Follow the Money to Asia’s Tech Hub
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
China’s slower economic data points and a surplus in copper and iron ore drove many commodities lower this week, while gold rose. In the short term, until the copper and iron ore surplus is liquidated, or absorbed at a slower pace, the base metals market will likely be sloppy.
As the second-largest economy in the world and a huge driver of commodities demand, it’s not surprising China provoked such a significant response from world markets. Interestingly, most of the media thought it was geopolitical fears from Ukraine that chopped up the market and lifted gold.
Over the past few decades, we’ve watched the country experience tremendous economic growth, with its share of world GDP growth going from only 1.4 percent in 1992 to nearly 20 percent two decades later. China has become quite an economic powerhouse, with a tremendous effect on domestic urbanization and wealth, changing consumption patterns dramatically.
So even if the country experiences short-term headwinds, we believe the long-term story remains slower, but stable. The important part is to look past the negative headlines to uncover the best opportunities, or as we like to say, “Follow the money!”
At U.S. Global, we strive to follow the money by analyzing the broader Asian market, focusing on the areas that are sustaining leadership, both by sector and by country.
For instance, did you know that the strongest-performing sector in Asia over the past year is technology? Take a look at the chart below showing that technology stocks in the MSCI Asia Index (excluding Japan) increased 14.2 percent over the past 12 months. The sector far outperformed energy, which declined the most in the same time frame.
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In the Investor Alert, we’ve often discussed how the tech industry has been gaining strength in Asia, but particularly in China, which is quickly becoming the largest e-commerce market.
The world has drastically changed since the last technology boom more than a decade ago. As China has become one of the best consumption stories out there, local technology companies have profited. Take a look at other discussions we’ve had on China’s booming sector:
You can see below that Chinese technology companies have far outpaced other major Asian technology sectors. Over the past year, China’s tech stocks grew 77 percent. In Taiwan, tech businesses rose 15.3 percent while Korean tech stocks decreased 11.6 percent.
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So what about China makes it a technology hub?
Similar to what’s happening in the U.S., mobile Internet is transforming consumer behavior in China, with further penetration of smart phones, proliferation of mobile-payment apps, and 4G networks rolling out in China. These technologies aid in the ease and pleasure of shopping from home and staying connected, facilitating the rapid adoption of mobile e-commerce in the country.
In fact, as of the third quarter of last year, mobile e-commerce transactions already comprised 9.5 percent of total e-commerce volume, up from just 0.7 percent in the first quarter of 2011.
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With this significant growth, what I think is really important in China these days is the entrepreneurial spirit taking place. You have these young entrepreneurs growing up in China, creating new companies and achieving incredible success. In fact, according to the Chinese government, the startup of new companies in the private sector increased 30 percent in 2013, reaching 233 million businesses!
The entrepreneurs have government support too. In the widely watched annual press conference following the end of the National People’s Congress Conference, Premier Li Keqiang highlighted the government’s focus on innovation as a key driver for growth. In his signature no-nonsense and candid manner, the premier restated the importance of modernization and advancement.
As I wrote recently in my blog, innovation is one way companies grow and thrive in today’s highly connected and competitive world.
This innovation can be seen in the government’s recent selection of technology companies, Tencent and Alibaba, to open private banks. Currently, almost all banks in the country are state owned. This is yet another positive for tech companies, who have already collected deposits from many smart-phone users, who are able to achieve better rates than normal banks can offer.
Indonesia is Top-Performing Country in Asia
When it comes to country leadership in Asia, Indonesia is topping the performance charts. Among Asian countries, Indonesia has been the best performing country over the past six months, increasing about 8 percent as of March 14.
What is particularly impressive is that, despite investors’ worries about the country’s current account deficit and weak currency last year, businesses found Indonesia an attractive place to expand operations and do business.
Aggregate foreign direct investment has been strengthening across Southeast Asia, rising 7 percent in 2013 to $128.4 billion. Foreign investment was a particularly bright spot in Indonesia, as it grew 17 percent, according to Bank of America Merrill Lynch. What’s more, investment into Indonesia has been growing at a consistent pace over the past five years.
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This is a very encouraging sign, as there is great historical parallel, says Xian Liang, portfolio manager of the China Region Fund (USCOX). He says that in the 1980s and 1990s, foreign direct investment kept flowing into China, which helped the economy grow.
