Japan… Actionable Ideas

I’m relatively confident that without the mundane sanity of squabbling children, and my lovely mild-mannered wife, my head would explode given all of the events taking place on this ball of dirt we call home. It seems that every time I go to sleep I wake to find something of global significance smashing its way into my world, threatening my wealth and business interests. Actually what is just as troubling is the utter complacency that the markets seem to show when reacting to these events as they unfold.

Mutual fund cash levels are at all time lows, indicating cash has been deployed in the market and there is not a whole lot left in the kitty, investor sentiment is high, and the broad stock market for the most part is fairly or overvalued in our humble opinions. We’ve had a correction in the last few weeks, but relative to unfolding events its child’s play. I’m perplexed. For what it’s worth this complacency has me seriously worried. Cash actually might be the most undervalued asset class in the near term and I say that with the full knowledge that the big 3 (Euro, Yen, USD) are bankrupt and intent on destroying their currencies…. uhh, I mean debts.

Overwhelming Force of Nature

Following the Japanese quake, I recently watched with shock and awe as the Nikkei plunged 20% in a little under 2 days. The last time we saw anything of this magnitude was back in the ’87 crash. At that time I was likely blissfully unaware of any such event, and instead climbing trees and harassing my siblings.

Japan is the 3rd largest economy in the world representing roughly $5.3 Trillion. A hit to this country will not go unnoticed.  Without being too simplistic about Japan, it is a net exporter of finished products and a net importer of the commodities required to construct those same products. Estimates of the cost to the Japanese economy from the unfolding duel disasters of Earthquakes and Tsunami are running as high as $200 B. This doesn’t figure in any damage from radiation fallout, which is turning out to be a real issue.  Regardless of what the ultimate cost is, what we do know is that there will be repercussions, costs and opportunity.

When discussing this topic recently with a gentleman, I was accused of attempting to profit from the misfortunes of others. A “parasite on the underprivileged” was I think the term he used. I’ve got a thick skin, but I thought  I’d provide a very brief response to this attack, as its unfortunately an all too common view.

Ok, you got me. I go out of my way to find disasters and then relish in screwing people out of their last pennies when they are faced with severe challenges. It makes me sleep better at night knowing that someone paid me their last penny, and is now homeless and starving. The only way I can make money is by buying when everyone else is selling, and selling when everyone else is buying. I’m despicable!

What thoughtless DRIVEL!

Coincidentally when events such as the Japanese earthquakes, tsunami and nuclear tradgedy unfold, it is the very time when such do-gooders will propose that the “Guvmint” or “charity” should “fix” the problem. They do this while hitting the sell button on their e-Trade account. They see no correlation between the real world and their actions of pulling money out of companies that need capital to provide services. In other words, they’re happy to get the hell out of the way yet still have the audacity to expect others to step up to the plate to “do something,” and when its a private party and not a charity or government, clearly its unjust… but only if they profit from it; if they don’t, well its just dues. Astounding!!

Let me explain what happens in a situation like this. Nature inflicts damage to life and property. Resources are required to rebuild and repair property. Resources are required to provide medical treatment, food, shelter and clothing and a host of other services to people. An investor and speculator such as myself allocates capital to the services, people and industries that will provide these services when they are critically needed. What good is a medical facility that has no capital to purchase equipment? What good is a construction company that cannot rebuild an apartment block due to a shortage of capital?

That it happens at a discounted market price is a reflection of temporary risk miss pricing.

The hand of the market is powerful, and it should be let loose to do its work. I am not saying that the hand of the market is perfect, as that would imply collective human activities are perfect. What I am saying is that it is vastly superior to centralized government led initiatives. It is also ethically sound.

As an example I would provide you with the not-too-recent earthquake in Haiti (a centralized government led initiative) and contrast that to the Chilean mining accident (essentially a private market initiative). I believe the results speak for themselves.

OK with that as a precursor to todays topic, lets look at some of the sectors worth paying attention to in Japan.

Automobile industry

It’s entirely likely that in the short term there may be a supply shortage of parts for Japanese made vehicles. Especially those where the primary production facilities are located in Japan. I’ll be staying away, but as time progresses sound players in this market may present value.

Construction

Japan is somewhat unique in that its housing market is dominated by timber housing. Post and beam type of construction dominates the market. Lumber related companies in this sector are worth a look. I’ve had my eye on Plum Creek Timber (PCL:NYSE) for some time. I think there are better plays, but PCL will probably benefit directly and indirectly from the shipments of lumber to Asia and has the secondary advantage of acting as an inflation hedge.  Take a look at some of the Canadian-traded lumber companies as well.

