Fear and Soap in China

It's the fear.

In The Frost Report I have written numerous times about the incredible rise in home prices (ie. real estate bubble) that will overcome China at some point in the future.

Chinese authorities and news agencies are incredibly open and honest about the whole situation. On May 5th, for instance, Chinese news agency Xinhua noted that, “rocketing home prices have become a major source of public complaint across China. The government raised the down payment and mortgage rates notably for the non-first home buyers to crack down on hoarding and speculation, but house prices still remain stubbornly high.” With the sense of invincibility common to the nouveau riche, wealthy Chinese citizens completely ignore warnings like this and keep buying.

Not limited to real estate, prices in China are rising for just about everything. Citizens fear that they will soon be unable to afford the necessities of life. How bad is this fear? Well, just ask Unilever China.

This March, a spokesperson for Unilever China announced that due to inflation, as of April 1st the company would be raising prices by 10-15%.

Consumers responded by panicking.

Worried about paying more for popular products like Lux soap, Omo detergent and Lipton tea, consumers flooded stores and began stocking up. Shelves soon cleared of products for both Unilever and those of competitor Proctor and Gamble. Nervous government officials warned retailers to order more inventory and keep up with the demand.

For the month of March, retailers reported sales of up to ten times the normal volume for Unilever products. On May 6th, unimpressed Chinese trade officials handed Unilever a two million yuan fine (about $300K US) for “disrupting market order.”

By making a simple announcement – “we will be raising prices” – Unilever exposed just how much inflationary fear exists in the Chinese market. People are buying not because they want to, but because they feel they have to. This new lifestyle is expensive.

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“I hate to say this, but this place is getting to me. I think I'm getting the Fear.”

Hunter S. Thompson, Fear and Loathing in Las Vegas

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see also:

REFILE-P&G and Unilever raise prices in China -paper

China punishes Unilever for price hike remarks

China's banking regulator denies report of down payment rise

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Citigroup: the 1-for-10 reverse split

Some Citigroup shareholders woke up this morning to a surprise; they found that the price of their stock had jumped from around $4.50 to $44.00!

Unfortunately, today’s price jump was not an overnight stock rush, but merely a 1-for-10 reverse split. That is, if you owned 10 shares of Citigroup on Friday with earnings of $0.31 per share, you now own 1 share of Citigroup with $3.10 of earnings per share. In other words, aside from the price, there is no material change in your ownership. Why would Citigroup do this?

CNBC suggested on its website that the reverse split was done to “improve investor’s opinion” of the stock. Other blogs have suggested that doing a 1-for-10 reverse split is a way to “trick” or “fool” investors into thinking they are buying a better company.

Pardon me for saying, but if you think that a $40 stock is “better” than a $4 stock, or a $100 per share company is “better” than a $50 per share company, you need to stop buying stocks until you know what you are doing.

In fact, there are several good reasons for doing a 1-for-10 split, none of which are listed above.

The first reason is to counter day trading. When a stock has a low price but trades with high volume (like Citigroup), it becomes a favorite with day traders. For a low priced stock, a change of a few cents means a few percentage points, and so such trades can be profitable for a day trader. Unfortunately, day traders do not add value to a company the way that long-term shareholders do. Increasing the share price helps keep day traders out and, according to Citi CEO Vikram Pandit, therefore reduces volatility. In the very short-term, the exit of day traders will likely cause a drop in Citi’s stock price.

The second reason is to bring in potential institutional buyers, such as mutual funds. Many mutual funds are not allowed to purchase a stock that is priced below a certain threshold, usually $5 or $10. At $4.50, many mutual funds are simply not allowed to buy shares, no matter how good the company might be as an investment. Although a 1-for-10 reverse split doesn’t really change anything except the price, more mutual fund managers will now be able to buy Citi shares.

The third reason is to allow pension funds to buy the shares. Just as many mutual funds are not allowed to buy stock worth less than $5 per share, many pension funds are not allowed to buy a stock that does not pay a dividend. With 29 billion shares outstanding previously, Citigroup would have found it difficult to pay even a token $0.01 dividend per share. As of today, there are 1/10th as many shares, and so Citigroup can once again introduce a dividend. Once this dividend is in place, more pension funds will be allowed to buy.

Aside from growing revenue and earnings, part of any good company’s strategy is to manage their stock. Institutional investors and pension funds add stability, since they tend to hold for weeks or months rather than just hours. And, if many institutional investors buy and hold, this limits the availability of the stock, driving up prices.

Today’s 10-for-1 reverse split was an immaterial - yet smart - long-term move for Citigroup.

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"You never want to think the best things are in the past. You want to get yourself to believe that the best things are going to be in the future."

Sandy Weill, former CEO of Citigroup


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The Death of Silver

Silver died an untimely death this week.

Retribution was swift and merciless. As soon as the Chicago Mercantile Exchange raised margin requirements (meaning you have to provide more of your own money to speculate), skittish traders headed for the hills. Silver lost a quarter of its value in just 3 trading days.

On of the big winners of the silver bonanza was billionaire George Soros. In weeks past, Soros noted that although gold prices kept rising higher and higher, the price of silver hardly moved. Realizing that at some point people would opt to buy the grey metal instead of gold, Soros loaded up. He was quickly proven correct as silver rose in a parabolic chart.

Soros reportedly sold heavily early this week: a beautiful trade - and the reason why he is a billionaire.

As for me...I'm not a big fan of jumping on any fast-moving investment train. I can't babysit my investments on a minute-to-minute basis, so I don't like investing in anything that I know will end in a major crash.

As Soros was busy making his latest millions, I received my first silver-related injury. While generously helping a client unload a large quantity of silver ingots, I somehow managed to hit myself in the face. Handling a 120-pound safety deposit box is not as easy as you might think.

Even as the blood streamed off my nose, I recognized that owning a horde of physical silver must be gratifying.

Will silver rise from the dead, and achieve its previous highs? Who knows. But, I sincerely hope that the volatility lasts for a few days more. I have been busy entering lowball orders for great mining companies, just in case the chaos continues. It would be nice if they all fill.

Silver is dead! Long live silver!

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"I feel like a virgin on prom night."

"Uncle Red," in the Stephen King movie, Silver Bullet.

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