Archive for December, 2006

Caution: new high in Shanghai Stock Exchange Composite Index

Saturday, December 30th, 2006

Today, we just looked at the chart of the Shanghai Stock Exchange (SSE) composite index and found that it had hit a new high on the last trading day of 2006:

Shanghai Stock Exchange Composite Index- last trading day of 2006

With the vast pool of foreign money pouring into China (see Why is China printing so much money? and Speculative fervour in the Chinese stock market), this is expected.

An example of such foreign money joining in the wild party of raging liquidity in the Chinese stock market is the AMP China Growth Fund. That fund listed on the Australian Stock Exchange (ASX code: AGF) on the 22nd Dec 2006. Within 4 short trading days, the price of AGF surged 20% upwards to $1.20 from its issue price of $1.00. Should we sink our money into AGF? Let?s take a look at its 4 days of trading history?on its first trading day, the volume of trade for that stock was 5.3 million. On the second day, it was down by half to 2.7 million. On the third and fourth day, it was down to 1.8 million and 1.4 million respectively. What do you see? As the stock price surged upward, the quantity of volume traded declined significantly. It looks to us that the upward momentum for the stock is weakening.

Next, we look at the above-mentioned chart for the SSE. Looking at the technical indicators, we see that the upward momentum is very strong?in fact, too strong for our comfort. Also, the chart is becoming parabolic in shape, almost becoming a vertical line at the end. And here is a number one basic rule of trading: when the chart becomes parabolic to the point of becoming a straight line, it is a classic sign of a bubble about to burst. If you are holding that stock, get out as soon as you can. That is what happened to the gold price in May 2006 before the correctional crash. If you look at the 10-year chart for gold, you will see a parabolically vertical line around that time:

10-year gold chart on final trading day of 2006

Again, we would like to stress that we are not trying to predict an imminent crash in the SSE (and a corresponding crash in the AGF). We are urging the exercise of caution?the party cannot last forever. As with most bubbles, the collapse in price is usually more rapid than its rise.

Analysing Web 2.0 businesses: Shoutwire vs Digg case study

Thursday, December 28th, 2006

The advent of the Internet heralds the Information Age, which brings in radically different ways of doing business from the preceding Industrial Age. Unfortunately, the Information Age is relative new and many business people have yet to fully grasp and understand the implications of this paradigm shift. With the proliferation of Web 2.0 businesses (e.g. Digg, Youtube, Google, etc), how are we to comprehend the significance and viability of each one of them? Hence, we will look at the art of analysing Internet businesses for their investment merits, using Shoutwire as a case study. For today?s topic our recommended reading is New Rules for the New Economy, which among the books in the Recommended Books section.

Before that, let us give a quick introduction to the idea of community-based news. The philosophy is very simple. An individual in the community will submit news stories to be voted (in favour of or against) by the rests of the community. Through voting, the community express its collective view on the value of the submitted story. Popular stories will be promoted to higher visibility whereas unpopular ones will be demoted to obscurity. Thus, the power of the community?s collective wisdom is harnessed to do the bulk of the dirty work of promoting, editing, filtering and censoring. This is a very powerful concept. A few web businesses emerged to implement this concept. To name a couple: Digg and Shoutwire.

However, not all businesses are created equal. Some will survive and others will wither and eventually die. In this article, we will look at Shoutwire as a negative example of how not to do a web business. As Graeme Philipson said in this article, The coming digital showdown:

We are not even a decade into the digital millennium and already the battle lines have been drawn. Two camps have emerged, each with widely divergent views on the nature of information, who owns it and how it should be distributed.

The forces are at this stage evenly matched, and it is not apparent from the day-to-day squabbling which side will emerge victorious. But one side must, because their views are diametrically opposed and can’t coexist in the long term.

On one side are those who believe information is a commodity that can be owned, bought and sold, and its distribution controlled. This naturally leads to a restrictive view of information. This group comprises most of the music, publishing and film industries, and most hardware and software companies.

On the other side are those who believe that information by its nature should be free, and that its distribution should be uncontrolled. This viewpoint naturally leads to an expansive view of information.

It would be clear from this article that which camp Shoutwire belongs to.

