17^th October 2023

 

Dear Investor,

 

Over the next few mid-month commentaries, we will have a look at various of our themes to make sure the rationales are still intact.

We will start with China which has been the biggest disappointment for us in terms of performance. As we have discussed previously, in our opinion the reasons for the poor performance are, in no particular order:

• A weak recovery after reopening from Covid lockdowns. (Unexpected to many investors, but not unexpected to us as they didn’t follow the Western playbook of giving money directly to the public or as much support for companies).
• The well-publicised issues in the property sector which has led many investors to claim that China is on the verge of imploding. (This was a controlled demolition with the Chinese leadership trying to cut the economy’s reliance on the sector and the accompanying debt. In fact they pulled back on some of the restrictions but by then COVID was in full force and so not much impact).
• A lack of confidence by the Chinese consumer due to the above two points and the seemingly arbitrary nature of openings and closings during Covid. (This will take time to come back).
• Geopolitical concerns with the Russia/Ukraine war bringing to the surface the tensions between nations with different ideological views.
• A concerted effort by the Western media and financial establishment to deter investment in China and paint the situation in the worst possible light including an economic implosion, a potential invasion of Taiwan etc.
• The ongoing strength of the dollar which has impacted the Renminbi and, as importantly the Japanese Yen.
• The economic strength of two Asian markets which are more geopolitically aligned with the West, namely Japan and India, which draws the marginal investment dollar to them at the expense of China.

Reading all that and one couldn’t be blamed for not wanting to invest in China, but at some point the pendulum swings too far the other way. Looking at the 20 year chart of the Hang Seng Index below, we could make the assumption that a lot of the above is priced in. You have a very interesting set up where sentiment is extremely pessimistic, the valuations are very supportive (though of course it could get cheaper) and a lot of capital has already fled the market. Any change in the above list or even less bad economic data could trigger a sharp rally.

In terms of demonstrating the above, we think it is very clear that sentiment is extremely poor on China. It is very hard to find a news story that is not extremely negative.

 

As an example, let’s look at the story below:

 

BlackRock Says Investors Reassess China Allocation Amid Slowdown

Investors must reassess their allocations to China amid rising geopolitical tensions with the US and a slowing economy, according to BlackRock Inc. Vice Chairman Philipp Hildebrand.

China’s growth could slow to just 3% by the end of the decade partly to demographic changes, he said in an interview with Bloomberg Television on Thursday. Its shifting relationship with the US is also forcing investors to price in additional risks that could lower allocations.

“What might have been an obvious kind of play to say ‘we need to increase allocation to China’ now has a different calculus driving it,” he said. “We have to reassess how to allocate in China.”

“China is slowing down both cyclically and structurally,” Hildebrand said. “You have this sort of short-term fragmentation problem to reckon with, and on top of it you have a very significant demographic challenge that invariably leads to much lower growth in China over the next years to come.”

 

Now, this man is the ex-head of the Swiss Central bank and now Vice Chairman of Blackrock so he has a lot of credibility in the investment world. Blackrock is one of four firms which control large portions of many stock markets around the world through their dominance of the ETF industry,  which allow investors to own sectors/themes etc. The enormous expansion of ETF investing over the past 20 years, unfortunately separates ownership from control as those investors owning ETFs won’t vote and so Blackrock is able to vote as it sees fit. This is the company that has been promoting the whole ESG investing style over the last 10-15 years. As an aside, as we wrote in commentary #3, we fully support a pollution free world but the unintended consequence of the ESG investing craze is going to be a lot higher prices of fossil fuels and the people impacted the most will, as usual, be the poorest sections of society, not the people making these policies.

 

So, investing in China is bad so Blackrock, in exactly the same way it forced a disinvestment of fossil fuels, will vote against investment in China or for divesting assets from China and its influence is widespread. For us, we believe it is a concerted strategy by the West to defund China and that will likely continue until it impacts Western voters to a breaking point (or until a new war breaks out to distract attention from the issues).

Below is a selction of headlines from Bloomberg ALL on the same day last week.

Mega-Cap China Tech Bears Brunt of Deepening Foreigner Exodus

• US, EU funds sell net $1.6 billion of China shares this month
• Tencent, Alibaba among names sold most, Morgan Stanley says

Morgan Stanley Warns Against Buying the Dip in Chinese Stocks

• Foreign funds withdrawal from shares at ‘unprecedented’ stage
• Redemptions could pick up towards year-end amid higher rates

China’s Property Woes Pour Cold Water Over Steps to Boost Stocks

• CSI 300 Index slides 4.2% this week, the most in almost a year
• Benchmark of onshore stocks erases all of its reopening rally

One thing I do agree with on the above is the possibility of more redemptions out of any remaining China funds by year-end, but as stated above, sentiment is very washed out and valuations very supportive. 

