Friday, May 8, 2009
Despite general fear, some companies in the developing countries are optimistic with the business outlook and entered the market when others stayed on the sideline. In particular, China has taken the lead in spreading its optimism in the stock market with the rest of the world. Its aluminum-product maker, China Zhongwang Holding Ltd., is the world’s biggest IPO ($1.26 billion) this year so far. It is followed by U.S. pediatric nutrition company, Mead Johnson Nutrition with $828 million.
Zhongwang entered the market at this time because it wants to take advantage of the Chinese government’s 4 trillion yuan stimulus program, which will spend a large portion on infrastructure construction. These railroad and transport-related projects will certainly increase the demand of Zhongwang’s aluminum products.
Hopefully, with Zhongwang’s big IPO issuance, other companies will feel more confident in the financial market outlook and resume their IPO issuances again in the rest of 2009.
According to the report, because more companies filed for bankruptcy in this quarter, Berkshire took a loss from its credit-default swap (CDS) portfolio. CDS is a form of insurance against the default of a loan.
In addition, the loss also contributed from its $3 billion preferred stock on Dow Chemical Co. What made it a bad investment because Dow Chemical lost the funding for an acquisition from Kuwait’s government; this immediately put Dow into a financial distress and further credit crunch. Since then, Dow’s share price plunged.
To many people, this news implies that nobody was immune from this financial crisis, even a legendary investor like Mr. Buffett also suffered a loss. But one thing that distinguishes Berkshire from other financial institution is that it did not take any TARP money from the government. Hence, it will be easier for Berkshire to return to profit in the coming quarter.
Tuesday, May 5, 2009
Obama also wants to use this proposal to increase the U.S. employment. But I don’t think it is feasible. Will the U.S. multinational corporations scale back their overseas businesses to minimize their tax expenses and sacrifice the overseas business opportunities to other foreign companies? I doubt it would happen. Here are the reasons:
The current recession is not turning into a depression because a lot of manufacturing activities are supported by many multinational corporations such as Caterpillar, Procter & Gamble, Johnson & Johnson, 3M, etc. Their annual reports showed their profits over the past couple of years were mainly driven by an increasing growth in international businesses and sales, especially in Asia. On the other hand, corporations that do not have international businesses were struggling hard to maintain profit margins, and even suffering losses.
As the multinational corporations have to incur heavier tax expenses, their profits will be lowered. However, foreign companies who are not affected by this proposal will generate more profit, given all else equal. Therefore, Obama’s tax proposal will seriously drag down the U.S. multinational companies’ competitiveness in the global platform, and possibly increase unemployment from those multinational corporations.
Therefore, if Obama really wants to create jobs in his tenure, this tax proposal may not be the right one.
Monday, May 4, 2009
Prior to Chrysler’s bankruptcy, besides constantly injecting funds to the auto-companies by the U.S. government, the government used an overprotective measure, by kept forcing the lenders to convert their debt into less amount of equity, meaning forcing the lenders to make a huge loss on their investments. This abrupt change in rules is extremely unfair to the lenders. At the same time, this is not a suitable solution for the problem. The problem is how to make the U.S. auto manufacturer more competitive.
When comparing to the Japanese auto manufacturer such as Honda, Toyota and Nissan, the U.S. auto-companies can feel that the Japanese auto-companies are taking up more market shares from the U.S.’s in the auto-market.
The labor union also contributed to the collapse of the auto manufacturer because the healthcare and other workers’ benefits are enormous. These excessive expenditures drained a large amount of cash out of the auto-companies. If the labor union wants to become more competitive and secure their jobs, instead of having prolonged strikes and delaying production, they should cooperate will the auto-companies’ restructure proposal by reducing those benefits.
Personally, I don’t think the bankruptcy of Chrysler is a bad think but is the opposite. Even though this event reflected the auto-industry is still in big liquidity crunch, Chrysler’s bankruptcy and subsequent operation by Fiat will make the auto industry more competitive in the future. Because now, with Ford and GM remaining, they really need to figure out how to be more competitive globally in order to survive in the auto-industry.
Sunday, April 26, 2009
It began in March 2009, when Chinese Premier Wen Jiabao voiced his concern on the fact that China was holding about $2 trillion U.S. Treasury in its foreign reserves. China bought so much U.S. debt without diversifying its foreign reserve because of the low default rate of the liquid U.S. Treasury market. However, since the U.S. government has been printing and pumping money into its economy in this financial crisis, an economic recovery will inevitably generate inflation, which will depreciate the value of the dollar. As a result, holding too much U.S. Treasury will be detrimental to its value, and thus China’s foreign reserve. Therefore, according to Zhou, moving to a reserve currency that belongs to no individual nation would make it easier for all nations to manage their economies better because it would give the reserve-currency nations more freedom to shift monetary policy and exchange rates.
