region. We initiated positions in three companies in Korea, i) a leading furniture manufacturer with a strong brand name with a leading position in office, kitchen and living room furniture in the domestic market; ii) a global leader in Digital Video Recorders for Security Devices (a rapidly growing market given the World we live in today) and the last in a niche supplier of cleanroom supplies for both domestic and overseas market. With certain supplies commanding over 90% market share domestically, especially for the TFT-LCD market, this company is well positioned to take advantage of the increasing shift to LCD TVs.

In HK/China, with the ever mouth watering “China retail play” hanging in the background, valuations are stretched for most players exhibiting any form of success in their Chinese retail strategy. On the other hand, as focus fixes on Chinese retail plays, the textile sector, in my view remains one of the most undervalued sectors currently. Having met the top five players in China and some of the top players in India, we are comfortable with the long term prospects for this sector in both countries. However, given the significant discount of the Chinese players (post quota re-imposition), we have leant more towards the Chinese players, all of whom are still significantly ahead of the Indian producers in technology, know how and cost competitiveness. We have initiated a couple of positions in both a higher end home textile producer in China with excellent growth prospects to replace fabric currently produced by uncompetitive US/Europe domestic manufacturers and one of the top five Chinese knitted fabric producers.

Finally in Thailand, we have taken positions in one of the leading IT retailers in the country as well as a leading F&B company in Thailand. With one of the lowest penetration levels in Asia for personal computers (PC), PC and related equipment sales are expected to remain strong (+17% same store sales growth last year). The beverage market in Thailand remains buoyant, in light of continuing shift of consumers away from carbonated soft drinks to healthier alternatives. With a commanding position in the premium juice market and with good export potential, growth should remain high for this market leader.