First, we look at their submission policy, which in our view is detrimental to the long-run viability of their business: ?Remember that ShoutWire is primarily a news site and submissions which have little or no news value are more likely to be deleted than those that are news. It might seem like we delete a lot of stuff, but remember that ShoutWire is your site after we give you our brand of quality; besides that, all links that make the front page are decided by ‘you’. We?re just trying to ensure that the selection of links you have to choose from when looking for stories to shout is of the highest possible quality.?

We have quite a number of criticisms on their submission policies because they contradict the original philosophy of having a community-based news. On one hand, they deemed that the ?the front page are decided by ‘you’?, yet on the other hand, they play the role of police and arbiter in deciding which news are worthy of be voted by the community. Our views are:

  1. Their staffs perform the role of the police and arbiter. We see a significant weak point in such business policy. Firstly, staff members are people who have their own personal bias, prejudice, predisposition and perspective. This implies that any news that can make it to the voting gallery are already ?censored?. That is why some people think that Shoutwire has an ?agenda??their very policy of ?management? (in the name of quality) doomed their stories to possess a slant.
  2. Such ?management? (censorship) implies that subjective judgements of their staffs will inevitably override some of the collective viewpoints of the community. This defeats the entire purpose of having community-based news in the first place.
  3. At this point in time, they have enough staffs to play the roles of police and arbiter. But how can they possibly continue to do so without being overwhelmed in the long run when the number of submitted stories grows in magnitude?
  4. There is no way for Shoutwire staffs to be an expert in all fields of human knowledge. As such, how is it possible for them to be competent judges on the quality of technically specialised stories? For example, this site holds contrarian investment viewpoints. Does that mean we are conspiracy theorist lunatics? Or are we independent thinkers? The only way to tell the difference is to study the merits of our arguments, reasoning, logic and the origins of the school of thought that influence us. A person without specialised technical knowledge is in no position to make such a judgement.

We can see that Shoutwire?s insistence in controlling the quality of their news stories will be the cause of their decline in the long run. The whole point of having community-based news is to harness the collective power of the community to do the quality control. As such, do you think they have a cause to worry about angry teenagers, conspiracy theorists, spammers, advertisers, parasites, self-promoters and so on from ruining the quality of their stories? Such policies of theirs weaken the whole philosophy of their business model in the first place.

Next, we look at the possible long run result of Shoutwire and their rival, Digg. As Kevin Kelly?s book New Rules for the New Economy says:

Mathematics says the sum value of a network increases as the square of the number of members. In other words, as the number of nodes in a network increases arithmetically, the value of the network increases exponentially.* Adding a few more members can dramatically increase the value for all members.

By frustrating their users through deleting their submissions and locking their accounts, Shoutwire is driving their users away to their rival, Digg, which adopt a more laissez-faire and liberal approach. As a result, Digg will grow more and more in size as their members and the number of news stories increases. This in turn will increase the value of Digg?s network exponentially (e.g. more members means that there will be more pair of eyes ensuring the quality of stories), which in turn will attract even more members and news stories submission. That in turn will further increase the value of Digg?s network exponentially. The curious nature of the network gives rise to what is called a ?natural monopoly? in economics.

So, if Shoutwire continue such a self-defeating policy, we believe that the long run feasibility of their business will be put in serious question. So, after reading this article, if you are given a choice to invest in either Digg or Shoutwire, which one will you choose?

Will gold price rise next week?

Tuesday, December 26th, 2006

Today, we read this article, Gold May Rise as Investors Seek Alternative to Dollar Assets in Bloomberg. That article reported that ?Thirteen of 34 traders, investors and analysts surveyed by Bloomberg from Sydney to Chicago on Dec. 21 and Dec. 22 advised buying gold, which rose 0.5 percent last week in New York to $622.30 an ounce, the first gain in three weeks. Nine respondents said to sell the metal, and 12 were neutral.? So, from this survey, 38 per cent are bullish, 26 percent are bearish and the rest (36 percent) unsure. Further down the article, it said, ?Speculative long positions, or bets prices will rise, outnumbered short positions by 69,893 contracts, down 11,936 from the previous week, the Washington-based commission said Dec. 22.?

What does this all means?

All these differences in opinion make the market fun and interesting to observe. They make the price go up and down. Given that at this time, the bulls seem to outnumber the bears, gold may soon rise. But the market, as fickle and unpredictable as it is, may reverse course any time. As we said in The story of gold, does the mob really know the significance of gold? Does it really understand the macroeconomic big picture and history of gold? Does it really appreciate the fundamental reason for holding gold?