The proposal also allows China to regain face, especially in response to U.S. Treasury Secretary Timothy Geithner’s criticism of currency manipulation, or the notion that China artificially keeps the yuan weak against the dollar (even after Mr. Geithner declined to cite China as the currency manipulator in April). Peter Gries’s book, China’s New Nationalism, states that “face is fundamentally political, involving a contest over power” (Gries 26). Currently, the SDR is only composed of four major currencies in the world (G4): the U.S. dollar, the euro, the Japanese yen, and the British pound. If the IMF SDR program includes the Chinese yuan, it will certainly enhance national pride in China.
As a consequence of rising Chinese nationalism, the Chinese will “altercast the relationship between China and the U.S. as teacher and student, respectively” (Gries 33). The U.S. government (as the student) is busy implementing different economic stimulus solutions to rescue its economy, while China (as the teacher) is slowly preparing itself to teach the student a lesson by attempting to overtake the U.S., the single economic superpower. According to The Economist, “the crisis would severely weaken the economic, political, military and diplomatic power of developed countries. This would create a “historic opportunity” for China to strengthen its position. To do this, China should export capital to South-East Asian countries to strengthen their economies. Doing this would help prevent political turmoil and win strategic influence in the region (The Economist 28).
On the other hand, China has been continuously opening up its economy to the world since Deng Xiaoping became the leader of China in 1978. After Deng set up four Special Economic Zones in China, namely Shenzhen, Shantou, Zhuhai and Xiamen, China underwent rapid economic development. When Jiang Zemin became the new Chinese leader in the 90s, he greatly favored Shanghai and the Yangtze River Delta to become the next big economic regions in China. When Hu Jintao became president in 2002, he led China to increase its participation in developing the domestic front such as the “Open up the West” policy, the completion of the Three Gorges Dam, and the international economics affairs. Consequently, these actions would contribute more to the Chinese economy during his tenure.
If China wants to expand the international use of the yuan, in addition to having a low inflation rate in its economy and a huge GDP and export figures, China still needs to broaden its financial markets by increasing the yuan’s usability and convertibility. Due to this, China has been taking great steps to strengthen the importance of yuan in the foreign exchange market, even though China is still proposing a reserve currency under the IMF. China has not only set up tens of billions of dollars in currency swaps with Hong Kong, Malaysia and South Korea, which enabled those regions to settle their trade accounts with China in yuan, but in late March 2009, China also entered a 70 billion yuan currency swap deal with Argentina. This deal effectively allowed China to settle the trades with yuan, which further enhanced China’s influence in Argentina’s economy while strengthening China and Argentina’s geopolitical relationship. Hence, we can see China is slowly bypassing the dollar to settle its bills on the international trade platform.
Recently, on April 9, 2009, China picked five cities (Shanghai, Shenzhen, Guangzhou, Zhuhai, Dongguan) for the yuan settlement program. This program allows foreign trades to be conducted wholly in yuan rather than in conventional U.S. dollars in those cities. This is an innovative move, as the yuan settlement program not only reduces the risks of exchange-rate fluctuations for the Chinese companies, but also promotes the development of China’s currency investments products.
From China’s view, all these recent currency policies have shown that even if the Chinese yuan failed to be included in the reserve currency by the IMF, China’s new currency policies and political positioning are preparing the yuan to become an increasingly important global currency with implications for reducing the use of the U.S. dollar in the future.
Russia’s reaction may be a good implication on the strategic importance of China’s recent decisions. Once China released its reserve currency proposal, Russia echoed its terms and proposal change. Before the G20 meeting, Russia’s President Dmitri Medvedev supported the creation of strong regional currencies as a basis for a new reserve currency and the consideration of backing this currency by gold. According to Reuters, Russia said that the new international reserve currency, which dislodges the dollar, could curb the volatility of foreign exchange markets. In April 2009, the Kremlin’s chief economic adviser Arkady Dvorkovich also asked the IMF to study the risks and possibilities of the new global currency. These actions reflect how anxious Russia is to remove the primacy of the U.S. dollar.
In comparison to China, Russia’s economy is less export-oriented and Russia’s currency, the ruble, has been devalued by more than 35% since the commodity bubble burst in the summer of 2008. If the U.S. dollar is no longer a dominant currency, the ruble should appreciate against the dollar, which will increase its currency reserve.
In addition to Russia’s own benefits, Russia supports China because of their geopolitical relationship, since Russia and China share the same border and both countries have serious currency concerns over the potential depreciation in the value of the U.S. dollar that they are currently holding. In addition, Russia and China have important economic relations. China has been invested in Russia’s natural resources, such as the deal with the China Development Bank in February 2009, which I have mentioned in Part 1 of The Global Strategy of the Dragon.
From the U.S. standpoint, the U.S. does not want to lose the dominant status of its currency. The use of a country’s currency as an international store of value allows the country issuing it to benefit from seigniorage (the net revenue derived from the issuing of currency), and lower borrowing costs. In response to the reserve currency proposal, the U.S. President Barack Obama said the U.S. dollar still remains the primary global currency and there is no need for a new global currency. At the same time, since many commodities are denominated in dollars globally, changing the current system would take a lot of effort and time for a worldwide adaptation to occur.