So what else will happen. It appears that Beijing is now extremely focused on the stock market as evidenced by certain announcements over the last few months.

 

How China is trying to boost its stock market

Sept 4 (Reuters) – China is launching a campaign to revive its lagging stock market, and boost investor confidence in an ailing economy.

A slew of measures announced include reducing trading costs, slowing the pace of initial public offerings (IPOs), encouraging margin financing and protecting small investors.

The securities regulator also introduced fresh measures on Friday to improve the two-year old Beijing Stock Exchange, focusing on boosting the market’s liquidity.

China Securities Regulatory Commission (CSRC) aims to boost liquidity in the market by relaxing investor thresholds and improving trading mechanisms. The team of market-makers will be expanded, and all shares listed in the market will be eligible for margin financing, the CSRC said.

The CSRC said it will guide more mutual funds to expand their investments in the market.

The stamp duty on stock trading was halved on Aug 28, the finance ministry announced. Transaction handling fees submitted by brokers to the exchanges had also been reduced, according to the CSRC.

Chinese stock exchanges will also lower margin requirements to encourage financing by investors. The measure will be effective on September 8th.

And, following CSRC guidance, a growing number of mutual fund companies are cutting management fees.

China’s securities regulator approved the launch of 37 retail funds, signalling faster registration for index funds and boosting the development of equity funds. Market participants expect the emergence of more innovative index products.

The regulator is working on optimizing rules covering share repurchases, including relaxing requirements when share prices tumble. Company share repurchases are considered a good sign by investors, as it implies the stock is undervalued.

 

 

SCMP 12th October 2023

China’s US$1.35 trillion sovereign fund boosts stake in Big Four banks, fuelling speculation on stock market intervention

• Central Huijin Investment spent the equivalent of about US$65.4 million to pick up additional A shares in China’s four biggest lenders
• The symbolic move is fuelling speculation Beijing is intervening to shore up confidence in the market after a record sell-off by foreign funds
• China’s US$1.35 trillion sovereign wealth fund is increasing its equity stakesin the nation’s four biggest banks, stoking speculation authorities are trying to shore up confidence in the market after an exodus of foreign funds and a slump in the local currency.

China ramps up liquidity support to banking system

SHANGHAI, Oct 16 (Reuters) – China’s central bank ramped up liquidity support to the banking system as it rolled over medium-term policy loans on Monday, but kept the interest rate unchanged amid concerns about the risk of more sharp yuan declines.

The People’s Bank of China (PBOC) is walking a tightrope between keeping liquidity ample to aid a struggling economy and stabilising the yuan amid expectations of “higher for longer” U.S. rates.

With 500 billion yuan worth of MLF loans maturing, the PBOC is pumping 289 billion yuan of fresh liquidity into the banking system, the biggest such net injection in nearly three years.

 

There are more things that the Central government can do such as reducing mortgage rates and there already have been moves to reduce mortgage restrictions for individuals in the major cities.

Does this mean we will increase the allocation to HK/China now? No, but we will be paying close attention to this market as the potential upside is very high while the price has discounted a lot of the risk already.

 

This last announcement is also telling as they “put their money where their mouth is”. The last two times for major buybacks was in 2015/16 after the “shock Yuan devaluation” and 2018/19 after the global sell off prompted by Fed tightening (or actually just talking about tightening). Both times, generated decent short-term returns.

 

BEIJING, October 17 (TiPost)— A host of Chinese companies announced their plans or moves to repurchase shares the same day, joining in a buyback spree fuelled by the policy stimulus.

A total of ten state-owned listed companies, including Sinopec, Baosteel Co., Ltd., COSCO Shipping Holdings Co., Ltd., China Mobile, China Railway Construction Corporation, China Coal Energy, China Three Gorges Corporation, Power Construction Corporation of China, Hikvision and China Resources Microelectronics Limited, released statements on Monday, promising billions of dollars’ input for shares repurchase.

As of Monday, there are 18 state-owned enterprises that disclosed buyback or raise stakes. More than 40 listed companies released disclosures about acquiring more shares by shareholders, management or dealships since September, and over 60 companies unveiled their share repurchase programs in the same period, the state-backed financial and securities newspaper the Securities Times estimated. Prior to Monday’s statements, more than a hundred Chinese companies engaged in buybacks or withdrawal of share sales in August after the government introduced new rules to shore up the stock market.

 

Next, we will turn to the energy sector.

Our reasons for being positive on the sector were laid out in Commentary #3 and #19. From the latter:

 

“To recap, we are positive on the oil price and the energy sector for three main reasons. You can read a more detailed discussion in commentary #3.

