Rare Earth Metals – China’s Trump Card?

Historical enemies Japan and China are at it again, this time about a disputed territory in the Diaoyu islands (known as the Senkaku islands in Japan).

On Sept 7th, two Japanese coast guard ships collided with a Chinese fishing vessel (or perhaps spy ship, since fishing vessels are used as spy ships by many nations). The Chinese captain (agent?) is now incarcerated in Japan, and Chinese officials are demanding his release.

There are many uninhabited "islands" in the oceans East of Japan, some of which are no more than lumps of rock a few inches above sea level, surrounded by concrete and tetrapods so they don’t wash away. The islands are important, of course, because whoever owns them can claim the surrounding mineral rights. At least, this is the presumption, despite a UN convention that “rocks that cannot sustain human or economic life of their own shall have no exclusive economic zone…”

What is interesting about this most recent incident is that China may be playing the “rare earth metals trump card" to end the conflict.

Rare earth metals are used in batteries, wind turbines, lasers, cell phones and other high-tech devices. In this latest diplomatic incident, China's customs clearance of rare earth metals into Japan has been “delayed.” China of course denies that they have implemented a trade ban.

Since China produces the vast majority of the world’s rare earth metals (more than 97% by some estimates), rare earth could become a handy negotiating tool for China in the future.

There is no doubt that rare earth metals - and therefore rare earth mining - will be an important area for investors to watch in the years to come.
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See also:

Govt Probing China's Rare Earth Trade Embargo

China will never waiver on issue of sovereignty: experts

Chinese people's willingness to travel to Japan drops amid diplomatic dispute

China denies tightening rare earth trade

Mabuchi worried about China fallout
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“Life is really simple, but we insist on making it complicated.”

Confucius
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Happy Birthday, Warren

The richest man in America turns 80 today.

In his time, Warren Buffett has positively affected the lives of thousands of investors, including those who became wealthy employing his techniques (based on the work of Benjamin Graham), as well as those who simply bought his stock (BRK.A & BRK.B).




In addition to being a great investor, people connect with Buffett because he just doesn’t act like a typical billionaire. He is frequently spotted chatting with shareholders, enjoying T-bones at the local steakhouse, or playing bridge. Several years ago, a shareholder was surprised to see Buffett and his friend, Bill Gates, walking around a McDonalds restaurant in China, looking for a table.

In recent years, Buffett has developed an almost saintly reputation, which is not entirely accurate. He has always had a complicated social life that includes “female friends.” He unapologetically buys stocks of military hardware developers, tobacco companies and breweries if he considers them to be of good value. He takes advantage of the suffering of large companies (like all good value investors) by rescuing them in return for convertible preferred shares paying high rates of interest.

Despite his arguable flaws, however, most agree that his positive attributes - both personal and business - vastly outweigh them. While most billionaires are hated simply because they are billionaires, Warren Buffett’s likability and charm have actually grown with his riches.

Honesty and humility go a long way.

Rationality adds still more.
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”Testing…one million, two million, three million.”

Warren Buffett, at the microphone of the University of Florida
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Are U.S. Stocks “Cheap?”

Reading the news, one could easily be duped into believing that stock prices accurately reflect the business potential and economic health of a nation. Of course, this is false.



Although stocks do, over the long run, tend to reflect underlying profitability and growth, in the short term stock prices and reality are not even necessarily related.

In the short term, stock prices are largely dependent upon the mood of investors. During times of pessimism, a company's earnings of $1.00 per share may give the stock a value of approx $10-14, or a P/E of 10-14. During times of optimism, the exact same stock with the exact same earnings may be valued at between $17-20, with a P/E of 17-20 or higher.

At present, the DOW 30 Index (thirty of the largest corporations in the US) has a collective P/E ratio of approx 18. Is this cheap? No. Is this expensive? It depends on your expectations.

A P/E ratio of 18 indicates that investors expect the profitability of the companies in the DOW to improve. That is, investors are willing to pay a slight premium over current earnings, with the understanding that earnings in in the near future will be greater.