On the other hand, even though a move towards global currency reform may detract from the dominance of the U.S. dollar in the foreign exchange market, it may not necessarily be a bad thing. Since China is an export-oriented country, if the U.S. dollar is no longer a dominant currency, the Chinese yuan will surely appreciate against the dollar and make Chinese exports relatively more expensive than those in other emerging markets. Moreover, as most of the Chinese exports are shipped to the U.S., Chinese goods will become more expensive than U.S.’s goods, which the U.S. will import less from China and consume more domestic goods. If this were to occur, it will hurt China’s economy while benefiting US’s domestic economy by reducing its trade imbalance and trade deficit.
From a global perspective, in the recent G20 meeting, the G20 leaders have announced plans under Point 19 of the communiqué to replace the role of U.S. dollar as the world reserve currency, which stated to support a general SDR allocation into the world economy and increase liquidity, which is not under the control of any sovereign body. The G20 leaders have activated the IMF’s power to create money and begin global ‘quantitative easing.’ The global leaders also agreed to increase IMF’s financial capacity to $1 trillion commitment.
Moreover, it is possible for China to first create a common currency among the East Asian countries that mirrors the euro, which was established in 1999 by the European Union. The euro’s position has becoming increasingly important since then. As of today, the euro is even more expensive than a dollar. However, critics argue that this process would require a tight trade agreement among the East Asian countries, which will potentially take a long time to become stabilized.
While it is still early to draw conclusions about whether the switch to a new reserve currency is technically feasible, it would take a long time for this global currency reform to take effect. We can also see that this new global currency proposal is a two-edge sword to China. However, this currency debate will surely mark the beginning of a new era when emerging markets, especially China, are developing the capabilities to lead major reforms in the international monetary system.
Thursday, April 16, 2009
Even after the pirates were defeated in the Maersk-Alabama hijack, the pirates not only refused to scale back their hijack activities around the Gulf of Aden, but according to a recent report from the US Report, the pirates were also seeking revenge on the U.S. Navy after three of their pirates were shot and killed by the U.S. Navy’s snipers in the Maersk-Alabama rescue mission over the weekend.
The comment from the pirate also reminds me of what happened in Somalia in 1993, which was depicted in the Hollywood movie: Black Hawk Down, about a conflict between the U.S. Army and the Somalia militias. That event resulted in the death of more than a thousand Somalia militias and 19 American Soldiers. Eventually, the former U.S. President, Bill Clinton, decided to pull out the U.S. Army from Somalia.
Instead of a clash between the Somalia militia and U.S. Army similar to the one in 1993, would this conflict lead to another tragic event between the Somalia pirates and the U.S. Navy again?
Tuesday, April 14, 2009
The first clip shows that the picadore, who was riding the armored horse, was rammed by the bull, and the picadore used the lance to stab the bull’s neck to weaken the bull’s muscle and draw the bull’s first blood.
The second clip shows three banderilleros stab the bull with three banderillas, which are sharp barbed sticks, onto the wound on the bull’s neck to further weaken the bull and cause more blood loss.
The third clip shows the bullfighter killed the bull with a final sword thrust, which penetrated the bull’s shoulder and heart. Even though the bull was still moving afterward, it didn’t take much longer for the bull to hit the ground in the end.
The last clip shows that after the bull was dead, it was dragged by the horses around the arena for a lap before exiting the arena.
The bull-fight was one of my favorite parts during the trip. In addition to the show, the bullfighters’ colorful costumes were beautiful and the bull-fight arena was also gorgeously constructed. All these characteristics reflected one of the important traditional cultures in Spain.
Friday, April 10, 2009
According to the USDA’s planting survey released on March 31, 2009, it showed that many U.S. farmers plan to cut back on planting. Corn production is reduced from 86 million acres in 2008 to 84.7 million acres in 2009. However, only the soybeans production has increased slightly from 75.7 million acres in 2009 to 79.1 million acres in 2009. However, the actual planting may change due to weather during the planting season and agricultural products’ futures prices movement. Therefore, we should pay attention to the upcoming Acreage report released by USDA at the end of June, which shows how many acreage did the farmers actually planted.
When commodity prices fell in the second half of 2009, U.S. farmers responded by cutting back their planting and production. In March 2009, the agricultural Department said that farmers will idle millions of acres of land as they cut production of corn, wheat, and soybean. However, as the consumption of corn and soybeans are still high in developing countries such as China, this planting reduction will increase the volatility in crops prices in the coming year in from packaged food and biofuels to feeding livestocks.
Furthermore, farmers moved away from high-cost crops such as corn in exchange of soybeans which don’t require expensive nitrogen fertilizer, but cheaper phosphate and potash. They are reducing production because of increasing costs of fertilizer and seed, and the slowing demand of crops in some countries during this economic downturn. Even though farmers are cutting back crops’ acreage in 2009, the potential shortage in crops will eventually bring the crops’ acreage back to a higher level in 2010. Therefore, fertilizer companies will face a higher demand from farmers in 2010.
