Two More Investment Warnings on Value


Investments warnings here show how China’s Factory Workers Could Destroy Your World

A warm South China sea fog swept up the mid levels like a spider’s
web in fast air. …then hung like a moist blanket over the thin ribbon
of asphalt that snaked the ridgeline through the jungle ahead. Low city
rumbles blunted the green tropical freshness and fought nature’s
cacophony of dawn. Since it is one day before my 39th anniversary of
traveling abroad, may I reminisce? Actually there is a more than a
nostalgic reason to do so.

Bowen Road runs flat as a pancake through the mid-levels of Hong
Kong . I lived there for several years decades ago and took early
morning runs most days. No one can spend time in this part of the world
without respecting the determination and competitive energy in commerce
of the Chinese. So it is with no surprise when there was a big fuss in
Wanchai.

The US was fighting an errant and losing war in SE Asia in those
days. These were the times when Pete Seeger’s song, sung by Peter, Paul
& Mary “Where have all the flowers gone, …Oh, when will we ever
learn.”

Hong Kong was filled with loads of GI’s who were shipped or flown to
HK for R&R. Most of them were not in town to look for flowers.

Wanchai was a district full of bars and a few years early Nancy Kwan
and William Holden starred in a popular film version of Richard Mason’s
book, “The World of Suzie Wong”.

Many of the soldiers, sailors, marines and pilots headed quickly to Wanchai to visit its numerous girlie bars.

One competitive entrepreneur who owned a bar or two in Wanchai came
up with a great new gimmick… all the beer you could drink…just five
dollars. This was back in the days when a dollar was still worth
something but really…these were young sailors and soldiers on R&R
who did not know if this would be the last fling of their life.

“How can the bar afford this?”, we often thought. These warriors
could and would slug away a lot of beer and stay the night. They also
would not be polite about not drinking too much. Was the beer watered
down?

Investment Warning #1

Not quite, we finally learned when one of the sailors died. Turns
out the bar owners were lacing the beer with arsenic. The drinkers
would chug a few glasses, feel sick and head back to their ship or
hotel. Finally someone died and this let the cat (or should I say the
arsenic) out of the bag.

Investment Warning #2

The reason I recall this is that it came as no surprise when I was
forwarded yesterday’s New York Times headline “Filler in Animal Feed Is
Open Secret in China ” by Ariana Lindquist

The article said: “As American food safety regulators head to China
to investigate how a chemical made from coal found its way into pet
food that killed dogs and cats in the United States, workers in this
heavily polluted northern city openly admit that the substance is
routinely added to animal feed as a fake protein.

“Workers at the Shandong Mingshui Great Chemical Company say they
commonly add the chemical melamine in the process of making animal
feed. Melamine appears as protein but has no nutritional value. For
years, producers of animal feed all over China have secretly
supplemented their feed with the substance, called melamine, a cheap
additive that looks like protein in tests, even though it does not
provide any nutritional benefits, according to melamine scrap traders
and agricultural workers here. ‘Many companies buy melamine scrap to
make animal feed, such as fish feed,” said Ji Denghui, general manager
of the Fujian Sanming Dinghui Chemical Company, which sells melamine.
“I don’t know if there’s a regulation on it. Probably not. No law or
regulation says ‘don’t do it,’ so everyone’s doing it. The laws in
China are like that, aren’t they? If there’s no accident, there won’t
be any regulation.”

This article provides an important investment warning to understand about value.

Investment Warning #3

We live in an era where marketing and spin are considered more
important than reality. Marketing research is more valuable than
R&D. A brand’s image is more important than its quality control. If
something goes wrong, containment is more important than correction.
These facts can have a dramatic impact on value.

Let’s take Alpo and Purina dog food as an example. These brands are
owned by Nestle, a huge and seemingly safe company to invest in. Why?
Because people trust the name, Nestle.

We now know that a Nestle company allowed the food cooked and served
to be laced with a poison. So much for care or product control. What if
consumers suddenly realize that the same care may go into the milk, or
the candy bars and such? Or how about the Nestle’s baby food? Nestle’s
website even focuses on baby food and says:

“The production of infant food goes right back to the origins of the
Nestlé Company. Henri Nestlé’s ‘Farine Lactée’ was the first product to
bear the Nestlé name. In 1867 a physician persuaded Henri Nestlé to
give his product to an infant who was very ill — he had been born
prematurely and was refusing his mother’s milk and all other types of
nourishment. Nestlé’s new food worked, and the boy survived.” Nestle
even bought Gerber’s Baby foods for $5.5 Billion.