Just today, the country was upgraded to market weight by Goldman Sachs, which cited various reasons investors could see a pick-up in the investment cycle within the country.
We see additional positives for Indonesia, including the following:
- The country’s current account deficit in the fourth quarter improved significantly. Indonesia managed to produce a trade surplus of $50 million compared to economists’ expectation of a $775 million deficit.
- Indonesia inflation stabilized as November CPI was 8.37 percent versus the consensus of 8.45 percent.
- The country is getting ready for its presidential election on July 9, which could be positive for stocks. According to Goldman Sachs, “elections have historically been an important domestic catalyst” for Indonesia. In addition, depending on the outcome of the vote, pro-growth policies “could help boost investment activity and provide impetus to the overall growth cycle,” says Goldman.
- Secular drivers remain intact for Indonesia. Younger demographics, lower labor costs, robust domestic demand, and rising geopolitical competition among superpowers should help sustain favorable investment cycles in Southeast Asia, especially in faster growing countries such as Indonesia.
This is only a glance at some of the strengths in Asia where the China Region Fund is focused. With its ability to dynamically adapt and move to these areas, the fund can overweight these areas of relative strength while trying to avoid areas that have been under pressure. See how the fund has outperformed its benchmark over the one-month and one-year time frame by downloading the fact sheet here.
- Major market indices finished lower this week. The Dow Jones Industrial Average fell 2.35 percent. The S&P 500 Stock Index dropped 1.97 percent, while the Nasdaq Composite declined 2.09 percent. The Russell 2000 small capitalization index fell by 1.82 percent this week.
- The Hang Seng Composite declined 4.82 percent; Taiwan dropped 0.30 percent while the KOSPI fell 2.77 percent.
- The 10-year Treasury bond yield fell 14 basis points this week to 2.65 percent.
Domestic Equity Market
The S&P 500 Index pulled back roughly 2 percent this week as geopolitical events and global growth concerns dominated the headlines. It was a “risk off” week with utilities, staples and telecommunication services outperforming, as Chinese economic data disappointed and the Russian/Ukraine situation continued to simmer.
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- The utilities sector rose by more than 2 percent this week as virtually all the companies in the index were higher. Bond yields fell sharply and interest-rate sensitive areas of the market rallied.
- The consumer staples sector was also a relative outperformer this week, with Tyson Foods and Archer-Daniels Midland (ADM) leading the way, both rising about 3percent. Tyson Foods reaffirmed guidance and commented that the company was able to pass on price increases to consumers. ADM is likely reacting to higher ethanol prices that continue to grind higher.
- Newmont Mining was the best performer in the S&P 500, rising 6.42 percent this week. Gold and gold mining stocks also moved higher, continuing a trend that began late last year.
- The industrials sector underperformed. It was a “risk off” week and economically-sensitive areas of the economy were the hardest hit. ADT Corp., Ingersoll-Rand and Fluor Corp. were among the worst performers.
- Financials also underperformed in a broad-based selloff. Citigroup, Prudential Financial, AIG and Goldman Sachs all fell by more than 5 percent.
- General Motors (GM) was the worst performer in the S&P 500 this week, falling 9.55 percent. The company recalled 1.6 million vehicles on an ignition flaw, which has been connected to 12 deaths according to GM.
- The current macro environment remains positive as economic data remains robust enough to give investors confidence in an economic recovery, but not too strong as to force the Federal Reserve to aggressively change course in the near term.
- Money flows are likely to find their way into domestic U.S. equities and out of bonds and emerging markets.
- The improving economic situation could possibly drive equity prices well into 2014.
- A short-term market consolidation period after such strong performance over the past six months cannot be ruled out.
- Higher interest rates are a threat for the whole economy. The Fed must walk a fine line and the potential for policy error.
- A lot of good news is potentially priced into the market and the economy will need to deliver to maintain the positive momentum.
The Economy and Bond Market
Treasury bond yields virtually erased last week’s move higher, ending this week roughly the same as just two weeks ago. Macro-geopolitical events were one driver, as Treasuries likely benefitted from a flight to quality. The other driver was weak economic data out of China that threatens the global growth story.
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- Initial jobless claims fell to 315,000, which was the best reading since November and points to an improving jobs picture.
- Oil prices pulled back this week, continuing a trend that began at the beginning of the month. We should see a reaction in gasoline prices soon, which have almost gone straight up for the past month.