In my opinion, the recent sharp planting reduction will potentially lead to another commodity bubble in the coming year. If consumers are aware of this problem now, they can effective protect their food expenses by hedging on the cheap agricultural products’ futures contracts now.
Tuesday, April 7, 2009
In Q1 of 2009, the U.S. M&A deal volume was almost double the total volume in Q4 of 2008. However, these gains were mainly derived from two major deals in the healthcare sector—Pfizer acquiring Wyeth for $68 billion and Merck acquiring Schering-Plough for $41 billion. These two acquisitions alone accounted for more than half of total U.S. deal volume. The justifications behind these aggressive inorganic growth strategies were:
• Pharmaceutical firms have been concerned with the pending patent expirations of its blockbuster drugs, which have driven a majority of their revenues. In addition, generic drug competition will continue to drive drug prices down, and negatively impact the profitability of these firms.
• Even during the market downturn, these companies have continually maintained large cash positions on their balance sheets. This financial flexibility enables firms to expand their businesses when investment opportunities arise.
• An additional bonus is the current low stock prices of target firms, which makes them attractive to larger pharmaceutical acquirers.
As a result of these acquisitions, the combined synergies will bolster product pipelines and lower expenses, thus increasing operating margins and partially-solving the patent problems.
President Obama’s $634 billion healthcare reform plan calls for health coverage affordability. The savings will come from quality incentives, efficiency and accountability, and shared responsibility. In particular, the U.S. government has increased Medicaid rebates from 15% to 22%; however, Medicaid sales as a percentage of overall U.S. pharmaceutical sales remain relatively small (less than 10%). In addition, federal law requires these healthcare companies to pay specified rebates for medicines reimbursed by Medicaid in order to provide discounts for certain healthcare facilities.
In the coming months, the federal administration also plans to crackdown on U.S. companies’ ability to avoid taxation on international earnings. Consequently, Obama has aimed his efforts to shut down offshore tax abuses, which currently amounts to $100 billion each year. This will negatively affect the large pharmaceutical companies that generate a significant portion of sales abroad.
Some people may believe the opposite view, but I can see the healthcare industry will face a certain amount of pressure from the government in the coming year.
Wednesday, April 1, 2009
In early March, amid the slowdown in foreign investments, the Chinese government announced a decision to lower its conventional heavy bureaucratic hurdles for foreign companies and allow local governments to approve certain foreign investments, shifting control away from Beijing in a move to ease foreign investment at a time when it has been declining sharply. Under the new rules, foreign businesses setting up an investment company with registered capital of less than $100 million will need to seek approval only from local commerce bureaus. The rules will create greater transparency of approval processes on a local government level and attracts more foreign investments.
Foreign investments have been vital for providing jobs and introducing new technology and management practices. However, amid the global financial crisis, China cannot solely rely on economic growth stemming from foreign investments, but rather in conjunction with domestic demand. During the annual meeting of the National People’s Congress (NPC) in China in mid-March, which delivered the 2008 government work report and 2009 economic and budget plan, China’s Premier Wen Jiabao stated that China must significantly increase investments and government expenditures to stimulate economic growth, improve people’s lives and deepen reform. Even though there are no major changes from the existing objectives and expansionary policy framework set last year, I think the Chinese government can achieve its objectives by expanding its expansionary monetary policy which aims for credit growth. With China’s new loans extended in February came in at $1.03 trillion yuan which grew strongly to 24.2% from 21.3% in January, I believe this loan growth will remain positive while slowly decreasing in the following months for two reasons.
First of all, we can expect China’s budget surplus will decrease as the government plans to use cuts and rebates to ease tax burdens for businesses and individuals. This would be the most efficient way to release consumers’ purchasing power and boost consumption, especially for the urban middle class. If the Chinese government wants to maintain an 8% revenue growth while reducing tax for businesses and individuals, the only achievable way is to provide that businesses and individuals will increase their borrowing needs.
Secondly, with the $4 trillion yuan the Chinese government’s stimulus package starting to show some positive effects, China’s manufacturing indicator – the Purchasing Manager Index – showed an ease in dropping in February and reflected some signs of stabilization and recovery. Moreover, China’s fixed-asset investment exceeded the market expectation with a growth of 26.5% from a year earlier. In my opinion, with more investment projects to start in the coming months, businesses should increase their borrowings. Therefore, with both increasing businesses and individuals expenditures, the loan growth can be maintained at a firm level while slowly decreasing throughout the year.
In order to cope with oversupply and under-demand in the Chinese economy, another significant economic reform highlighted by the premier during the NPC is the industry revitalization plans announced over the past couple of months. In addition to conventional monetary and fiscal policies that focus on boosting demand, these revitalization plans from the Chinese macroeconomic management are largely focused on reducing overcapacity through two measures to facilitate supply control: mergers and acquisitions, and increasing national strategic reserves of various commodities.