One simple thought because a Nestle subsidiary did not correctly
care for its supply line could wipe billions of dollars from the
company’s share value overnight.

In other words the attitudes of a few factory workers in China could
bring a huge company (like Nestle or whatever) to its knees.

But there is an investment warning that is much worse!

This investment warning is not that Nestle is bad nor that the baby food industry will suffer due to a pet food recall.

The investment warning is that global markets create a new dimension
of quality control that has not totally evolved. The global market
place creates enormous opportunity, but for now also makes the world
less safe. The global market place forces manufacturers to use global
supply lines. The more extended the lines, the less control. The more
nations (and systems) are involved, the more confusion. Take less
control, throw in confusion, add in an image dominated market place and
mix in one scandal. Bingo, you get panic in a flash.

This is important to know because risk aversion is important right now!

Yesterday’s message warned of a deadly equity mixture, the downside
of seasonality and a number of highly leveraged, thinly traded equity
markets. Investors have not been risk adverse recently but showed in
early March that they are ready to immediately become so. The Chinese
equity market crashed 10% overnight. The world followed.

The gun is loaded. The hammer is locked. All we need is one little pull.

This problem is magnified by a second investment warning from one of the world’s best investors.

An email article from the street entitled “All the World’s a
Bubble”, says Legendary Value Investor Jeremy Grantham by Brett Arends:

“The bursting of this bubble will be across all countries and all
assets. — Jeremy Grantham. While euphoria sweeps stock markets here and
worldwide, there are at least a few voices of dissent. One,
unsurprisingly, is legendary value investor Jeremy Grantham — the man
Dick Cheney, plus a lot of other rich people, trusts with his money.
Grantham, chairman of Boston firm Grantham Mayo Van Otterloo, has been
a voice of caution for years. But he has upped his concerns in his
latest letter to shareholders. Grantham says we are now seeing the
first worldwide bubble in history covering all asset classes.
Everything is in bubble territory, he says. Everything. ‘From Indian
antiquities to modern Chinese art,’ he wrote in a letter to clients
this week following a six-week world tour, ‘from land in Panama to
Mayfair ; from forestry, infrastructure and the junkiest bonds to
mundane blue chips; it’s bubble time! Everyone, everywhere is
reinforcing one another,’ he wrote. ‘Wherever you travel you will hear
it confirmed that ‘they don’t make any more land,’ and that ‘with these
growth rates and low interest rates, equity markets must keep rising,’
and ‘private equity will continue to drive the markets.’ As Grantham
points out, a bubble needs two things: excellent fundamentals and easy
money.”

I am not sure I can disagree. Look at the performance of the five
portfolios I developed and am tracking this year with the help of Jyske
Bank.

Last year we had, what I consider, really outstanding performance:

US Dollar Long

9.04%

US Dollar Short

10.43%

US Dollar Hedge

11.46%

Emerging Market

42.93%

Asia Emerging Market

114.16%

These annual returns are a portfolio manager’s dreams. This is hitting .400 in the big leagues.

Yet look at what has happened so far this year.

chart_1.jpg

You can get our upcoming portfolio update and learn why these
portfolios have performed so well. See International Investments Course
with Multi Currency Investments and Portfolios

At our upcoming IBEZ in N.C., we will update our green and other
multi-currency portfolios and much more. Join us May 25 – 27, 2007 at
the International Business and Investing Course in North Carolina.
Thomas Fischer joins me to update global economics there. International
Investments and International Business Course, West Jefferson, North
Carolina, May 25-26-27, 2007

My 38 years and 364 days of international experience had a bit to do
with this. Jyske Bank’s skills and excellent organization added a lot.
Yet such profits are not normal.

I am taken back to the early 70s when gold was selling at $860 and
ounce and silver $48 an ounce. A lot of people who investing in those
precious metals thought they were geniuses….but the gold and silver
dealers did not. I recall that the spread on silver was $48 sell, $38
buy. Those with real experience in the metals markets were
nervous….with reason. So my take is…this is great…but we must now take
extra care…profits are coming too easily and life just does not
normally work this way.

If this investment warning is wrong, I am the first and most
delighted. Yet you are warned. There are many reasons to exercise extra
caution now.

Until next message, good investing.

Gary


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