The most precious commodity (and no, it's not gold!)

The markets for the past two months have been seemingly suffering from a classic case of rabbit caught in headlight syndrome. The faster responding funds immediately sold, however, the majority of the funds could probably only look on helplessly as share prices continued to drop on low volume (MSCI Far East Free was down another 0.8% MoM in June). Some of the markets were seeing volumes last seen during the crisis, for e.g. the Thai market traded with less volume than Christmas day. Yet selling continued as funds sold to prepare for the wave of redemptions (that so far has not yet materialized, but then most funds, especially hedge funds, need a certain amount of notice before investors can redeem). Although the markets seem to have taken the latest statement from the Fed after announcing another 25bp rate hike well, response may be exaggerated by some window dressing activity.

After the recent rapid declines in the markets, everyone wants to believe that the worse is over and that the Fed will probably stop raising rates, giving the US economy (and US housebuyers) a welcome relief. When I read Mr. Bernanke’s statement, it didn’t looked that dovish to me, or maybe I’m just not reading the fine nuances in it as I don’t normally scrutinize the Fed statement every rate hike. In meantime, exports to US continues to flood in as companies hope the US consumer will be able to recover and for stockmarkets to go back on their way. That’s wishful thinking in my view, and frankly, there is no room for wishful thinking in investments. Hope that the stock you bought, which is now down 30%, will recover is what will lose you another 50%. There is no escaping the fact that the US consumer is leveraged up to the hilt and given where house prices in the US are and look to be going, there is no escaping a potentially painful adjustment period, one that has only just begun. With this in mind, we have to be wary of the impact of the stocks in Asia, especially those that are especially reliant on exports to the US.

Given our focus on achieving absolute returns rather than relative returns, these kinds of markets are not easy. But I much prefer this headache to one I would have if we could not find any stocks for the fund to invest in. From my past experience, these are the kind of markets we can generate handsome returns when invested over longer term. The heightened perceived risk from investors actually provides an improved risk return reward, in my view. But how do we ensure that the stocks we invest in at these levels, which we feel over the longer term will generate superior returns for us, but in the short term won’t actually lose money for us? The answer is simple, we can’t. The shorter term we go, the more unpredictable it becomes. This is part of the reason for the fund’s longer than average redemption period (90 days notice), and also a way to ensure that investors in the fund have a similar mindset to us. The way I see it, the more we don’t have to follow what everyone is doing, the more opportunities for higher returns.

Some people call it luck, some call it strategic positioning, but our strategy is so far proving sound as the portfolio continues to perform well despite the difficult markets, partly because the stocks we are holding have very cheap valuations, relatively low institutional investor holding and have high cash value (as percentage of market capitalization) and partly because of continuing stream of positive newsflow for some of our bigger holdings. In these markets, we ended up trading a little more than we would have liked, reducing some weighting in stocks that had gone up substantially and in the more volatile stocks. Given the size of our fund, we can be a lot more nimble than the larger funds, allowing us to produce returns that would be more difficult if we were a lot larger.

Though we are pretty much a bottom up fund, we still cannot escape some macro and thematic analysis. Our final decision is bottom up but long term macro trends will still inevitably have some influence. It never hurts to always have the big picture in mind. One of the more consensus views, is that the US$ will continue to weaken. The inevitable slowdown of the US economy, the unsustainably high trade deficit and finally the reduction of importance as the primary trading currency in the world will all contribute to ongoing weakness of the US$. However, trade cannot function without a common currency (people just don’t barter anymore) and the Euro, I believe, it will go someway to replace the US$ as the major trading currency. Implications are significant, especially as the view that the US$ will continue to weaken gains more traction. One thing that all central banks hold a lot of is US$ assets and if they feel that the value of this asset would continue to depreciate, at some point they are going to think of diversifying their assets into more Euros (or even gold) instead.

In fact, as the US$ dollar continues to weaken, it may signal the end of the great US consumer driven global growth phase, and instead see the rise of the Euro spender. Last month, I noted how over 40% of the revenues for the companies in our portfolio comes from Eurozone. Given Euro was up 4.7% from end March, results for these companies should be quite good for 2Q06, purely from forex basis, but in addition, as some of the exporters to Europe has already found, given the stronger currency, orders from Europe have been much stronger than expected.
In meantime, I’m starting to see a lot more value popping up across the region, with stocks that two months ago looked unattractive but at current prices looks quite inviting. We are running through our filters again at current prices and preparing to do another round of visits across the region to try and dig out some more ‘undiscovered’ stocks, to boldly go where no investor will. With that, I will leave you this thought for this month…

The most precious commodity (and no, it’s not gold)
One of the oldest stockmarket newsletter writers of all time, Richard Russell (www.dowtheoryletters.com – a website I highly recommend for all investors alike) puts it very well in one of his popular articles on investing. Anyone can make money, it’s just a matter of time. So for e.g. if we invested in a risk free investment which yields 5.5%, over a period of 13 years, we would double our money, and assuming all the returns were reinvested, an investor would continue to double their money every 13 years, eventually ending up with so much money, they would have to donate most of it to charity. As such, when we launched our fund to try and beat the risk free rate returns by more than 2-3 times, we are in fact trying to shorten the time we take to ‘double our money’ by 2-3 times, i.e over 4-7 years instead of 13 years. This is also the basic tenet of value investing. We have no idea when a stock would reach its fair value, however, as time progresses, we can expect this discount to narrow. In the short term, the discount could widen even more, but we are more confident over a 3-5 year period, it should be less, not more, especially if the business continues to grow steadily and management delivers a consistent return. When an investor speculates and hopes for a quick profit, he is trying to save some time. When I look at the markets now, I see valuations for some stocks that are approaching or are even lower than July 2005 and late December 2004, despite little changed outlook for the companies concerned. As such, I see an opportunity to ‘buy effectively 1-2 years of time’ if I were to buy at current prices. So who said you can’t buy time. Time, is the most precious commodity we can buy.