First of all, in an economic reform generated by mergers and acquisitions, big state-owned companies with close relationships with the central government will be most likely to survive in the consolidation waves while small companies, especially those that are not state-owned will be restructured and acquired by the big state-owned companies. This process enables enterprises to preserve the overall industrial profit margins. As part of the supply control, the Chinese government raised gasoline price to encourage competition among fuel suppliers and better reflect supply and demand. It also helped to protect the domestic refiners’ margins and prevent them from incurring losses, which in turn the government will have to provide more subsidies to the refiners.
Secondly, in terms of increasing national strategic reserves of commodities which I correctly predicted in my China’s strategy discussion last month, China has started to build up its sugar reserve inventory in March to 2.8 million metric tons to secure an adequate food supply. This measure not only comes at a time when commodity prices are low but also helps the government to prepare for any unforeseen disasters that would severely drop the global sugar production. The success in both measures would be able to bring supply and demand back to equilibrium.
In late March, China raised the heated debate of substituting the U.S. dollar’s dominant currency status with a new reserve currency. China’s central bank governor, Zhou Xiaochuan, called for moving toward a super-sovereign reserve currency, or one that doesn’t belong to any particular country, and expand the International Monetary Fund’s Special Drawing Rights (SDR) – a kind of synthetic currency whose value is determined by a basket of major currencies – by including the Chinese yuan. According to Zhou, moving to a reserve currency that belongs to no individual nation would make it easier for all nations to manage their economies better because it would give the reserve-currency nations more freedom to shift monetary policy and exchange rates. Even though this is a possibility, it would take a long time for this global currency reform to take effect. Moreover, though a move towards global currency reform may detract from the dominance of the U.S. dollar in the foreign exchange market, it may not necessarily be a bad thing. By losing the dominant status in the foreign exchange market, U.S. dollar would depreciate, making its exports relatively cheaper and more price-competitive than those in China. If this were to occur, it would beneficially impact the U.S.’s current trade imbalance and reduce its trade deficit. While it is still early to draw a conclusion of its technical feasibility, this currency debate will surely mark the beginning of a new era when emerging markets, especially China, are developing capabilities to lead major reforms in the international monetary system.
Paving the way for China to assume more active participation in the global economic platform, most recently, China expressed its willingness to add funding to the IMF to help developing countries hurt by the financial crisis and also to buy bonds issued by the IMF. However, with sufficient liquidity on China’s hand thus more leverage in negotiating, China wants to have more voting power in IMF in exchange for the new funding. If these objectives are achieved, it will provide more influence to China in the IMF and global finance in the coming decades.
Although China’s aggressive policy stimulus remains absolutely crucial in terms of China’s economic outlook, its strength of recovery still hinges on that in the developed economies. If the developed economies fail to rebound in the second half of this year, it will hinder China’s economic recovery and will require more policy stimulus on top of the existing package in order to sustain a rebound. But with China's stronger influence in the overall structure of the new global financial system, surely China’s international economic and finance position will gain more credibility and exert more impact over this economic downturn and in the future.
Wednesday, March 11, 2009
According to Dictionary.com, a pet is defined as any domesticated or tamed animal that is kept as a companion and cared for affectionately. However, I don’t think a chimpanzee is included in this category (domesticated and tamed animal). Even though Herold, the chimp’s owner, said the chimp was her life after her daughter was killed in a car accident, does it make any sense to keep a 200-pound chimpanzee at home as a substitution of her lost-daughter?
Sadly, not only has Herold lost her daughter, but also her friend, Nash, who is still in the hospital in a critical condition, having suffered losing her arms and nose and incurring a brain injury.
Therefore, as the government gives the Department of Environmental Protection (DEP) more authority to set up stricter rules – having the authority to remove any animals from the home of anyone who violates the statute and refuses to relocate the animals, and an increase of civil penalties from $1,000 to $2,000 per day and imprisonment of up to one year for owners of the animals who refuse to relocate them – similar tragedies can be prevented from happening again.
Among the new rules, I think pet owners should take the responsibility to train their pets and refrain from disturbing public safety. Therefore, public education of keeping pets should be given to pet owners. It is also essential for the DEP to impose stricter rules such as charging a fee to pet owner whose pet meets the following criteria: larger than a certain size, heavier than certain weights, etc. Furthermore, setting up more severe punishments such as lengthening the period of imprisonment and civil penalties would be the most effective to deal with similar cases. I know that if I had to go to prison or pay $2000 a day, I’d probably think twice about bringing a 200-pound chimpanzee to live in my home.
Sunday, March 8, 2009
In February, despite many companies cutting dividends to retain cash on their balance sheet, Coca-Cola decided to raise its dividend by 7.9%. Last week, Coca-Cola opened its $90 million innovation and technology center in Shanghai, China. Coca-Cola also announced its plan to invest $2 billion in China over the next three years, including new plants, R&D, sales and marketing. Coca-Cola’s $2 billion investment plan is also a response to its rival PepsiCo Inc.’s $1 billion investment plan in China over the next four years. Currently, Coca-Cola is still waiting for Chinese government’s approval on its acquisition deal with China’s largest juice maker Huiyuan Juice Group Ltd. for $2.4 billion in cash. If complete, the deal will be Coca-Cola’s largest overseas acquisition.
