 | | The Daily Reckoning | Monday, July 19, 2010 |
- China's manufacturing sector pushes forward...and benefits its Asian neighbors...
- Chris Mayer describes two companies primed to "fertilize" your portfolio...
- Plus, Bill Bonner on consumer spending in the "Bubble Époque" and the paradox of making money without working...
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|  | | | Manufactured in the Middle Kingdom | | Why increased wages in Chinese manufacturing could benefit China’s Asian neighbors | |  | | Joel Bowman |
En route to Vancouver, Canada...
Stocks were up some on Monday...after falling some more last Friday. All in, major indexes in the US are still sitting a few percentage points below where they began the year. That's not too bad...until one considers that the modest move south comes after the largest, collective global stimulus program ever implemented.
Fellow reckoners are invited to make of that what they will.
Aside from the intra-day blips, month-to-month moves and year-to-date noise, there are larger, stronger undercurrents in these waters.
Right now, for example, the weary old world is witnessing the largest human migration in the species' relatively short history. People are literally marching out of the provinces all around Asia in the hope of finding a better life for themselves in the continent's swelling mega- cities.
According to People's Daily, China's official English language publication, the Middle Kingdom's urbanization level is expected to exceed 50% during the next (12th) "5-year plan."
"By 2009, China's urban population has reached 622 million people," the Daily reports, "and urbanization rate has been increased to over 46 percent by statistical counting."
Statistics can read more or less whatever you want them to, of course, so they are to be taken with a grain of salt. Still, even "ballparking" the figures inspires some awe.
"For the next 10-15 years," the paper continues, "China will still be in a rapid urbanization development stage, and the level of urbanization will increase average 0.8-1 percent every year."
The effects of this massive urbanization, as with almost any trend of such magnitude, are mixed. On the one hand, the world's most populous nation has managed to graduate some 350 million poverty-stricken people to the ranks of the middle class during the past decade. Not bad. On the other hand, she now hosts 15 of the 20-most polluted cities in the world. Not good.
Water flows downhill...birds fly south for the winter...and, whether by force of gravity of desire for a better environment, humans move to cities. For better and for worse, that seems to be the general trend of things. What is it all these people are seeking? Throngs of hard working peasants, fighting and scrapping their way out of abject poverty, are pushing hard for a better quality of life. In short, they want to be part of the "Made in China" success story.
Next year, the United States' 110-year reign as the worlds leading manufacturer will come to an end. China's manufacturing juggernaut, which exported around $1.7 trillion of factory-made gadgets and gee- gaws last year, will be the new number one.
Of course, all trends have surges and lulls, peaks and troughs. Already, the Middle Kingdom's ubiquitous "made in" branding is beginning to be replaced by cheaper competition from her Asian neighbors.
Manufacturing wages across China rose an average of 14% over the past year. This relatively nascent trend has led some, including Alistair Thornton, an analyst with IHS Global Insight, to declare that China may have reached the "Lewis Turning Point." Named after the British economist, Arthur Lewis, this is a kind of epochal moment in a developing nation's pubescent stage, when it exhausts its supply of low-cost rural workers, which, in turn, puts upward pressure on wages.
The recent, high-profile case of Foxconn Technology Group - where strikes over working conditions after a spate of suicides led to a 70% increase in wages at the company's South China plants - certainly supports the loose thesis that "Made in China" may already be under threat from the likes of Bangladesh, Sri Lanka, Viet Nam and other low cost producers. "Tools down" protests at Honda factories echo a similar sentiment, and already some high-end brands are actively seeking cheaper labor abroad. This, from today's China Daily:
Two large US companies, Ann Taylor Stores, the women's clothing retailer, and Coach, the luxury handbag maker, are poised to relocate production to countries where labor rates are cheaper. Whether this is a turning point, as some suggest, remains to be seen. To be sure, China's cheap labor pool is far from shallow. When Foxconn decided to relocate its controversial South China plants, the news sparked a bidding war among emerging "tier-2 and -3" cities around the country. Zhengzhou, in Henan province, Chengdu in Sichuan and Wuhan and Langfang in Hubei are all in contention to host the world's largest contract for the electronic maker's relocated factory. China Daily continues:
A company document acquired by China Daily shows that the Taiwan- headquartered firm, whose clients include Apple and Sony, will hire 100,000 workers from 18 cities by Sept 20. As of June, about 38,000 people had already joined. As China's manufacturing margins "thicken" due to the gradual increase in the cost of labor, jobs will indeed head overseas. But nobody in the countries buying those gadgets and gee-gaws is prepared to work for less than a Chinese factory worker. The Middle Kingdom may yet share some of its world-beating manufacturing windfall, in other words, but it won't be with the west.