• The lack of investment in supply due to ESG constraints over the last 10 years and the incineration of a lot of capital due to the last boom bust cycle in oil, means very few investors are willing to fund new exploration and any cash flow is used to pay dividends or buy back shares.
• The increase in demand coming from developing countries such as India, China, Indonesia, Latin America all of whom want the “Western lifestyle” of a fridge, air-conditioning, a car etc.
• The fiction that renewable energy is going to provide a replacement for fossil fuels, in a time span short enough to address points 1 and 2.

 

The icing on the cake for being positive on energy is unfortunately the new world order and the continued bifurcation of the world with the US/UK/EU in an economic cold war against a significant portion of the world (Russia, China, Saudi Arabia etc) leading to frictions between nation states and a focus on energy security.”

 

Now we believe the above is not only true but continuing despite increases in the prices of fossil fuels and the impact on the main in the street. Let’s look at some news stories to see what is actually happening:

 

 

Sydney Morning Herald 17^th July 2023

‘What went wrong here?’: Big banks refuse coal king $1b debt refinance

Australia’s big banks have turned their backs on the country’s largest pure-play coal miner, refusing to refinance a billion-dollar debt in a major rebuff that will force Whitehaven Coal to source loans offshore, sending a worrying signal to other large coal producers and potentially speeding up the demise of the sector.

Whitehaven revealed its funding problems in a quarterly update on Monday, saying it has managed to source credit for mine rehabilitation, clean-up costs, port, rail and other activities, but could not to get a $1 billion finance facility renewed.

The company’s chief financial officer, Kevin Ball, said the banks initially provided the $1 billion loan facility for the company’s newest and largest Maules Creek coal mine in NSW’s Gunnedah Basin, an open-cut project that started operating in 2015 and has enough reserves for 40 years of production.

“Anybody who’s in thermal coal is going to be facing similar challenges in mobilising funding from traditional sources,” Ball said. “It is increasingly difficult being a coal producer to attract external funding,” he said, adding that the miner was instead focus on sourcing loans from the US debt capital markets next year.

 

So what does this imply? Well for a start, it means there won’t be many new entrants to the industry so competition for the existing players will decrease. Without new sources of funding, potentially mines won’t get built and less coal will be produced. While the example given is Australian coal, the story is very similar in the rest of the Western world and with all other fossil fuels.

This is great news, say the uninformed crowd as, we will use less polluting coal and instead get all our energy from renewables. Now we like this picture as much as the next sane person but the reality is that that is not the reality:

 

June 22, 2023 Bloomberg

India Plans to Keep Adding Coal Power Capacity as Demand Surges

India will continue to build more coal-fired power capacity to feed its booming energy demand even as it expands renewable generation.

The nation, one of the world’s top carbon emitters, has about 27 gigawatts of coal-based power plants under construction and another 24 gigawatts capacity is in pre-construction stages, according to Power Minister Raj Kumar Singh.

“We will generate more capacity if required,” Singh told reporters in New Delhi.

 

This next story is just laughable. They may well be increasing coal at the expense of oil to generate electricity for all the new electric vehicles, but this cuts straight to the fiction of things like electric cars. Where will the electricity come from? All you do is move the pollution from one part of the chain to another. And coal is a lot more polluting than oil products.

 

China’s huge coal plant building has weird climate logic

LAUNCESTON, Australia, Sept 19 (Reuters) – China is building two-thirds of the coal-fired electricity generation capacity currently under construction globally, and this may not be as disastrous for the climate as it sounds.

The world’s largest producer and importer of coal has 136.24 gigawatts (GW) of coal-fired generation under construction, according to data released in July by the Global Energy Monitor.

This represents 66.7% of the global total of 204.15 GW, and China is streets ahead of second-placed India, with 31.6 GW being built and third-placed Indonesia with 14.5 GW.

These three countries represent 89% of the coal-fired plants currently under construction, and it’s not a coincidence that all of them have large populations, growing energy demand and vast domestic coal reserves.

The large coal-fired construction programme can be seen in the wider context of China’s rapid shift to electric vehicles and away from internal combustion engine (ICE) cars and trucks.

 

The bold highlighted paragraph above shows exactly what is going on. Fossil fuels are so energy dense that they are responsible for increasing many, many people’s standard of living. We have had that in the West and we are now trying to deny it to the 4 or 5 Billion people in the world who are aspiring to this also. Now we actually believe nuclear is the best way forward for the world and hopefully we will get there as the price of fossil fuels rise and renewable energy is not stable or sufficient enough to power the West.

And in case you think it is only our Eastern friends, let’s look at the heroes in Germany who switched off all their nuclear power plants and relied on Russian gas (We believe the population was actually sold out by their leaders as many politicians are (or at least were) on the books of Gazprom , the Russian gas giant- not least Gerhard Schroder- ex Chancellor of Germany).