Coke’s latest move will definitely increase investors’ confidence in its overseas business and will bring in more revenue to the company in the future. It will also provide more pleasure to Chinese consumers.
If Coca-Cola successfully acquired Huiyuan, will Coca-Cola create a new product line that focus on Chinese customer’s taste? How about a Chinese-tea-flavored Coke?
Saturday, February 28, 2009
China made a series of international investment in natural resources starting early February 2009. In early February, Aluminum Corp. of China (aka: Chinalco) invested US$19.5 billion in Australian mining giant Rio Tinto in exchange for $7.2 billion convertible bonds. If all the bonds are exercised, Chinalco will take up to 18% stake and 2 board seats in Rio Tinto. In addition, Rio Tinto can use the investment to repay part of its $40 billion debt generated by its acquisition of Canadian aluminum company Alcan Inc. in 2007. Then, a week after, in mid-February, China Minmetals Corp. launched a takeover bid of US$1.71 billion for Australian zinc miner OZ Minerals Ltd. This deal can help OZ Minerals refinance its US$560 million debt by the end of this month. On the other hand, China can increase its exposure to the zinc, a major material for anticorrosive coating for steel, to meet the potential rising demand of steel in the rapidly developing China after reversing course from the current economic downturn. In the same week, China Development Bank announced the completion of two international deals. First of all, China Development Bank reached a deal to lend a total of $25 billion to two Russian state-owned energy companies, OAO Rosneft and OAO Transneft, in exchange for an additional 15 million metric tons of crude oil a year for 20 years under the terms of the deal. Second, China Development Bank will finance $10 billion in Brazilian state-owned oil company, Petroleo Brasileiro SA (aka: Petrobras), for its deep-water oil reserves. With China’s financing, Petrobras will be able to pay for its oil and gas discovery costs. Recently, in late February, China’s Hunan Valin Iron & Steel announced that it will buy 16.5% of Australian iron ore miner Fortescue Metals Ltd. for US$770 million thus becoming Fortescue’s second largest shareholder. Fortescue will use the funds to expand its Western Australia’s operations. On top of gaining easier access to natural resources by investing in those companies, the key of those deals is to establish an international business relationship politically and strategically with the involved countries (Australia, Brazil and Russia). This approach will undoubtedly support a more rapid and robust economy in the continuing politic, social and economic reforms for the post-capitalism in China.
In addition to China’s international investments, Chinese government is also aware of the overcapacity in its domestic iron and steel industry. In response to the plunging demand of steel in China, in mid-February, Chinese government announced a consolidation plan in its steel industry – financed by China’s natural resources government-backed funds – by combining three major steel groups to stabilize iron and steel price and to reduce excess capacity by 24% in steel making capacity by 2011. The three groups are as follow: Baosteel Group Corp., Wuhan Iron & Steel Corp., and the combined group of Anshan Iron & Steel Group Corp. and Benxi Iron & Steel Corp. Furthermore, under the 4 trillion yuan stimulus plan released by China in late 2008, to encourage technological improvement in both sectors, the Chinese government recently approved a plan to help petrochemical producers and light industrial companies by increasing export-tax rebates, improving the energy-pricing mechanism, speeding up the expansion in its strategic oil reserves, and curbing coke production projects. By implementing this plan, China’s international investments will provide benefits to the material sector, which will also spill over to the industrial sector. In late February, China agreed to buy $15 billion of machinery, automobiles and food products from Europe. These investments include jet engines from Rolls-Royce Group PLC, cars from Jaguar and Land Rover, and railway equipment and olive oil. All these government spending and investment projects illustrated China’s determination in fostering its domestic economy and its reputation of helping the global economic recovery in the current financial turmoil.
While many countries are suffering from their shrinking balance sheets when they pumped capital into their domestic market, we can see that financially, China is well-prepared to turn itself into an economic superpower during this global financial turmoil. For example, in observing all these expensive deals, some may wonder if China has enough money to pay for them. However, according to Chinese government’s statistics, China will have sufficient “ammunition” for the investments. Even with a slowdown in China’s GDP in 2008, its current account surplus – the sum of foreign trade and income surpluses – in the end of 2008 still had US$440 billion. Moreover, with China being the biggest holder of the U.S. Treasury bill in the world, China does not have any credit risk exposure as the U.S. Treasury bill is seen by the global market as a default-free security. In addition, the current high demand in U.S. Treasurys will allow China to use them as a medium of exchange for its foreign investments.