- Puerto Rico sold $3.5 billion in bonds, which was widely watched, providing relief to the island and allowing time for reforms to take effect.
- Chinese industrial production rose 8.6 percent in January to February, down sharply from December and well short of expectations. Retail sales were also below expectations and fixed-asset investment was the slowest in 12 years.
- Confidence indicators continue to trend lower with the University of Michigan Confidence Index disappointing this week along with the NFIB Small Business Optimism Index, which measures small business sentiment.
- Business inventories and wholesale inventories both increased more than expected in January leaving the stocks-to-sales ratio at an elevated level. This could be a drag on future growth.
- The Federal Reserve member commentary this week more-or-less confirms that tapering would proceed as planned.
- The International Monetary Fund (IMF) released a report recently highlighting the deflation risk in Europe. It is exactly this type of thinking that could spur additional easing policies from the European Central Bank (ECB), especially as the euro continues to strengthen as it approaches the 1.40 level versus the dollar.
- There are many moving parts to the taper decision and while the Fed began the process, it is very possible that tapering could be delayed if the economy stumbles.
- Several emerging market countries are raising interest rates at an aggressive pace to either deal with inflation or a weak currency. It could be the beginning of a new global interest rate cycle for higher rates.
- Trade and/or currency “wars” cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
- China remains a wildcard for economic recovery and the economy has shown some cracks in recent months. This is similar to how last year started and China found its footing, something similar needs to happen this time around.
For the week, spot gold closed at $1,382.65, up $42.67 per ounce, or 3.18 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 5.38 percent. The U.S. Trade-Weighted Dollar Index lost 0.36 percent for the week.
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- Gold posted a very strong week, rising $43.07 per ounce as Chinese macroeconomic data revived fears of a global slowdown, and geopolitical tensions brewed ahead of the scheduled Crimea referendum this weekend. Furthermore, and as shown on the chart above, the 50-day moving average closed less than $10 below the 200-day moving average, which implies that barring a gold collapse below $1,300 next week, we should see gold making a golden cross before the end of the week. Our analysis shows that, going back to 2000, a golden cross in gold is followed on average by a 50 percent rally lasting on average 15 months.
- Gold ETFs appear to be back in fashion, as total known gold ETF holdings are now 870 thousand ounces higher since bottoming at 55.8 million ounces in mid-February. The ETF data comes as the situation in Ukraine reinforces gold’s safe haven status and the weak macroeconomic data coming from China highlight gold’s hedging properties amid a risk-off investing environment.
- Pretium Resources announced the addition of James Currie to its executive team as chief operating officer. Currie has notable mine-building experience, and was recently chief operating officer for New Gold where he led the construction of the New Afton gold mine. On a different note, Aldridge Minerals received environmental approval for its Yenipazar Project in central Turkey. With the completion of this milestone, Aldridge is positioned to advance the project towards financing and construction.
- The China Gold Association (CGA) said China’s gold demand may decline by 17 percent to 250 tonnes in the first quarter of 2014, from 300 tonnes in the first quarter of 2013. Despite this fact, CGA vice chairman Zhang Yongtao expects annual demand to remain strong at 1,176 tonnes, very close to the actual annual demand for 2013. According to HSBC Research, Mr. Zhang's forecast indicates that China's gold demand should be stronger for the rest of 2014 after the first quarter, when compared to the same period in 2013. This may indicate that China's strong appetite for gold is likely to be sustained well into 2014.
- As part of its fourth-quarter results release, Detour Gold stated it is permitted to enter into transactions to hedge up to 50 percent of its forecasted gold sales. As a result, Detour sold forward 40 thousand ounces at $1,241 and 45 thousand ounces at $1,327, for a total of 85 thousand ounces at $1,287. With gold closing above $1,380 per ounce today, it could be said that the hedging exercise will cost Detour shareholders nearly $80 million in forgone revenue this year.
- Hochschild Mining suspended its full-year dividend despite beating its production guidance. According to the company’s top management, 2013 proved to be a very challenging year, and despite the cost saving and cash flow optimization measures implemented, the company posted a net loss of $128.7 million after impairments, and decided to suspend its payout.
- A Royal Bank of Canada report shows similarities between the 2005 to 2008 gold price rally and the current gold price environment, which analysts believe could lead to a sustained gold price rally over the next 12 to 24 months. While still early in gold recovering from its lows, Chinese and emerging market gold demand combined with the absence of central bank selling both offset any ETF liquidations. Given the volumes seen in China recently, and the fact the Chinese market is not as price sensitive – thanks to high savings rates – Chinese demand on its own could replicate the 2005-08 ETF-driven gold rally.