 

Germany approves bringing coal-fired power plants back online this winter

BERLIN, Oct 4 (Reuters) – Germany’s cabinet on Wednesday approved putting on-reserve lignite-fired power plants back online from October until the end of March 2024, the economy ministry said, as a step to replace scarce natural gas this winter and avoid shortages.

In the wake of Russia’s invasion of Ukraine and a sudden drop in Russian gas imports to Germany, Berlin reactivated coal-fired power plants and extended their lifespans, with a total output of 1.9 gigawatt hours generated last winter.

 

So we have a continued squeeze on the funding for fossil fuels as well as increased demand. Now what about geopolitics?

Well I wish I could say it was getting better but tensions remain high. Anyone following the recent news will have seen the recent horrible headlines in the Middle East. I won’t repeat the details as they are all over the media, but I will say that it seems very strange that the most surveilled border in the world could have been crossed by so many Hamas fighters with such a slow response from the Israelis. The IDF, Mossad etc are held up as the most professional of armies, secret services so it is strange.

Secondly the atrocities committed by Hamas seem destined to attract a disproportionate response from Israel and maybe that is the point? The response by Israel would inflict real damage onto Palestinian citizens who are not all Hamas supporters, drawing condemnation from the “Arab world” and potentially drawing more players into the war.

We don’t know and very few people do know, but we do know that the people to suffer will be the civilian casualties on both sides of the war, while the warmongers on both sides call for the elimination of the Palestinian people/Iran or the state of Israel.

Politico 16^th October

Graham to Iran: ‘If you escalate the war, we’re coming for you’

“If Hezbollah, which is a proxy of Iran, launches a massive attack on Israel, I would consider that a threat to the State of Israel,” Sen. Lindsey Graham said.

Sen. Lindsey Graham (R-S.C.) threatened Iran on Sunday, calling the Lebanese militant group Hezbollah “a proxy of Iran” and warning that Iran would face consequences should Hezbollah escalate the tense situation along Israel’s northern border.

“I will introduce a resolution in the United States Senate to allow military action by the United States in conjunction with Israel to knock Iran out of the oil business,” he said. “Iran, if you escalate this war, we’re coming for you.”

 

Way to reduce tensions….

The attack also happened shortly after this was announced

 

Exclusive: US-Saudi defence pact tied to Israel deal, Palestinian demands put aside

 

Sept 29 (Reuters) – Saudi Arabia is determined to secure a military pact requiring the United States to defend the kingdom in return for opening ties with Israel and will not hold up a deal even if Israel does not offer major concessions to Palestinians in their bid for statehood, three regional sources familiar with the talks said.

A pact might fall short of the cast-iron, NATO-style defence guarantees the kingdom initially sought when the issue was first discussed between Crown Prince Mohammed bin Salman and Joe Biden during the U.S. president’s visit to Saudi Arabia in July 2022.

 

Now there are a lot of people who would like such a deal to fail, not least China, Russia, Iran etc, all who have in the last 2 years buddied up together with China playing the peacemaker. So, was this event a plan to disrupt this pact? Again who really knows but what is clear is that oil security as we have been saying is going to be paramount over the foreseeable future so we continue to like oil, energy and ancillary industries. We believe the body of evidence suggests that oil will be going much higher in the short to medium term.

Now in the short term there has been a lot of volatility in both oil and gold with big moves in both direction, so it has been hard to increase the allocation as we would have liked on any weakness. War premiums for gold at least rarely last. We can look at the short term action for both over the last month.

WTI Crude went from $94 to $82 and then after the incursion by Hamas over the weekend, jumped back up to $88.

 

Gold similarly dropped from $1940 to $1820 before bouncing back up to $1945.

All the while, US bonds continue to sell off, despite their reputation as a safe haven in times of chaos. With the massive fiscal deficit as we discussed in commentary #18, the world doesn’t want to hear things like the below:

 

Sky News 18^th October 2023

Janet Yellen: America can ‘certainly’ afford to support Israel and Ukraine, US Treasury secretary says

Janet Yellen has told Sky News the United States can “certainly” afford to support wars on two fronts, as the conflict between Israel and Hamas threatens stability in the Middle East and the US continues to back Ukraine’s fight against Russia.

Talking exclusively to Wilfred Frost ahead of a meeting of finance ministers in Luxembourg, the US Treasury secretary said the economy and public finances were in good shape to ensure backing for US interests abroad.

 

The bond market disagrees with her, with 10-year notes hitting a record 4.96% (at least a record since 2007)

If the War on Drugs and the War on Terror wasn’t enough (both highly successful-if you are in the drugs or terror business)…there’s always room for another war….

 

We are hoping saner heads will prevail and the tensions will subside. This will be good for the world but selfishly will allow us to buy more oil and gold on the subsequent price drops.

 

Until next time,