Further down the Bloomberg article, we read that ?Some analysts are sceptical gold can gain for a seventh straight year, a feat unmatched in the metal’s trading history. There will be ?new interest initially,? said Christoph Eibl, co-founder of Tiberius Asset Management AG in Zug, Switzerland, who predicts gold will average $580 in 2007. ?Then commodities will burst.??

We are simply amazed at how this opinion could possibly come out from the mouth of a professional money manager who has millions of dollars worth of assets under his management. Simple put, he believes that the fact that gold has been rising for seven straight years is unprecedented in its trading ?history? (the trading ?history? that he talked about is nothing compared to the gold?s long history that stretched for millenniums into early human civilisations). Thus, he reckoned that this unprecedented rise is due for a correction. The fact that he said such things betrays that he did not understand: the nature of gold (see Is gold a commodity?), the fundamental value of gold (see Entrenched perception on the value of paper money) and the history of humanity?s relationship with gold. Yes, the rise in gold price for seven straight years is unprecedented. But what is more unprecedented: such a rise in gold price or the unparalleled inflation of fiat money and credit? Does he understand the underlying factors that give rise to this phenomenon in the first place?

We shudder to think that even the professionals do not know their stuffs. And many of those professionals are handling our retirement funds.

More Chinese and Middle Eastern money heading Down Under: recipe for inflation?

Saturday, December 23rd, 2006

In our previous article, Awash with cash?what to do with it?, we asked the question of where the vast amount of surplus US dollars reserves (from China and the oil-producing Middle Eastern nations) will be recycled to.

Today, this news article caught our eye: The rush is on, the ride is wild. From this article, we learnt that according to the ANZ chief economist Saul Eslake, the private equity boom (we are more inclined to call it a ?bubble?) is funded by ?an absolute flood of money coming out of Asia and the Middle East. There is a huge amount of money looking for homes, and some is going to risky areas.?

It is forecasted that in Australia, the pace of takeover and leveraged buy-out activities by private equity will accelerate in 2007. We can imagine that with more flood of liquidity (money) heading for Down Under, we can expect price inflation to become more of a problem as these money permeate to the rest of the economy (see our article, Cause of inflation: Shanghai bubble case study, for our discussion on the Austrian School?s view on inflation).

The world is still flooded with too much liquidity (money). Just like in 1929…

Artificially undervalued coins: government interference cripple the free market

Saturday, December 23rd, 2006

We wonder at the wisdom of government intervening into the free market to maintain the status quo. Granted, sometimes the government have no choice but to impose controls in order to prevent a full-blown crisis from developing. But our question is: how did such condition (that require government interference) occur in the first place? The fact that control imposition is required points to the fact that something has gone wrong in the first place. Worse still, sometimes government prove their ineptness through their policy. The recent Thai government decision (and subsequent retraction) to impose capital restrictions to control its currency is a case in point.

Today, we look at the situation described in our previous article, One funny effect of monetary inflation: ?New rules outlaw melting pennies, nickels for profit?. This is exactly a repeat of what happened in the 1960s when the US government made it illegal to melt silver coins. The fact that the underlying value of a coin far exceeds its face value proves that there is a serious underlying problem in the monetary system. As Murray Rothbard said in What Has Government Done to Our Money?:

Government imposes price controls largely in order to divert public attention from governmental inflation to the alleged evils of the free market. As we have seen, “Gresham’s Law”?that an artificially overvalued money tends to drive an artificially undervalued money out of circulation?is an example of the general consequences of price control. Government places, in effect, a maximum price on one type of money in terms of the other. Maximum price causes a shortage?disappearance into hoards or exports?of the currency suffering the maximum price (artificially undervalued), and leads it to be replaced in circulation by the overpriced money.

In other words, the US dollar notes (artificially overvalued money) will eventually drive out nickels and pennies (artificially undervalued money) out of circulation. Even if the people faithfully obey the law by refraining from melting their nickels and pennies, we can be sure many of them are thinking of hoarding them right now. If ever the nation should be plunged into a financial crisis of hyperinflation, we are sure those coins will be traded as money at their worth far above their face values. In that case, even if the government is still inept enough to impose another law to prevent it from happening, such usage of the coins will be driven underground as a result.