- Integra Gold Corp. reported the results of the preliminary economic assessment carried out at its flagship Lamaque Gold project in Val d’Or, Quebec, showing an expected after-tax internal rate of return of 38 percent on peak annual production of 143,000 ounces per year. The Lamaque project is one of a handful of high grade, low capex, and stable jurisdiction projects in development right now. On a similar note, Alacer Gold reported record annual gold production at its Copler gold mine, at all-in costs of $864 per ounce. The company expects this outstanding performance to continue into 2014, at one of the lowest all-in costs in the industry.
- An independent analysis has determined that Australia’s Mineral Resource Rent Tax (MRRT) has only managed to raise A$232 million this fiscal year, a far cry from the A$4 billion originally forecast. A spokeswoman for Australia’s Treasurer Joe Hockey stated the tax should be eliminated because it has destroyed jobs and investment. Australia’s Prime Minister Tony Abbott has pledged to repeal the tax.
- A recent report by several non-governmental organizations including the Sierra Club asserts NAFTA “provided the ingredients for an explosion of dangerous foreign mining activity in Mexico.” Dorothy Kosich, Americas’ Editor for Mineweb, reports contents of the original report stating Mexico has become the largest importer of multiple toxic chemicals which are major sources of water contamination. The report concludes that NAFTA has protected foreign mining corporations and allowed harmful environmental impacts to Mexico.
- A wave of weak economic data released by the Chinese government agencies this week helped propel gold higher as U.S. and Europe markets weighed the risk of a deceleration in Chinese economic growth. The weak data points released show the risk of Chinese physical gold and jewelry buyers to defer consumption to a later date. As a matter of fact, Chinese retail sales data showed growth of 11.8 percent, missing analysts’ estimates for a 13.5 percent increase. As a result, gold demand from China may be lower in the short term, or until the festive and marriage season starts later in the year.
- The instability in Ukraine, together with the China hard-landing fears, has not changed Goldman Sachs’ bearish view on gold. According to Jeffrey Currie, the bank’s head of commodities research, the weakness in the U.S. and the turmoil in Ukraine are not driving gold. Instead, the lower mining costs mean it is more probable that gold drops below $1,000. Marc Faber on the other hand believes the near tripling of the S&P 500 since the end of the bear market in 2009, together with heavy insider selling, high valuations, and extremely high corporate profits should make any investor consider the possibility that we may be at a top of the U.S. equity cycle.
Energy and Natural Resources Market
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- The International Energy Agency (IEA) boosted its demand forecast for global crude oil consumption by 95,000 barrels a day due to improving economic growth. The IEA now forecasts global consumption to increase by 1.4 million barrels per day, or 1.5 percent, to a record 92.7 million barrels per day.
- February saw the first monthly inflows into U.S. and European commodity exchange traded products (ETFs) in over 12 months.
- The best performing commodity this year has been coffee, where prices are up over 80 percent in response to extreme droughts across Brazil. Additionally, uncertainty over grain shipments from Ukraine has also supported prices of corn and wheat.
- Despite concerns over China’s economy, the price of nickel on the London Metals Exchange gained nearly 3 percent this week on further concerns over the export ban in Indonesia.
- Chinese commodity imports showed a slow return from Chinese New Year. February imports saw a decline in copper, crude oil, petroleum product and iron ore. Steel product, net exports also decreased somewhat during the month, but remained up year-over-year. Soybean imports remained strong.
- The debt default by a Shanghai solar company, followed by weaker-than-expected Chinese trade data, sparked a sharp decline in iron ore and copper prices. The declines are also due to fundamental weakness of physical markets for both commodities due to increasing supply and weakening demand from China.
- Recent weakness in WTI crude oil could be temporary as the turnaround season for refineries comes to an end. This is especially true given that the test sale of Strategic Petroleum Reserves contributed to the selloff in WTI this week, pushing the brent-WTI differential past $10.
- The U.S. Geological Survey estimates that 3.5 billion tonnes of undiscovered copper may exist globally, enough to satisfy current world demand for more than 150 years. This assessment also notes that 2.1 billion tonnes of copper resources have been discovered.
