ArabianMoney.Net

ArabianMoney in Dubai has been following Bill Bonner and The Daily Reckoning crew and their decennial declaration of Japanese stocks as the ‘Trade of the Decade’.

Mr. Bonner’s London office has golden balls on the roof – and a red flag predicting a stock market crash very soon – but you really need balls of a stronger metal if you are thinking about investing in Japan.

Undervaluation

After a 20 year bear market Japanese companies are indeed incredibly undervalued on price-to-book but there is still the absence of the spark necessary to revive the market. It might well come within the next decade. That makes Japan a smart decennial pick but not necessarily for those with more immediate time horizons.

For the ‘Trade of the Year’ nearby China is looking much better as a short. Mr. Bonner’s MoneyWeek team in London have been goading the Chinese dragon as a bad case of hot air and monetary inflation.

They are in good company with the King of Shorts, Jim Chanos whose string of shorting hits includes Enron and sub-prime. For this sovereign to tilt his lance in the direction of the Chinese dragon is news indeed, and he is making no secret of what he clearly hopes might be a self-fulfilling prophesy (see this video).

ArabianMoney has been talking about how to short China with ETFs, and how did we do yesterday? FXP up 7.9 per cent, CZI up 7.5 per cent and EDZ up 6.44 per cent.

Friendly trends

They could reverse out again tonight. But if the trend is your friend – and if the shorts are right then we are talking about a six month or so bear correction for China – you could see these instruments compound to the upside at a ferocious speed.

Jim Chanos is not the only investor to note that shorting can be highly profitable. You just do have to get it right, for compounding works even more aggressively in reverse with these ETFs. This is not for widows or orphans or for anything more than the speculative portion of an investment portfolio.

So for a solid and reliable investment for 2010 ArabianMoney is still behind gold, and silver if you don’t mind a bumpy ride. But for something more exciting with greater upside shorting China looks the ‘Trade of the Year’. Perhaps Japan can wait another 12 months!

Already faltering after a record rally from the depths of last March, global financial markets are facing an unwelcome headwind from China where the authorities have unexpectedly tightened bank lending, leading to fears that the local stock and housing asset bubble will now explode.

The Shanghai Composite Index dropped 2.9 per cent yesterday and the Hang Seng Index fell 1.9 per cent on news that regulators had told some Chinese banks to limit lending.

Oil price down

Any slowdown in demand from China will clearly be bad for global commodities, particularly oil and industrial commodities. Shares in mining groups are falling today on the news from China, and oil is off a buck.

Readers of ArabianMoney will not be terribly surprised to hear that Chinese stocks are falling. For the past month a number of articles have highlighted the danger in investment in the booming Chinese market which has become a classic bubble (see this article, and this one).

The King of Wall Street Shorts, Jim Chanos is actively promoting a shorting strategy for Chinese stocks (see this video) and we have been looking at which ETFs offer the best shorting option for China (see this item).

The question is not if but when to short China. Short ETFs can lose a great deal of money while you wait for a market to crash, so you need to be pretty sure.

Shorting the sweet spot

One strategy is to deliberately miss the start of the downturn and attempt to capture just a part of the fall before it hits bottom. Even that is tricky as the Chinese authorities will surely reverse their action to some extent if a market correction becomes a rout.

But it ought to be possible to capture some of this market movement. However, it is really the longs who should watch out. For a correction in Chinese stocks will drag the entire global financial market down, and the extent of the recent rally will come under critical scrutiny.

So selling out of long positions and going into global short positions might also be very wise. Don’t get burnt by the Chinese dragon.

It is curious to read Thomas L. Friedman’s attack on shorting China as a valid current investment strategy. He is appalled to hear that the ‘King of the Shorts’ Jim Chanos is shorting the Chinese economic miracle (see this video).

Friedman did not make billions shorting US sub-prime loans like Mr. Chanos, nor did he warn on Enron (and make a fortune shorting its stock). Successful investors seem better placed to make tips than a Pulitzer Prize winning author and a highly respected Middle East correspondent whose fortune is comparatively modest.

That said Mr. Friedman commands a huge readership for his twice weekly column in the New York Times, and what he says clearly carries some weight. So why is he against shorting China?

Anti-short case

First, he says ‘never short a country with $2 trillion in currency reserves’. Fine but in the case of China that is only $1,600 per capita. And if you have been spending on a stimulus plan equivalent to half your GDP in the previous year things can clearly not go on like this forever.

Second he cites and dismisses the relevance of China’s ‘enormous problems’ including ‘low interest rates, easy credit, an undervalued currency and hot money flowing in from abroad’. That is indeed the immediate source of the 29 per cent growth in the money supply and the bubbles in the stock market and housing.

But Mr. Friedman is viewing China through the looking glass of Wall Street rather than getting down to the economic fundamentals of an over-expanding emerging economy where the next phase in the business cycle is an unavoidable and massive slump.

It is much easier sat in Dubai as a long-standing correspondent of this city to understand how that can happen. Booms will go bust, and the bigger the boom, the bigger the bust.

Exports crash 16%

Why does Mr. Friedman imagine that the Chinese have pumped such a huge amount of money into their economy over the past year? It is for one reason: the export machine that made China rich has suffered a massive contraction in demand. Chinese exports fell by 16 per cent last year, and that really hurts if exports amount to 38 per cent of GDP.

The real problem for China now is that you cannot actually brush such a huge business crash under the carpet without economic consequences. Those consequences are the massive bubble in stock and housing prices, and the correction from a liquidity driven asset boom is generally a vertical down.

Longer term this might just appear as a big blip on the chart of the long upward march of the Chinese economy, or it might be a correction back to the reality of a very poor country whose economic policy has run horribly out of control. My guess would be somewhere in between, with a shorting opportunity of the century.

Spectacular video of the opening of the Burj Khalifa, formerly the Burj Dubai and today named after the President of the United Arab Emirates of which Dubai is a member. Now revealed at 828 metres tall, the Burj Khalifa is twice the height of the Empire State Building in New York and the tallest building in the world.

Marc Faber once suggested that if you did the reverse of what the Swiss banks said then you would have a rewarding investment career. I do remember the warnings about gold being over-priced at $400 from a very well qualified lady analyst from Credit Suisse visiting Dubai. So perhaps for a contrarian this video is a lesson in what to be contrary about!