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| | The Daily Reckoning Presents | | The Fertilizer Crisis | |  | | Chris Mayer |
People need food. Food needs fertilizer. One of the world's most important fertilizers is in short supply. That fertilizer is potash.
One of the first things people change as they emerge from poverty is their diet. They move toward more meat and a greater variety of fruits and vegetables. So while we may wonder about how many cars or toasters the brave new world's top consumers will want, we know for sure they'll eat more food.
But the web of food production shivers and shakes in the short term in response to economic pressures. Farmers cut back - like everybody else - in 2008 and 2009. One of the things they cut back on was fertilizer. They used 30-40% less potash than usual, for instance. Potash, a key fertilizer ingredient, saw six consecutive quarters of falling volumes.
Farmers ran down their inventories. All that deferred buying pushed North American potash inventories below their five-year averages - first time that's happened since November 2008. In some cases, farmers didn't apply potash at all. Potash stays in the soil for up to two years, so you can skip applications. But you can do that for only so long.
In any event, farmers are now returning to the market. PotashCorp (NYSE:POT)reported its highest potash volumes ever in the first quarter of 2010 - a fivefold increase, year over year. With corn at around $4, famers have every incentive to buy fertilizers. Grain prices support good returns for farmers at current fertilizer prices.
Longer term, there will be pressure to produce more food. In turn, farmers will seek to boost crop yields. Fertilizers are one way to get there. There is plenty of room for growth here, as application rates remain well below recommended rates.
Of all the nutrients, potash has the greatest potential for growth - a potential 298% increase to match that recommended rate of 66 pounds per acre.
One interesting piece of news from China in February was the government initiative to boost crop yields by sending out 100,000 agronomists to educate 160 million farmers about modern farming techniques. The goal is to boost fertilizer use and demonstrate the benefits by way of soil samples. China is the biggest fertilizer market in the world, but crucially, it lacks much in the way of potash. China must import most of its growing needs.
That's because potash is a rock and quality mines are scarce. It costs a lot of money and time to bring one online. A brand-new (or greenfield) 2 million-tonne potash mine will cost you a minimum of $2.2 billion - not including what it would cost for infrastructure such as rail, power, etc. It would also take seven years.
So the bigger-picture reasons for owning potash still make sense. More importantly, for our purposes, is the value of the stocks. We own the No. 1 and No. 2 producers of potash in PotashCorp and Mosaic (NYSE:MOS). They also produce the other nutrients, nitrogen and phosphate. PotashCorp is the second largest nitrogen producer and third largest phosphate producer. Mosaic has no nitrogen exposure, but is the second largest producer of phosphate. This latter nutrient is also a rock for which potential supply issues loom.
The April 20 edition of Foreign Policy included a story titled "Peak Phosphorous," with the subhead: "It's an essential, if underappreciated component of our daily lives, and a key link in the global food chain. And it's running out."
The story begins:
"From Kansas to China's Sichuan province, farmers treat their fields with phosphorus-rich fertilizer to increase the yield of their crops... Our dwindling supply of phosphorus, a primary component underlying the growth of global agricultural production, threatens to disrupt food security across the planet during the coming century. This is the gravest natural resource shortage you've never heard of."
You think OPEC is a force with 75% of the world's oil reserves? Well, just five countries control 90% of the world's phosphate reserves: Morocco, China, South Africa, Jordan and the United States.
The US has only 12 phosphate mines; nine belong to Mosaic. Two others belong to PotashCorp, including its facility in Aurora, N.C., the largest in the world. When food supply issues get hairy, countries essentially stop exporting phosphate. China did this in 2008. (China has the second largest reserves of phosphate, after Morocco.) I don't see a phosphate shortage as imminent, but it's a potential flash point that would surely light a fire under Mosaic's stock price in particular.
Either way, both of these stocks are potential monsters. Potash and Mosaic could double their output by 2015 and 2020, respectively. About 75% of new supply coming online till 2020 is from these two titans. This provides a powerful way to increase earnings even if potash prices go nowhere. If prices do climb, then earnings will jump sharply.
The value in these stocks, though, really comes from their huge net asset values (NAVs), as seen by looking at replacement values. In other words, let's answer the question, "What would it cost us to build these assets from scratch?"