We heard rumours that this state of affairs is also happening elsewhere in the world?South Korea and Philippines (where people are exporting Filipino coins to China to be melted). This is indeed another sign of the times. Be warned. Buy gold. Hoard the coins.

Joke: What is the principal export of the United States?

Wednesday, December 20th, 2006

There’s something that the US exports which is worth billions of dollars a month. It is such a ‘valuable’ item that countries hoard trillions of dollars worth of them. People are known to kill for them. Rogue countries attempt to replicate it with fakes but to no avail.

Guess what is it?

US dollars.

On a more serious note, read our article, Awash with cash?what to do with it? 

Why you may not get the best returns from the professional money managers?

Wednesday, December 20th, 2006

The vast majority of the money sloshing around and influencing the movements in the market today is from managed funds (e.g. superannuation, life insurance, hedge funds, etc) and the ?professional? money managers. Individual private investors and traders usually do not have enough weight of money to move or affect the markets in a big way.

One of the pressures that fund managers often face is the unrelenting judgment on their performance. Their performances are usually measured against their competitors? performance and against the market average. To compound their pressures, their performance is often measured on a quarterly or annual basis, which in our view is woefully too short a time-frame to form an opinion on a money manager?s skill. Thus, if they under-perform their peers in the short-term, they risk losing their lucrative jobs. As a result, many fund managers have to focus on chasing short-term gains to grab an edge from their peers even though their performance, in absolute terms are unimpressive. For example, if they lose 20% in a year, they will be considered doing well if their peers perform worse and the market average is not any better.

Where is the source of such pressure?

Many managed funds seek their business among the mass retail consumers. Most of these retail investors are insufficiently educated in the art of investing. That means the only way these investors can judge the quality of fund managers is through their performances, which are measured in ridiculously short time-frames of a few months to a year. Some of these retail investors are quick to switch their wealth to another managed fund the moment they perceive that their fund manager is ?under-performing.? As we said before in How do you define risk?, one?s perception of risk will depend on whether one is investing from the retail level or among the legendary investors of excellence. Since most people investing in managed funds are investing from the retail level, managed funds have to cater to their needs by using such simplified but inadequate and misleading metrics as quality measures.

Now, our question to you is, do you want to be just an average investor or do you want to run along with the best in investing? If you decide to choose the latter, it will certainly demand a lot of commitment to acquire the necessary skills, knowledge, wisdom and patience. Many of the most lucrative returns involve taking contrarian positions, which require patience to see them bear fruit. In the meantime, short-term relative performances are irrelevant.

Awash with cash?what to do with it?

Tuesday, December 19th, 2006

Not long ago, an Australian executive went to the Middle East to promote one of his company?s software systems to potential Arab clients. In his sales pitch, he sprinkled the words ?low-cost? all over to stress the cost effectiveness of the product. After a while, one of the Arabs pulled him aside and growled, ?What do you mean by ?low-cost?? We don’t care about the cost! Just cut the nonsense and give us what we want now!? Upon returning to Australia, that executive remarked that the Middle East is ?just awash with money.?

Just where do all these money come from?

The answer, as you would have guessed by now, is the United States. The US, being in the enviable position of having its money as the world’s primary reserve currency, is not subjected (for now) to the same rules as the other countries?it can spend more than it earns simply by printing its own dollars to pay foreigners. Thus, it can sustain greater trade deficits than would otherwise be tolerated by foreigners.

For years, the US has been running a ballooning trade deficit?its imports, which is paid by its own printed dollars, has been exceeding its exports by an ever-widening margin. From China, the US has been importing consumer goods and from the oil-producing nations, oil. The US dollars that are used to buy oil are nicknamed ?petrodollars? (the money in the above-mentioned story is such dollars).

Today, those foreign countries that account for the vast majority of US imports (namely the oil-producing Middle Eastern nations, Russia, China and Japan) are sitting on so much US dollars that they do not know what to do with it. Therefore, they recycled much of those dollars by purchasing US Treasury bonds. As a result, the long-term interest rates in the US are being artificially suppressed by those purchases.

As we said before in Will the US dollar collapse?, some of these countries are murmuring about diversifying their reserves away from the US dollars because they see that such state of affair is increasingly unsustainable. With the US continually inflating its money supply (printing money), their reserves of US dollars are increasingly become more and more worthless. In fact, we believe that given the swelling amount of US dollars in the world, its current price is overvalued.