Yesterday’s selloff was thousands of investors second-guessing their expectation that the US and world economies will improve. If the US economy declines, today’s stock prices are indeed slightly overpriced. If the US economy improves – even modestly – today’s stock prices are perfectly in line: neither overpriced nor underpriced.

Many world markets are set to slow down or even decline, including mainland China, Hong Kong, Taiwan, Canada, Australia, Israel and others – all of which has been well-documented in this blog. Yet, the US market will continue to improve, albeit slowly, because of various factors that I will be covering in detail in the days and weeks to come. The US economy was hit by the crisis first, and it will also be the first to emerge from the crisis, potentially stronger and more competitive that it has been in decades.

The US recovery may stall temporarily, but it is not in jeopardy. But of course I must add this caveat – in the short term, psychology trumps intrinsic value every time. That is, being fairly valued does not mean that prices cannot fall. Since I have no crystal ball, I unfortunately cannot tell you what stocks will do tomorrow.

My advice, as usual, is to buy the stocks of solid companies that are valued as if the present gloom will last forever.

PS – Don’t go looking for bargains in the Nasdaq. Thank you.
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"Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions..."

Benjamin Graham
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Buy High, Sell Low!

Or is it the other way around?



Ridiculed by professionals, “retail investors” are known for making terrible errors of financial judgement, including selling at the worst possible times, and keeping money in worthless investments. So what is a retail investor, and how do you avoid acting like one? To find out, ask yourself the following questions...

What is the difference between a stock and a bond?
What is the difference between nominal and real rate of return?
What is a P/E ratio?
What does a balance sheet tell you?
Why does the Federal Reserve raise interest rates to “cause” a recession?
What are the contents of a balanced mutual fund vs. an aggressive mutual fund?

If you do not know the answers to these basic questions, then you are a retail investor. That is, you are a person who invests money without really knowing what you are doing; therefore, you rely on news and opinions to make your investment decisions. What this article will explain then, is how to save you from yourself.

What marks the retail investor (RI) is fear caused by lack of understanding, occasionally accompanied by greed and Hubris - the belief that you know more than you actually do. The goal then, is to accumulate just enough understanding not to be a menace, while at the same time recognizing your limitations. The first step in this process is to understand how RIs behave, and how this differs from professionals. As a rule, RIs follow a pattern similar to the following scenario…

As the economy begins to recover from a recession, RIs remain sceptical (or scared and angry) and stay on the sidelines, putting their money into low-yielding GICs and money market funds, or under a mattress. They aren’t aware that when inflation is at 2% and their GIC yields 1.5%, they are actually losing money.

As the economy improves further and stocks begin to rise, RIs remain in cash. The market continues to rise, but with occasional drops (corrections) that keep edgy RIs out of the market, and leads them to believe that the market is "rigged" against them. Eventually, after stocks have risen significantly and the economy is well on its way to recovery, news stories of “excellent markets” begin to make headlines. At this point, RIs begin buying mutual funds and stocks in quantity.

The return of RI money to the market causes markets to rise. Seeing their stocks values improving, RIs get excited and put even more money in the market. Markets rise dramatically and stocks become overpriced. The fantastic economy makes front-page news. Neighbours of existing investors, not wanting to miss out on getting rich, join the party. News reports explain that this economy is different from all others before it (due to the Internet, Globalization, rise of China, or some other excuse) and that therefore the good times will never end.

Consumers –flush with cash - go on a spending spree that causes wage increases, labour shortages and inflation. Workers in their early 20s skip work to go to the beach, confident that if they get fired they will be able to find a new job within days. Industrial workers who normally don’t save a dime start buying as if they are high-rollers in Vegas.

The Federal Reserve begins to warn professional investors using cryptic phrases such as “irrational exuberance” or “froth” to describe the overheated market. Professionals start selling their overpriced stocks to euphoric mechanics and pizza-shop owners. To cool down the economy, the Federal Reserve raises interest rates so that fewer people can get loans to buy homes, cars etc. With the decline in business -- or in anticipation of it -- stocks drop slightly. Professionals buy bonds or put their money in cash.