In my opinion, China is making the right choices. Securing natural resources is only the first step of its economic expansion plan. By politically and strategically expanding through a better control on natural resources production, its price and quantity supplied can be stabilized. As natural resources are the basic raw materials of any given consumer and industrial products, securing the ownership of sufficient natural resources will increase China’s leverage in negotiating the production price of raw materials. The second step will be the industry consolidation that we saw. This consolidation not only stabilizes the production price but also limits its manufacturing output to better match the supply and demand equilibrium. Consequently, the flow of raw material will be controlled and price will not be depressed by excess supply, which will hurt raw material companies’ revenues. If I were China, my next step would be to secure a stable output of agricultural products. If China wants to expand its economy rapidly, it needs more labor, ensuring sufficient food source will minimize the adverse impact from natural disasters such as drought or flood which potentially leads to famine, depends on the duration and extent of the disasters. An adequate food supply will ensure a sustainable economic production in the long run. Once the economy starts recovering, the large amount of liquidity that was injected by the 4 trillion yuan economic stimulus plan last year will allow inflation to come in and lower the real money value. However, with the Chinese government controlling the appreciation of the Chinese yuan, it can slow down the rise in inflation more effectively together with a steady increase in its central bank interest rate.
In conclusion, China’s investment and consolidation strategies will be sustainable only if all the investment strategies and economic policies are interrelated and feasible based on the realistic economic environment. If successful, the combination of investments and industry consolidation strategies with the relatively cheap Chinese yuan will ultimately amplify the effect of the recovery in its economy and will boost its economic expansion.
Monday, February 23, 2009
Last week, British Petroleum PLC (NYSE: BP) announced a 50-50 joint venture partnership with Verenium Corp. (Nasdaq: VRNM) which includes committing $45 million in funding and assets to the joint venture company and building the world’s biggest biofuel facility in Florida. This facility will apply an innovative biofuel technology to ferment inedible plants such as grass or crushed sugarcane to produce cellulosic ethanol. The Florida facility will cost between $250 million and $300 million, will be completed by 2010, and expects to start its production in 2012.
By using a wide array of non-food feedstocks, such as agricultural waste instead of corn and sugarcane – the major raw materials in the conventional ethanol production method – this manufacturing method will reduce the price fluctuation in corn and sugarcane, etc. Moreover, this new ethanol production method not only generates a renewable energy source for the public in an efficient way, but is also environmentally-friendly by recycling the agricultural waste into energy production. Based on the biofuel’s production cycle, we can estimate a potential earning increase in agricultural companies, which can reduce its cost of agricultural production. Instead of paying a fee to dump the agricultural waste in the designated disposal sites, they can sell their agricultural waste to BP and Verenium’s biofuel facilities for a profit. This potential positive earning effect is yet to be reflected in the agricultural companies’ current stock price. If the whole process follows through, those agricultural companies’ stock prices are probably undervalued in terms of a 5-year outlook.
The ethanol can be used as a substitute for gasoline in fueling transportation vehicles. According to Verenium’s estimation, the Florida facility will make 36 million gallons of fuel a year and is aiming for a cost of $2 a gallon. However, the variable cost of the inputs might change depending on the production scale and demand of the market. The earnings of BP and Verenium depend on the price of the biofuel, which is affected by its close substitution, crude oil, and its complementary, cars that use biofuel. If the public has a positive perception to driving biofuel cars, then auto companies which produces cars with biofuel compatibility will gain a first-mover profit from this trend.
As we can see, BP and Verenium’s biofuel deal will create a chain effect to businesses and long term investments across several industries. If this next-generation biofuel is strongly welcomed by the public, we can expect more energy companies to jump onto the biofuel bandwagon and create another hot issue in the market.
Tuesday, February 10, 2009
As the price of crude oil has fallen sharply, gasoline which is derived from crude oil, has followed suit. To many drivers, especially commuters who drive to work every day, gas price contributes a large part of their monthly expenditure. Although the gasoline price has fallen from the peak of around $5 in the summer to about $2 now, drivers should implement certain hedging strategies so that they don’t have to worry about the spike of the volatile gas price again.
One way to do so would be an unreliable method of investing in gas companies such as Chevron, Exxon Mobile, etc. The profitability of these companies is partly derived from the gasoline sales at gas stations around street corners. However, unexpected corporate events also affect the stock prices which affect equity investors’ profit or loss. Therefore, since gas companies’ stock prices are not an accurate indicator for gasoline prices, this method has several weaknesses as a hedging strategy.
Besides using this indirect hedging strategy, we can use another method to directly hedge drivers’ gas expenses by investing in the United State Gasoline Fund (NYSE Arca: UGA). UGA is an exchange-traded fund (ETF) which seeks to track, net of expenses, the changes in percentage terms of the price of gasoline. This works because the retail gasoline price at the gas station is correlated to the gasoline future price traded in the New York Mercantile Exchange, with which gasoline futures are one of the most actively traded futures contracts and represent the primary US benchmark for gasoline prices. This ETF will invest in the futures contract on unleaded gasoline delivered to the New York Harbor traded on the New York Mercantile Exchange that is the near-month contract to expire. So why will investing in UGA stabilize drivers’ gasoline expenditure? If the price of gasoline futures rises, UGA price will rise as well, which will offset the increase in gas price.