Now, here comes a problem. Countries like China and Saudi Arabia are sitting on a massive pile of US dollars parked in US Treasuries. They also know that the US dollars are overvalued and are becoming more and more worthless as each day passes. On one hand, they would not want the US dollar to collapse to its intrinsic value because that would mean the purchasing power of their US dollar reserves would be crunched. On the other hand, they would not want to continue maintaining their holdings of US dollars because they lack confidence in its value. Selling their US Treasuries at once and using the proceeds to buy alternatives to the US dollars will be unacceptable because by virtue of the magnitude of their US dollar holdings, such action will have an immediate and significant impact on the market prices. This will have a very disruptive and destabilising effect on the global financial markets. Thus, the only sensible solution is to quietly and slowly diversify away from their holdings of US dollars so as not to disturb the market prices unduly. This would take a long period of time.

The next question is, what would these countries buy to replace their US dollars?

How do you define risk?

Monday, December 18th, 2006

The answer to this question depends on whether you are investing from the retail level or investing along with the legendary investors of excellence.

First, let?s look at the former case. In today?s financial services industry, a large part of risk is defined by the volatility of the price?the more volatile the investment is, the more ?risky? it is. This definition of risk arises from the fact that retail investors tend to perceive the safety of an investment in terms of how much of its value can be preserved within a given period of time. Since volatility does not engender the feeling of safety and confidence, it is to be avoided as risk wherever possible. The root motivation of this kind of perception is fear?the fear of losing it all. To assuage such fears, the financial services industry came up with ideas like portfolio management and asset allocation, in which their aim is to structure investment portfolios for the purpose of ‘controlling’ volatility, and thus risk, for a given return. However, in truth, no one can control volatility as much as the thermometer controls the weather. The best that can be done is to reduce the effects of volatility using past volatility behaviour as a guide.

Now, if you want to achieve results of excellence in your investment endeavour, you have to see risk differently. As contrarians, we define risk in terms of the soundness of the underlying economic and financial state. This implies that in order to understand the risk of an investment, we have to really understand the fundamental nature of the investment itself. Thus, if we invest according to our understanding of the economic and financial soundness of the investment, we should not let its short-term volatility perturb us.

To further illustrate today?s point, look at our views on gold. For this year, the gold price had been very volatile. Thus, compared with cash, the mainstream would see that gold is more ?risky? than cash. But in reality, if you understand the nature of today?s monetary system and economic reality, you will see that cash is in fact far more risky.

Hence, know your stuff.

Telstra?s share price vulnerable in the short-term

Saturday, December 16th, 2006

For those who bought Telstra T3, they made a giddy gain of 34% in one month. This gain in one month, through the extrapolation of 34% to the next eleven months, is equivalent to 6003.49% of return (compounded monthly) per annum! Of course, in reality, you will not get this kind of return for almost all of the stock market investments available in the universe. Perhaps you may find such a super stock, but we guess your chances of doing so are pretty much zero. On the other hand, if you are a very capable (or lucky) businessperson, you may achieve such a return through your own private business. But anyway, let us now all stop dreaming and get back to earth.

Today, for a change, we will delve into some technical analysis. Some analysts may scoff at technical analysis and place it in the same league as astrology. But for us, we prefer to be agnostic about it. The reason being, since there are so many traders in the market employing the use of technical analysis, it will become a self-fulfilling prophecy.

Looking at the chart for Telstra?s share price we saw that it rosed from a low point of $3.59 in 21st November to yesterday?s high point of $4.12. We guess those who sold Telstra shares at that low point must be kicking themselves now. Right now, Telstra?s share price is in a strong uptrend and has increased in volatility. However, our technical indicators are telling us that its momentum has already approached the overbought level. Therefore, it will be vulnerable to any less than favourable news in the short-term. At this point in time, short-term traders are most probably positioning their fingers at the sell trigger and will pull it at the first hint of a pullback in Telstra?s share price. Since the price of Telstra T3 instalment receipts tracks the price of Telstra shares, it will also follow suit in that event. Please note that we are not predicting the short-term fall of Telstra?s share price. For all you know, the upward momentum may continue. But in that event, it will even be more vulnerable to any short-term pullback.

However, for the long-term, our views on Telstra remained unchanged (see Is the Telstra T3 offering worth a buy?).