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June 2009 Newsletter: Profit taking time is here.

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May of 2009 was another good month for equity investors. The DJIA ended the month up 3.0% marking it the third consecutive month of gains. It gets even better by looking at the compounded return for the three months, amounting to 20.4% for the DJIA. This marks the best three months return since November 1998!

But it just gets even better by looking at Chinese stocks listed in the U.S. and in overseas. The Shanghai Composite is up 6.3% for the month and is up 26.4% for the three month period. The Hang Seng is the winner of this contest by a staggering 41.8% for the last three months. Chinese ADRs listed in the U.S. gained half of that but still outperformed the DJIA.


Now looking at our customary chart on the first page depicting the performance of major indices since the beginning of the year, the performance of the Shanghai Composite is absolutely stunning. The index is up 44.6% in 2009 far outperforming any benchmark. The Hang Seng index in orange caught fire in May playing a catch up with its domestic benchmark.

Major indices in 2009


So it looks as if risk takers got rewarded for not abandoning emerging markets.

We turned cautious last month suggesting you take profits off the table, an advice that we continue to say. Corporate earnings in the U.S. came out mixed with a positive bias but the housing market is not out of the woods yet. Even more worrisome is the soft employment numbers combined with rising commodity prices.

So while on one hand we more than welcome the rally on the other hand we warn you that the road to recovery is not going to be a walk in the park. Be prepared for a bumpy ride ahead.

Many point out that the staggering performance of the Shanghai Composite is just a bounce back from a disastrous 2008 performance, a year when China’s barometer crashed 64.5%.

There is certainly some truth to this argument since emerging markets are much more volatile, as experience has taught us. To be precise the DJIA lost just over 30% in 2008, a disastrous performance for the DJIA but a darling compared to Chinese indices.

But by looking at the chart below, we come to realize that for a 52 week period the Shanghai Composite in dark green has outperformed both the Hang Seng Index in red and the DJIA in blue. This performance of these indices imply that Chinese equities are not just technically supported, e.g. a simple bounce back, but are driven partially by fundamentals.


Bears are quick to point out that stimulus packages are not the best way to stimulate the real economy. This argument goes onto suggesting that the resurgence of Chinese indices is deceiving because corporate earnings have yet to follow.

But the matter of fact is that earnings are improving in China, according to the latest report of the Bureau of Statistics release on May 31, 2009. Based on this report earnings of industrial companies in 22 provinces in China improved in April compared to the first three months of the year. Combined net income fell 27.9% from a year earlier in April, an improvement from a 32.2% fall for the first three months.

Another piece of information suggesting that China is on a track to achieve close to the targeted 8% GDP growth for 2009 is based on a Bloomberg survey published on May 29. According to the article “China Economists Raise Growth Forecasts Amid Signs of Weakness”, the median estimate of 14 analysts for China’s GDP growth improved to 7.5% from 7.1% in February.

If that’s the case then the resurgence of the Chinese indices is well grounded and the question remains how to join the ride.

While we have some ideas what sectors are worth looking at right now, let’s be quick to point back to the warning on the previous page. If the DJIA pulls back then Chinese stocks will fall twice the speed and thus we urge you to exercise caution.

We’re not saying to abandon Chinese equities, but you have to be selective. As the chart below testifies, the Shanghai Composite is still underperforming the DJIA measured since its peak in October 2007. So if you happened to jump the train close to the peak of the unprecedented Chinese bull run, as many investors did, you are still in the woods.


While I personally pay attention to technical analysis and admit its usefulness, sensitive investors have to consider fundamentals in addition.

One of the key factors in estimating corporate profits for Chinese companies has been the price of the oil.


As the chart above testifies the price of crude hit $66.64 by the end of May, a record for 2009. It seems unlikely that oil will go back to under $45 in the near future and if that’s the case then we should pay attention to the following companies.

One of the most obvious is Petrochina (PTR), Asia’s largest oil producer. The company is benefitting from high oil prices and the profit outlook is even better after Beijing dropped the windfall tax back at the end of 2008.

Another obvious benefactor is CNOOC Ltd (CEO), China’s offshore oil producer.

Sinopec completes China’s oil triumvirate but as I said before Sinopec is adversely effected by high oil price and my advice is again, sell.


I suggested selling Shanghai Petrochemical (SHI) in the past Newsletter and I stress it again, if you haven’t done so. Both SNP and SHI had a 60% plus rally since March 2009 as the chart on the bottom of this page testifies, and with oil climbing higher, it’s time to cash in.

Looking at the airliners, high oil means high kerosene cost, the simple largest cost item for the companies. Both China Eastern Airlines (CEA) and China Southern Airline (ZNH) have been in the Conservative Portfolio for a long time and it is time to take profits off the table. ZNH was added to the Conservative Portfolio in November last year at $7.88 a share. It last traded at $15.10, making it a 91.6% return for the last seven months! China Eastern Airline (CEA) was added in February at $13.51 split adjusted price and is up 66.8% since then.

High oil price does a lot of good for way oversold Chinese solar companies. Based on previous estimates, solar starts to make sense when the crude is above $60 a barrel. With Chinese solar companies in a vastly oversold position, risk takers could venture back into the arena. Though most solar companies are up double or triple digits in the last three months, but given that they lost 80% or more of market cap a year before, they are still playing a catch up. But you have to be very selective and I suggest you sticking to the industry leaders. Suntech Power (STP) is a good start but LDK Solar (LDK) has problems. Trina Solar (TSL) has strong technicals but is fundamentally not as good in my judgment. If you are willing, get some Canadian Solar (CSIQ) instead.

High oil is good for Yanzhou Coal (YZC), the third largest coal producer in China. The price of coal is quasi international in China meaning that it follows international prices very closely. So as oil gets more expensive so is coal, making an easy case for Yanzhou.

Besides airliners, power generators are adversely affected by rising energy prices. Huaneng Power (HNP), the largest Chinese independent power generator, is thus hurting and I suggest you short it.

Another piece of advice I have to you is to cash out of pinks. As you recall, I just made a case for three pink sheet Chinese companies last month. As the following charts suggest, you have achieved TREMENDOUS returns on all of them just in a month. Angang Steel is up 36.9%, Jiangxi Copper is up 20.8% and Tsingtao Beer is up 47.3% since April 31, 2009. And while I still believe these are sound companies, these astonishing returns just for a month sound too good to be true. Cash out before it’s too late.


And finally, I have been bullish on Aluminum Corp. of China (ACH) since November 2008, when it was trading under $10. Then I said ACH is a steal under $10. It is standing at $24.39 right now and I think a short term (1-3 month) correction is very possible. My advice to you is to take some profits off the table.

Wish you profitable investing, Blaze Fabry

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