Bloodbath, Gold still undervalued

Little did I know how prophetic my last paragraph in my previous memoir was, as right after I sent it out, Asian markets began its rapid spiral downwards, with the MSCI AC Far East ex Japan index falling 10.1% from that date, or down 7.2% MoM. The index is still up 6.9% since the beginning of the year, but mood in general remains generally grim, as such, momentum may not come back until 2H06. In meantime, after a strong debut last month (+4.8% since inception), the fund gave back some of its gains in May and ended with an estimated NAV of 103.1, down 1.6% MoM but still up 3.1% from date of inception (24 March 2006).

Average valuations for the portfolio dropped slightly as we revised up some of our earnings post 1Q06 results announcements, with portfolio weighted average PER of 7.7x and 6.6x for FY06 and FY07, respectively against EPS growth of 21.5% and 20.1% for the same respective periods. PBV fell slightly also to 1.3x PBV vs ROE of 20.3% for FY06. The companies in the portfolio had a weighted net cash position of 2.4% of the market capitalization with expected dividend yield of 4.6%.

The sharpness of the drop in the markets has caused us to review our position a little more closely and we will continue to maintain a cautious stance into the next 2-3 months. With new subscriptions, we expect our cash position to stand at 24% in beginning of June, which I believe would put us in a good position to accumulate any stocks that are oversold. We are likely to step up our marketing efforts to look for new funds the next couple of months as we believe the recent pullback has already put some stocks back to attractive levels.

I noticed something interesting in the makeup of our portfolio which I thought would be worth highlighting to my investors. Looking at our country allocations, it seems to be split quite evenly with 41% in South East Asia and another 45% invested in North Asia markets; however, if we delve a little deeper, the ultimate exposure (i.e. main revenue sources for the companies in our portfolio) portrays a very different picture.

Forty two percent of the weighted average revenue for the stocks in our portfolio comes from Europe, and of that, a substantial portion actually comes from Germany (courtesy of our top two holdings, Pelikan International (PELI MK) and Eganagoldpfeil (48 HK), both of which have substantial business interest in Germany (as well as brand presence I might add). I will confess that this is pure coincidence and I had not set out with the intention of looking for German exposure for the fund in the first place, it just happened that way.
Having said all that, it’s not too bad to be having some German exposure at this stage. The economy looks to be recovering with unemployment continuing to drop…

…with opportunities for growth in East Germany starting to look more promising. Of course, do not forget that the Football World Cup will also be kicking off in Germany this June and should help support the seasonally weak retail period (which should bode well for retail sales for both our stocks!). Consumers across the Euro zone are also becoming more confident about their employment prospects, according to a European Commission survey released recently. The commission's surveys have shown rising consumer confidence since last July. Still, we did not highlight this aspect of our portfolio to show promising growth prospects in Europe but the fact that our exposure may not be what it would seem. Maybe I should rename the fund NTAsian-German Discovery Fund…

On a slightly lighter note, last month, quite a few people had asked me what I thought of gold, as such, I had suggested an alternative investment in the form of the SET index (given close parity to Gold at that stage). Since then, as it happens, Thailand have just launched SET futures market, so you can actually now buy SET index. The good news: If you had actually bought the SET index vs gold, you would have outperformed gold over the past month. The bad news: you would be down 7.1% MoM if you had bought the SET index. However, longer term, I would not bet against gold. The chart below shows how much relative value for gold has fallen against its cousin, “black gold”.


To put it into perspective, in 1988, at the previous peak for gold prices, one ounce of gold would have bought you 30.4 barrels of oil. Now an ounce of gold will only buy you a pitiful 8.9 barrels of oil, despite the recent run up in gold price. If you’re not willing to bet that high oil price is a temporary phenomenon, and at this stage I don’t think most people are, you better buy more gold.

Seeing as we’re on everyone’s favourite subject, I have to confess that I did manage to find what is probably the most undervalued gold play in Asia (do not fault me for not trying!). This company has 1.7 tons of gold held as fixed assets on its balance sheet at historical prices. Under HK accounting laws, a company cannot mark fixed assets to market, meaning that the 1.7 tons of gold it holds is valued at an average historical cost of US$300/ounce. Given that this company is currently trading at 0.63x PBV, this implies that the market is valuing the gold on its balance sheet at closer to US$189/ounce (vs current market price of US$630!). The only problem is, to unlock this gold value, you would have to buy a toilet (amongst other things) and melt it down, as almost a third of its gold assets is in form of the most expensive toilet in the world (verified by Guinness Book of World records), US$10m to be exact, at current market prices. Puts a new meaning to the saying “if you dig long enough in c*#p, you might just find gold”.

Despite this seemingly bargain of a lifetime, I could not bring myself to buy a gold toilet as a proxy to gold price and instead settled on accumulating more shares in Hourglass (HG SP), one of my favourite retail stocks in the Singapore market. The current price is so low in terms of valuation, that it is effectively valuing its inventory, comprising of high end watches at Hourglass’s cost, at a discount whilst valuing its regional branch network, brand name and other assets at zero. It recently reported its March FY06 earnings, which registered a net profit growth of 43% YoY, valuing it on 7x FY05 earnings. Longer term, I believe the growth potential for high end watch sales remains very good for Singapore, especially when the casinos open. Until then, Singapore is still one of the most attractive places in Asia to buy high end watches (watches is the top category in terms of retail product sales value for Singapore), especially with the recent introduction of taxes on luxury watches in China.

Happy sleepless nights for the month of June (hopefully not from the stockmarket!). It’s a time to make friends!