If it is cheaper to buy the stocks than to build the assets, we have a promising situation. Think about that as if you were potash producer. If it cost you $1 billion to build a 1-million-tonne facility or $500 million to buy a ready-made potash mine in the stock market, what would you do?
All things being equal, you buy the stocks. In today's market, the stocks are cheaper than building new mines. A number of global mining giants get the attractive investment profile I've laid out for you. Vale and BHP have already made small purchases. Vale bought Bunge's phosphate mines and took a majority stake in Fosfertil, a Brazilian fertilizer company. In 2009, Vale also bought potash reserves in Argentina and Saskatchewan. BHP already owns reserves for a possible mine in Saskatchewan. All of these would be greenfield projects.
So given all the risks, expense and time... Why not just buy PotashCorp or Mosaic if they are cheaper? (Not only are they cheaper, but the assets are of a much-higher quality). In past issues, I've shown you my own conservative estimate of PotashCorp's and Mosaic's NAVs based on replacement value - $120 per share and $70 per share, respectively.
However, I could be way conservative. Morgan Stanley's estimates are much higher, to give one other estimate. They include an estimate for infrastructure. They also use average costs based on existing publicly disclosed greenfield projects. Morgan Stanley gets a sum-of-the-parts NAV of $158 per share for PotashCorp and $86 per share for Mosaic.
Therefore, both stocks are trading at substantial discounts to their NAVs. At $96 a share, Potash is selling 40% below its NAV. Mosaic is even cheaper. At the current quote of $45 per share, Mosaic would almost have to double, just to get to its NAV. And in past cycles, these stocks often traded for premiums to NAV.
The high cost of new assets also provides price support for fertilizer prices. To lay out all of that cash for a new potash mine and get just a 10% return on your investment, you'd need potash prices of $500 per ton to make it work. Currently, prices are around $350 per ton. Brownfield expansions - or additions to existing mines - are cheaper. Some can work at prices as low as $250 per ton. These brownfield expansions are what Potash and Mosaic are doing. But they've got the best assets.
All in all, I think the case for these stocks is still a good one. Earnings are highly uncertain, but the asset values are there. And we've got good catalysts going forward. The market is focused on the near-term record harvest, but I look to the long-term value in these stocks. If you don't own it already, I'd take advantage of the disparity and buy some Mosaic.
Chris Mayer,
for The Daily Reckoning
Joel's Note: Interested in 8 stocks Chris has pegged for profits thanks to China's booming middle class? Daily Reckoning readers are invited to check 'em out, for a single dollar,right here.
| | | | An Outstanding Investments Research Note: |
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| | | | Bill Bonner | | The Role of Consumer Spending in Phony Economic Growth | |  | | Bill Bonner |
Reckoning from Normandy, France...
Good mornin' captain... Good mornin' shine.
- Jimmie Rodgers
Bet you don't know what a "shine" is. See below...
On Friday, everything went down. Well, almost everything. The Dow fell 261 points. Gold dropped $22. Copper. Oil. The dollar. You name it; it went down.
Unless you name US Treasury bonds - which were up!
What does this mean? Maybe nothing. But since it accords with the direction we think the markets ought to be taking, we'll say it's a trend. It's a Great Correction. Asset prices go down. Cash goes up.
Let's go back and see where we've come from. Then, maybe we'll see more clearly where we're going.
In 1999, the US stock market - led by the NASDAQ - clearly topped out. The bubble in the tech sector blew up. Equities started down.
This happened after 50 years of credit expansion. And after much of the "growth" in the economy had begun to look suspiciously like borrowing from the future rather than real growth, debt in the private sector had reached record levels.
It was time for a bear market/credit contraction. That is, it was time for a correction.
The correction began in January 2000. The NASDAQ collapsed. And in 2001, the economy entered a recession.
But this recession was phony. Consumer spending didn't go down; it went up. Consumers kept borrowing money. It wasn't correcting the debt problem, in other words, it was making it worse.
Why? Who knows? Maybe the consumer wasn't ready for a correction. Or, perhaps it was because the feds began the biggest countercyclical stimulus program in history. The prime interest rate was dropped to below the rate of consumer price inflation. The federal budget went from about $300 billion in surplus to $500 billion in deficit (from memory).
For the rest of the decade, the big banks could borrow at less than the inflation rate. And the deficits averaged about $1 trillion every two years.
The correction of 2001 had been held up and made much worse by the feds' efforts to stop it. At least $10 trillion of additional debt was added to the system in the decade of the '00s.
And guess what? It was soon the Bubble Époque!
