Taipan Editorial October 1998
Easy money in hard assets:
Play this low-risk commodity fund for 60% to 200% profits in eighteen months!
by James Passin
Stock up on bags of wheat! Hoard sugar! Buy gold coins! You'll die on the streets in January 2000 if you don't listen.
Just kidding. No, I don't believe that the dreaded Year 2000 computer bug will destroy civilization. Yes, there will be inconveniences, maybe tragedies. But I think fear-mongers have watched Planet of the Apes too many times.
What's far more likely is: a Y2K panic. Apparently, Hollywood is releasing a summer blockbuster next year about Y2K. The Y2K doom prophecy was awarded front page attention by the Weekly World News. The public could easily panic late next year, hoarding oil, food, and gold.
My chips are on a Y2K -triggered run on commodities. To position your portfolio for the huge run in commodities late next year, I recommend building up positions in commodity-related plays. Since commodities are trading at rock-bottom prices, it's an opportunistic time to load up...
Playing the commodity rebound
You should continue to accumulate beaten-down emerging market commodity
producers for the inevitable rebound. While sentiment towards oil and gold
producers is horrendous, the value in these stocks is incredible. Once it
turns around, the profits in stocks like SASOY, ASL, and HHLAF will be tremendous.
Market sentiment is difficult to time. It may take a sustained recovery in commodities to reverse all the psychological damage to commodity-related stocks. But there's a way to take immediate advantage of bearish sentiment towards commodities, while benefiting from the collapse in prices: the Commodity Trust Limited fund (CMT-London Stock Exchange).
CMT is a US$130 million closed-end fund trading on the London Stock Exchange. The fund managers try to roughly match the performance of the Goldman Sachs Commodity Index (GSCI). It's a pure bet on the general level of commodity prices.
Since the fund managers use zero leverage, the fund is totally safe. No hedge fund-like disasters for CMT shareholders - no matter how low commodities fall. CMT will participate in any broad bounce in commodities, regardless of sentiment.
Commodities are so beaten down, so despised, so out-of-favor, that they can only go in one direction: Up. I'm not an economist, but I know this: Any major change in economic reality is only recognized after the fact. Right now, betting on commodities is as contrarian as you can get.
CMT is one of the lowest-risk investments I have ever seen. Based on my bullish outlook for commodities, I rate CMT as a Strong Buy up to US$1.30 (78p) with almost zero risk and 60% upside.
15% discount - guaranteed to disappear
The real story behind CMT is the glaring 15% discount to Net Asset Value
(NAV). All funds are valued by the total NAV per share. Since closed-ends
funds are freely traded on an exchange, closed-end funds can trade at a
discount or premium to NAV.
The premium or discount is determined by supply and demand for the fund. Usually, it's a reflection of market sentiment towards the fund's assets. Also, premiums and discounts reflect the perception of the quality of the fund managers, as well as tax and liquidity issues.
You can score big if you buy the right closed-end fund at the right time. If you believe the fund's NAV will go up and the discount to NAV will shrink, you have to be a buyer.
The key to playing the discount is knowing the catalyst that will shrink it to zero. I have seen closed-end funds trade at deep discounts year after year, no matter what happens to NAV. Without a specific trigger, the discount has little value for investors.
That's why I love CMT. At the Annual General Meeting on April 30, 2000, shareholders will vote on whether to wind up the fund or continue for another five years. If the discount persists, shareholders will vote to liquidate the fund. As a shareholder, you would be entitled to full NAV. Goodbye, discount.
In the worst-case scenario, you would get US$1 worth of commodities for 85 cents. That's an eighteen-month return of 18%. Not a bad risk to take, since commodities are already at the lows.
But the 18% return assumes that there's no rebound in commodities. Taipan anticipates a 30% rebound in commodities by 2000. This will result in a 30% expansion in CMT's NAV. Since you can buy CMT at a 15% discount, your return on the fund rises to 53%. A 40% bounce in commodities would yield a 65% return on the fund!
The death of deflation
Deflation, a sustained decline in the general level of prices, is a mantra
in the mainstream press. But that doesn't mean that the mainstream press
has a handle on deflation. After all, the same experts who were warning
you about inflation when commodity prices were peaking in 1996 are now warning
you about deflation!)