Therefore, when another oil crisis or hurricane in the Gulf coast turns the oil market upside down and everyone is complaining abut the surge in gas price, you can just sit back without worrying about the high cost of pumping another gallon of gas.
Wednesday, February 4, 2009
If we look closely at McDonald’s business segments, we will find that in 2008, more than half of the total sales growth was attributed to the global sales from Europe, Asia-Pacific, Middle East and Africa, which amounted to 17.5% regional sales growth. The operating income in these areas also rose in double-digit proportions while the U.S. merely had growth of 8%, which was partly reflecting an increase in McDonald’s menu price. In addition, among all of McDonald’s business segments, Asia-Pacific, Middle East and Africa were the boosters of McDonald’s revenue in the fourth quarter in 2008 at 10%, which doubled that of the U.S.’s.
Another reason for McDonald’s strong sales growth is the sharp fall in commodity price in the second half of 2008 which significantly reduced its operating costs, including the cost of bread, potatoes, corn, etc. Moreover, the continued strengthening of the U.S. dollar in the second half of 2008 also benefited the conversion of foreign currencies’ into U.S. dollars from McDonald’s overseas businesses. This foreign-currency translation contributed an extra 2% increase to its earning from 2007 to 2008.
Although McDonald’s 2008 earning was impressive, it still faces some risks in 2009. For example, its business may be weakened by the strong U.S. dollar, as a strong U.S. dollar makes McDonald’s item prices relatively more expensive than those in the local restaurants in regions outside the U.S. Since food prices are volatile as they are vulnerable to changes in weather, an unexpected spike in food prices is possible at anytime of the year. Moreover, as many European and Asia-Pacific countries reported lower economic growth and employment rates, a drop in consumption expenditure may exert an adverse impact on fast-food chained restaurants such as McDonald’s.
Therefore, there is a chance that McDonald’s luck and management skills reflected in its strong earning in 2008 may not be able to be carried over to 2009. While applauding for McDonald’s success in 2008, investors should also pay attention to its downside risk.
Tuesday, February 3, 2009
What is Timothy Geithner doing as U.S. Treasury Secretary for U.S. President Barrack Obama? It seems like instead of trying to stabilize the global financial crisis, the only job he seems to be doing is instigating new conflicts with other countries and strategic partners. Several of his actions, including tax evasion, currency manipulation criticism and attempts to scapegoat other countries for the collapse of the financial market, have sparked controversy among the public about whether he is truly qualified to serve as a U.S. Treasury Secretary.
First of all, he failed to settle $40,702 in Social Security tax obligations between 2001 to 2004, until it was brought to the public eye.
Secondly, in late January 2008, he accused China its currency which deliberately preventing the Yuan from appreciating against the U.S. dollar, thus making Chinese goods relatively cheaper than goods in other countries, thus gives Chinese companies an edge over foreign competitors. However, according to a currency report, the Chinese Yuan has appreciated by 21% since July 2005, which shows China is allowing its currency to float in the foreign exchange market. In response to Mr. Geithner’s criticism, the Chinese Central Bank’s official said the currency manipulation charge is not only inconsistent with the facts, but also misleading about the reasons for the financial crisis. Furthermore, Chinese Prime Minister Wen Jiabao defended China’s currency policy, saying the strong fluctuation in different global currencies’ exchange rates is common and China should not take the blame from that. This currency criticism caused the interference of the White House to mitigate the furor when China and Russia criticized the U.S. of not taking enough responsibility in addressing the global financial crisis which started last year but only to blame other countries for causing this crisis.
Then, just one week after the Chinese currency manipulation accusation, Mr. Geithner suggested imposing stricter rules on the financial institutions asking for funds from the Troubled Asset Relief Program (TARP) which discouraged many qualified banks from accepting the Treasury’s funds. The new rules would require the U.S. Treasury to certify to Congress that each investment decisions are based on investment criteria and the health of the financial system, which aims at curbing the influence of lobbyists, politicians and others in determining which firms get bailout cash. In addition, the rules should cause more transparency since Treasury will have to explain why they are giving money to a specific company. These new rules are further complicating the financial system. While at least 50 banks that are qualified for aid, they have rejected the Treasury’s funds because they feel uncertain about the future requirements of the program which the U.S. may impose tougher restrictions on institutions that take government cash such as restricting their dividend payments, preventing them from acquiring other banks and expanding their businesses, and potential earnings dilution when government acquire convertible loans in exchange of the rescue funds. However, by declining the funds, these companies showed their investors that they have sufficient liquidity to operate its business without the government’s aid. It also shows that banks are starting to push back against increasing federal control of the banking system, raising concerns about the bailout’s effectiveness.
Since the financial sector suffered the biggest casualty, if the patients, who are the banks, are unwilling to take the medicine, which is the rescue fund, then the whole rescue plan will prove wasteful and unsuccessful. Therefore, Mr. Geithner should consider the effectiveness of his potential financial policies and rules to the banks before implementing them.