Stocks boomed. Spending boomed. Real estate boomed. Finance in all its formed boomed.
Growth was positive. But it was phony. Because it was almost all based on debt. It was a debt-fueled bubble - particularly in real estate.
If you take on debt in order to expand production, the extra output can make it possible to pay off the debt later, and you come out ahead. But when you borrow to increase consumption, all you're doing is taking output from the future and consuming it now. You'll have to settle up later - by taking your future output and using it to pay off your debt. Then, you're no longer borrowing from the future; you're paying off the past. And nobody likes it very much. Because it means living below your means rather than above them.
The bill came due in 2007. Subprime crashed. Then, the whole financial sector crashed, followed by the economy itself.
There are a number of ways to look at it, but we think it is most accurate to look at 2000 as the beginning of the present correction. That's when stocks hit their peak in real terms. Since then, stocks have gone nowhere. And probably 90% of the "growth" since then was phony. Certainly, the average person did not get richer; he got poorer.
But having learned nothing in the '00s, the feds set to work in '08-'09 repeating and magnifying their mistakes. Instead of running $500 billion deficits, they ran deficits of $1.5 trillion. Instead of dropping rates below inflation, they took them down as far as they could go - to effectively zero. In addition, they nationalized whole industries, bailed out big businesses, and proceeded to add immense new financial obligations that nobody really understood.
You have to hand it to the Obama administration. We didn't think anyone could be worse than Bill Clinton's bunch...but then along came George W. Bush. In comparison, Clinton seemed like a great president. And then, just when we thought we'd seen the worst administration ever, here comes Barack Obama and his team. Obama has continued all of Bush's programs (save torturing people). The war in Iraq continues. The war in Afghanistan continues. And the war on the correction continues. And Obama even added a new front - a health care initiative that is almost sure to be a financial and administrative disaster.
Not that we're complaining. To the contrary, we find it all very entertaining. But we don't think people are going to like the consequences.
The economy has been trying to correct since 1999. Every effort to stop it merely increases the size of the eventual correction. In round numbers, the US economy currently has debt equal to 350% of GDP. It averaged about half that much in the '50-'80 period. If it were to go back to that level, it would have to eliminate about $25 trillion in debt. According to the last number we saw, the private sector was currently writing off, defaulting on, or paying down about $2 trillion per year. Not bad. But that would mean another 12 years of correction.
It would go a lot faster. But, remember, the government is helping.
And more thoughts...
"Good mornin' captain, good mornin' shine..." is how "Mule Skinner Blues" begins.
A "shine" is what we call today an "African American." We don't know whether it is on the list of forbidden words or not. Rodgers uses it affectionately. It's a song about a fellow who just shows up on the job site and asks for work. Those were the days! Now, it's practically against the law to hire someone unless you have his birth certificate and social security number.
We have to be a lot more careful now than we used to be. It's not a good idea to drive past a police station without your seat belt fastened. And it's probably not a good idea to refer to Barack Obama as a "shine." It may even be against the law!
But heck, everything is against the law now. There are so many laws on the books it's inevitable that you break them from time to time. We had a couple of Henry's friends out for the weekend, helping with the work. We paid them 10 euros an hour. That is surely illegal. (If the gendarmes show up at our door, we'll know you ratted us out, dear reader. And we'll deny everything.)
We must have broken a few dozen traffic laws driving out here. We gave Henry wine with dinner. We dodged the census takers...we burnt our tree-limbs and branches in an open blaze...we installed a bathroom without a permit...and who knows what!
There are so many laws it makes us want to break them. We never felt like smoking until they made it illegal. We look for a "No Parking Zone" where we can put the car. And when Baltimore proclaimed a "No Killing Day," we didn't pop anyone that day. But we bought a handgun so we'll be ready for the next time.
*** It's a bright morning here in Normandy. We spent the weekend painting doors and windows. What a pleasure it is to work...at least when you're not getting paid for it.
The nice thing about having money is that you can afford to do honest work. You don't have to get a job and pretend. You can buy a piece of property and fix it up. Then, when the work is finished, you can buy another one. Or, you can start a business. You never run out of work!
The boys don't feel that way, though. They're redoing the joints in stone walls...and painting a fence...for money! Well, they won't actually get any cash. Instead, they're paying back their dad for expensive tickets. Henry (19) and Edward (16) said they wanted to go with us to Vancouver this week.
"Are you interested in investing?" we asked.
"Yeah...I want to make money. And I want to make money without working," Edward replied.
"That's not the way it works," we told them. |
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