Severe deflation has a tendency to become a self-reinforcing loop. Just as inflation is hard to control once it gets out of hand, deflation can spiral out of control. In a deflationary spiral, monetary policy is dysfunctional: Governments can print money, they can lower rates, but they can't make prices go up.
In my view, Asia represents a one-time deflationary shock, not a deflationary spiral. Just as the Gulf War was a one-time inflationary event (oil futures peaked out at US$40 per barrel in 1990), Asia was a one-time deflationary event. It will take some time for the global economy to work out this deflationary pressure, but it doesn't signal the beginning of a deflationary spiral.
Greenspan isn't stupid
The central banks will do everything in their power to prevent the emergence
of a global deflationary spiral. Japan just cut rates by 50% - even though
rates are already negligible. Greenspan is hinting at a long-awaited rate
cut. To prevent the sucking black holes of Asia, Russia, and Latin America
from destroying liquidity, the important central banks are (I've heard from
reliable sources) printing money to prop up the world financial system (this
supposition is backed up by global money supply figures, or OECD M1).
The panic towards emerging markets is overdone. Taipan believes that Asia and Russia will soon stabilize - setting the stage for a sustainable recovery. In this scenario, the reliquification efforts of the central banks would become excessive - supporting radically higher commodity prices.
Rock solid fundamentals
Most of CMT is invested in energy and agricultural commodities (49.3% energy,
11.5% livestock, 25.2% agriculture, 11.4% industrial metals, 2.9% precious
metal). These are the very commodities that will be most resilient against
global deflation.
Oil and gas producers have been slashing capital spending budgets - resulting in less oil coming out of the ground. Farming experts tell me that abnormal weather patterns have been threatening next year's harvest. Now, I know zilch about growing crops, but I agree that weather has been a little odd. First El Niño, then La Niña. I wouldn't discount the possibility of a supply-side shock for oil or crops.
Since CMT's annual meeting is on April 30, 2000, CMT shareholders will reap tremendous rewards from a Y2K hoarding panic in late 1999. Since commodity distributors like to keep inventories as low as possible (the latest fad in management is "just-in-time inventories"), commodity prices would inflate to mind-boggling levels - in a very short period of time!
Trump card
I use a computer system to generate trading signals for the futures market.
This system is so accurate that it generates an average 390% return on margin,
with 68% accuracy. It's a long-term trading system that signals major changes
in trend.
Recently, I have been getting buy signals in the CRB commodity index (Commodity Research Bureau) and in commodity-related currencies like the Canadian dollar. This tells me that commodities are ready to bounce. Usually, my computer system generates signals that run totally in the face of conventional wisdom - the kind of contrarian plays that yield triple-digit rewards.
I bring this up to provide technical evidence that commodities are ready for a rebound. When I talk to my collegues about the CRB Index, they argue that deflation is here to stay - and that the CRB has broken support at 200. According to their argument, the CRB will keep falling since it broke 200 (the level that marked the bottom of the last two declines).
Floor traders pushed the CRB index below 200 to hit stop losses, knocking any remaining weak buyers out of the market. Also, weak short sellers entered the market once the CRB broke 200, since this indicates a "breakout to the downside," to use their language. Since this earth-shattering "downside breakout," the CRB has solidly recovered above 200. Weak buyers have already sold. Weak short sellers are trapped. A perfect set-up for a big rally in the CRB.
300% upside from commodities
CMT is a low-risk play with 50% to 60% upside. While this represent a solid
eighteen-month return, there's an even better way to turbocharge your portfolio:
CMT warrants (CMTW-London Stock Exchange)!
The CMT warrants trade in London at US$0.14 (8p), down from US$0.56 (35p). They expire at the general meeting on April 30, 2000. The strike price is US$1.52 (95p). If commodities bounce 30%, the fund's NAV will be worth US$1.91 (119p). The warrants will be worth US$0.39 (24p) - 178% above the current price. If commodities bounce 40%, the warrants will be worth US$0.53 (33p) - 278% above the current price.
