Sunday, December 14, 2014

2015 Stock of the Year

IShares China large Cap ETF (FXI)

As I have done for the past seven years I am introducing my "stock of the year pick" for the upcoming year. The purpose of the stock of the year pick is to try and find a stock that has the possibility of doubling over the course of the following year. These picks are typically high risk/high reward selections and typically require a catalyst to get them moving. They are usually of a contrarian nature also which means that they are hated by the mainstream investment community and therefore are usually cheap and ignored. Unfortunately, for the last two years I have selected companies that have had bad news that killed their share price.

The 2014 stock of the year was Cub Energy. This is a company that drills for natural gas in Ukraine. Ukraine has exceptional pricing for natural gas due to its reliance on Russian imports ($11mcf vs. sub $4 in the US). The government in Ukraine was encouraging foreign companies to drill and apply western techniques to develop Ukraine's resources. The company has assets in both eastern and western Ukraine. Cub was having success increasing production in an environment of high gas prices. Then of course hostilities broke out and Cub was not able to continue its activities in eastern Ukraine. The new government put a "temporary" high tax rate on all gas production in order to help pay for the war in the east. This was way too much bad news for a junior oil and gas company and the stock cratered.

There has been quite a bit of volatility in the junior resource market this year so I am going to venture away from it and use an ETF this year. I am also going to recommend China. This will strike some as a strange idea considering all the media attention on the slowing Chinese economy and the impending Chinese credit bubble implosion that will be caused by the falling Chinese real estate market. I know about all this news and the attention it has been given. However, the contrarian in me also knows that when everybody already knows all of this isn't it already priced into the market? Recent experience in both Japan and the US should also have instructed us that a country's stock market performance is not necessarily correlated with its economic performance.

The conditions that fueled the recent big gains in the US and Japanese stock markets, notably an easy central bank, are now manifesting themselves in China.

Analysts say that mainland sentiment, driven mostly by retail investors, is celebrating monetary easing policies, which are seen as providing more liquidity for the current rally and also relieving Chinese banks from having to recognise bad loans by making it cheaper for borrowers to roll over debt.

China’s central bank cut interest rates unexpectedly on Nov. 21, stepping up support for the economy as it confronts slowing economic growth and mounting bad debts. Sources involved in internal policy discussions have told Reuters the central bank is ready to loosen policy again.

I have no doubt that at some point the Chinese are going to have to take their medicine  but in the meantime they will do what other central bankers have done and that is print money. The interesting thing to note is that the Chinese market has basically not done anything for years (late 2009 to be exact) until recently breaking out to the upside. China is a cheap unloved under owned market breaking out to the upside after years of sideways action. Couple this with interest rate cuts from the Chinese central bank plus a 40% drop in oil prices (China is the second largest importer of oil). All this equals a setup for a nice bull market. I am trading this with a 25% stop loss.

The blog Short Side of Long had an interesting post on the fact that Chinese stocks have had several periods over the last two decades when stocks in China have doubled.

Consider the fact that Chinese equities have doubled (sometimes almost tripled) over a 12 month time frame, five times in the last 18 years. In basic English, Chinese stocks have gone through the roof every 3.6 years in the last two decades. Also notice how the 3 year performance has been just as bad as it was during late 1990s, before the last great bull market began.

What fascinates me is the fact that throughout 2013 and 2014, pessimism on Chinese economy kept getting worse (until recently) and yet every China Stock Index refused to make new lows. Therefore, if the technical breakout seen in Chart 1 holds and continues to push higher, there is no reason to doubt that China equities could be starting a new multi-year bull market.

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