- Utilities cash flow and dividend yield is supporting performance. European utilities have outperformed the market by 4.2 percent year-to-date supported by stable earnings forecasts, declining rates and a high appetite for dividend yield.
- Indonesia’s next president is unlikely to make major changes to the tough mineral export rules, after major political parties backed an export ban. This will disappoint miners hoping the tough new rules were temporary measures imposed by a lame duck administration.
- Libya’s central government suffered another setback this week as Prime Minister Ali Zeidan was forced out office. This could lead to further unrest in the country and disrupt the global oil market in 2014.
- Turkey’s current account deficit narrowed to $4.9 billion in January from $5.8 billion a year earlier as a weaker lira boosted exports. The reading surprised analysts who estimated a deficit of $5.3 billion. The deficit is expected to keep narrowing in coming months as a weaker lira boosts exports, and lower consumer confidence curbs imports.
- Greek stocks broke through the 1,350-point barrier this week, bringing the index to a 34-month high as banks and financial services scored the highest gains. The recent strength is a result of the latest round of stress tests performed by the nation’s central bank and BlackRock showing Greece’s four big banks will need less additional capital than initially expected to meet minimum capital ratios.
- Jakarta Governor Joko Widodo, with a solid track record as a local policymaker, won his party’s nomination as a presidential candidate for Indonesia. The Jakarta Composite Index has rallied 23 percent since its August 2013 low, and the Indonesian Rupiah is trading around a four-month high.
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- Events in Ukraine have had a clear impact on the overall region’s risk profile. Yet, positive stock market returns in some of the neighboring Eastern European markets show the Russian market appears to be bearing the brunt of the rush to sell. The chart above highlights that the market risk impact following the events in Ukraine has been largely contained to the two countries involved in the conflict. Latvia’s and Lithuania’s risk have risen as a result of their close proximity to Russia, and the significant size of their Russian-speaking populations.
- Russia canceled a Treasury bond auction on Wednesday for the second week in a row arguing unfavorable market conditions. Developments in Ukraine have sent the ruble to all-time lows, which usually coincides with higher inflationary risks, and deters investors from buying into Russian Treasury bonds.
- Year-over-year growth in China’s exports, industrial production, fixed asset investment, and retail sales for January and February combined surprised the market on the downside, triggering the worst weekly selloff in Hong Kong’s Hang Seng Composite Index since May 2012.
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- Equity fund inflows to Indonesia from foreign investors rose consistently for months ahead of the parliamentary and presidential elections in the last three election years, and 2014 is no exception with $1.7 billion inflow year-to-date. Given global emerging market fund managers’ still neutral exposure to Indonesia, and incipient macroeconomic improvement in the country after last year’s currency crisis, odds favor a continuation of outperformance from Indonesian equities.
- Industrial production in Brazil rose 2.9 percent in January from the prior month, beating analysts’ expectations of a 2.5 percent rise. The January reading is the single-largest uptick in at least a year, and highlights the possibility that Latin America’s largest economy may finally be approaching a trough.
- Despite industrial output in the 18-nation eurozone weakening in January, countries in the 28-nation European Union (EU) but outside the eurozone fared significantly better and pulled the EU’s industrial output into positive territory. Eastern Europe is home to most of the EU members that are not eurozone members. Countries outside the eurozone that recorded the highest increases in industrial production were Romania (10.5 percent), Poland (6.4 percent) and Hungary (6.1 percent).
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- Russia’s significant dependence on Ukraine for gas exports has long been a source of friction between the two countries. As a result, Russia has been diversifying its supply options through the South Stream pipeline. As shown in the graph above, Crimea may prove to be crucial for reducing the astronomical costs of the project as both depths and distances could be reduced substantially. In addition, annexing Crimea may offer Russia access to the major part of the explored offshore gas deposits and prospective hydrocarbon resources in the Black Sea.
- With Russian stocks down over 15 percent year-to-date and the Russian ruble depreciating over 10 percent, billionaires in Russia risk further losses as market volatility and the threat of western economic sanctions draw down reserves and lead lenders to make margin calls. As a result, Russian stocks may see further downside in the coming days as the balance of risk versus reward has not yet tipped into favorable territory.
- Weaker-than-expected macroeconomic data from China, along with sporadic anecdotes of corporate credit defaults and seemingly higher tolerance of lower growth from Chinese policymakers for the sake of structural reform, may sustain the negative sentiment towards Chinese equities in the near term.
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