The CMT is the only way I know to turn a bounce in commodities into a 200% profit without playing futures. However, this is a high-risk speculation. If the NAV is at or below 95p (US$1.60) at expiration, the warrants will be worthless.
Buy this closed-end fund now!
At current levels, CMT is an incredible bargain. You can earn 50% to 60%
return from a modest rebound in commodities. Whatever happens to commodities,
the 15% discount to NAV will shrink to zero by April 30, 2000.
As a conservative play on commodities, Commodity Trust Ltd. fund (CMT-London Stock Exchange) is a strong buy up to US$1.30 (78p). As a highly speculative play on commodities, Commodity Trust Ltd. warrants (CMTW-London Stock Exchange) is a speculative buy up to US$0.16 (10p). You can follow the fund through the Financial Times of London.
The only American broker I know who can buy the fund and the warrants is Peter Schiff, c/o Euro Pacific Capital, 330 Washington Blvd., Suite 511, Marina Del Ray, CA, 90292, USA; tel. 800-727-7922 or tel. 310-448-8000, fax. 310-448-8008. I strongly recommend using Peter for this trade; if you overpay through another broker, even by a few pennies or a nickel per share, your potential profits will vanish.
Pohangerang
Pohang Iron and Steel, or POSCO (PKX-NYSE), released outstanding financial
results. Production rose 2.1% to 13,163,000 metric tons in the first half
of the year (1H 98). Revenue rose 29% to a record US$4.2 billion. Earnings
rose to US$496.1 million, or US$1.34 in earnings per share.
These results are incredible considering the economic collapse in South Korea! Once again, PKX has proven its operational resiliency and financial strength.
Even if PKX's profits collapsed to zero in 2H 98, PKX's price/earnings ratio would still be a super low 10! If PKX matched 1H, the p/e would drop to 5. While I expect PKX to make money 2H, the results will be somewhat below the stunning 1H performance. By my estimates, PKX is trading at 6x FY98 earnings - a ludicrous valuation for the world's lowest cost steel producer.
The economic environment in Korea is still terrible, but PKX has already discounted all the bad news. The company's balance sheet is built like a steel tank. The world's second biggest steel producer won't remain in the lower teens for long.
The yen has reversed some losses against the dollar. Yen strength is a key catalyst for a tradeable rebound in PKX. As the yen strengthens, Nippon Steel loses competitiveness vs. PKX. More importantly, yen strength tends to help sentiment towards Asian equities like PKX.
PKX is a strong buy on any dip under US$12.
The king of xDSL
Orckit (ORCTF-NASDAQ) has won the Deutsche Telecom ADSL/DSLAM tender. The
minimum order is 35,000 ADSL modem lines. With its dominant position in
Europe and the U.S. (through the GTE deal), Orckit is now the clear world
leader in ADSL.
At current levels, ORCTF has a market cap of only US$270 million. This is a very low price for the business. The stock tends to drop with the Dow, but seems to have found a bottom around US$15. At these levels, you can't go wrong.
ORCTF remains a buy at these levels.
Gold digger
Ashanti (ASL-NYSE) has jumped on the cheap gold price by making a strategic
acquisition. ASL acquired SAMAX, a Canadian gold company. The purchase price
amounts to US$135 million. Since SAMAX owns at least 1.6 million ounces
of reserves, ASL is buying reserves for US$84 per ounce-cheaper than average
exploration costs.
The SAMAX Geita property is adjacent to ASL's Geita property. The synergies are obvious. SAMAX is producing gold in Geita at an annual rate of 180,000 ounces. Production was expected to expand to 250,000 ounces. ASL will expand its production by 15% in Geita, while saving on capital expenditures through economy of scale.
According to management, the deal is earnings-neutral in 1998 and accretive in 1999. Since SAMAX shareholders have the option to take cash or ASL US$7.10 convertibles, there could be some pressure on ASL stock. Arbitrage sellers will keep a lid on the stock until the deal is closed.
ASL's CFO tells me that the company will continue to cash in short futures positions when the gold price hits US$280 per ounce, replacing the hedge with puts while freeing up cash for investments. ASL is a strong buy at current levels. Continue to write covered calls to lower your cost position.