Technology

Japan is the world’s largest supplier of flash memory and semiconductors. Supply shortages in these products will impact tech products of all stripes. This has the potential to impact profit margins as producers are forced to pay up for microchips, etc that are short in supply. It will in the short term be difficult for these same companies to pass on such costs to the consumer without losing market share. Short the sector?  Just yesterday Adobe shares fell dramatically as they announced a $50M hit to revenues due to the Japanese disasters.

Yen

It’s up 40% against the greenback in about 3 years. It goes without saying that the Japanese really don’t need a strong Yen right now. Intervention has in the past not been lastingly effective partly due to the BOJ giving jabs to the patient rather than an intravenous drip. It’s guesswork on my part, but I think the odds are that this time around we’ll get a concerted and coordinated intervention involving foreign central banks (They’ve already announced just so much). Would it be so strange to see Japan printing up Yen and using it to buy US Bonds? It certainly solves a couple of their problems, as well as pleasing Bernanke and the clowns at the fed.

With a debt to GDP of 234% Japan is clearly in the basket-case club. On a relative basis, the USD will likely outperform the JPY as the BOJ intervenes in the markets to weaken the Yen. Long Gold/Yen without too much leverage should pan out well.

Elephant in the room – Energy

Uranium, Coal and LPG. Since coal remains the “dirty”, polluting energy, it will be some time before policy changes in this sector. LPG stands out to me as the politically palatable solution as well as a cleaner-burning energy source.  In fact, natural gas has moved up recently, and just the other day the New York Times called it the, “… Safe energy bet.”

Japan has no natural energy sources to speak of, and as such has been very dependent on nuclear power. A loss of this nuclear power plant, and reticence to utilize it going forward, is going to put pressure on fossil fuels. The mayhem in the Middle East doesn’t appear to be just another dust-up in a sandpit this time around. I might be wrong, but I get the sense that things are getting worse in a hurry, and we’re a long way from peace in a region dominated by warring tribes.

Oil is a no-brainer in my book. Even without the Middle East in flames and Japan looking for alternative fossil fuels, the base case for oil is strong. Would I buy here now? Probably not, but only because I already own it. I’d certainly buy on weakness if I wasn’t positioned. Longer out I’m bearish Oil so note that this is a trade.

Uranium, which is likely going to be “In the Dog House” for a while, isn’t going away any time soon. The economics of uranium for mass power delivery are going to be very difficult to ignore. This will likely open up some truly astounding opportunities in this sector. What is important as investors is to keep our eye on those companies which will have the strongest balance sheets. Finding willing participants to throw money at this sector is likely to be akin to searching for Beethoven enthusiasts at a punk rock concert.  If you are looking for a good place to park some speculative money in the uranium sector, we would look at companies like Ur-Energy (URG:AMX), Bannerman Resources (BAN.TO) and perhaps Babcock & Wilcox (BWC:NYSE), maker of some of the new, smaller reactors.  The sector has already bounced, so we believe a re-test of the lows could be in order before a likely (not guaranteed) surge higher.  Also, companies like General Moly (GMO:AMEX), who mine for the more benign “ingredients” of nuclear power plants.

Interest rates

The BOJ will follow the NZ Reserve bank’s action after the recent Christchurch earthquake, either slashing interest rates or keeping them on hold. I expect no less from their US and European counterparts. The incentive to do so for any economy struggling under a mountain of debt are too great. For the adventurous amongst you, shorting JGB’s may actually work out to be a fabulous speculation this time around. There has been many a trader and speculator who has failed from this trade for nigh on 20 years now. With a debt to GDP over 200%, a potential $200B cleanup cost, a demographic implosion, and an immigration policy that is a major disincentive to acquiring a young tax base, the picture for Japanese government debt is about as appealing as signing up for a hysterectomy. Position sizing is super important here though. Don’t let yourself get wiped out. This insanity can and probably will prevail for longer than any of us think possible.

Outside of direct influences I can think of a bunch of other sectors that will be impacted, but we’ll save that for a later date.

What did I miss?

Given now the 3rd Muslim war that the US has just blindly walked into, maybe the Japanese can build some very expensive missiles to sell the US Military. It’ll help the Japanese rebuild their manufacturing base and will assist Bernanke in his mission to bankrupt the US government and annihilate the dollar once and for all.

-Chris

Instead of an inspiring quote today I share with you the photo below I took recently at a Thai food market. I never did try the pictured item to find out if the marketing lived up to its promise.

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