RIs don’t worry about the decline in their stocks, because they know that the economy is doing spectacularly well: the media says so. Stocks drop more. RIs still feel confident. Stocks drop more, making the news. Although RIs begin to worry, they remind themselves that they are “long-term investors” and will simply wait for prices to rise again. Analysts warn of a difficult market. Consumers spend less. Stocks drop further. Finally, unable to sleep at night, RIs start selling their mutual funds.

A wave of selling brings reduced prices and still more selling. Panic sets in. Financial news anchors start babbling hysterically and arguing with their guests. Retail news agencies announce that we are in a recession, that life is terrible, and that the horrors may never end. Retail stock writers pen articles warning people that they may lose “everything.”

After days or weeks of frightening stories, financial news anchors finally run out of adrenaline and become gloomy and exhausted. The evening news tells the story of a lady next door who saves $10 a week by using cooking oil to power her car. Another story explains how to save money by using coupons. Shortly thereafter, Wall Street professionals announce that the stock market has hit a low plateau – all the retail investors have finished selling! Professionals buy. As they are buying, they make TV appearances warning retail investors not to buy, since it is still very risky.

And so the cycle continues…whether it be (as is this story) with stocks; or, with oil, gold, real estate, tulip bulbs, or frozen concentrated orange juice.

Although everyone knows that to make money in the market you have to “buy low and sell high,” retail investors typically do exactly the opposite: they are so afraid of losing money that they consistently lose money.

To be successful in the market, you must conquer your fears surrounding money. You must "buy low and sell high," which in practice means “buy pessimism and sell euphoria.” That is, you have to buy at a time when everyone else is afraid to do so.
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"They are stupid, the dumb money that always gets beat up. Retail waits until a stock works, and only then buys it. They they complain when it goes down. Or they won't sell something that works, convinced it's going higher, and then blame you when it blows up. Stay away from all of them. Use garlic and crosses if you have to."

Tom McDermott, as told to Andy Kessler in "Wall St. Meat"

Is Buy-and-Hold Really Dead?

Since the credit crunch began, many a financial professional has suggested that the buy-and-hold approach to investing is dead. You cannot, they say, simply buy a stock and forget about it. You will lose money.

The most powerful argument against buy-and-hold, popularized during the heat of the crisis, is that if you invested your money in U.S. stocks in 1999 and held them until 2009 (a ten year period), you would have made absolutely nothing: your stocks would not have increased in value at all. Many people found this statement shocking. I also found it shocking, but for a different reason. 1999 was the peak of the Internet bubble. 2009 was dead bottom after the housing bubble. So basically, they were saying that if you were stupid enough to buy stocks at the worst possible time, and then stupid enough to sell those stocks at the worst possible time, you’d still come out even. Truly remarkable.

In reality, buy-and-hold has never meant buying a stock and forgetting about it. Buy-and-hold means buying the stock of a great company at a good price, and holding it for as long as it stays a great company at a good price. If the company's competitiveness declines, sell it. If there are serious “accounting irregularities,” sell it. If the company becomes overvalued, sell it. This is buy-and-hold. So, why does the press always suggest that trading is better? Partially it’s because of ego (surely a complex strategy must be more effective than a simple one); but mostly, it’s because of commissions.

If you buy a stock and sell it several years later you may have a large capital gain, and the government may receive tax income, but Wall Street gains almost nothing. Commissions and trading spreads are the way that Wall Street makes money, and buy-and-hold doesn't encourage either.

You may notice that when you open an account at an online brokerage, they always have free seminars about level II quotes, day trading, chart reading, and anything else that encourages people to trade more. They also have special benefits and pricing for “frequent traders.” In contrast, I have never seen an online brokerage offer a value investing or buy-and-hold seminar, ever. And I probably never will.

Trading certainly has its place, especially in choppy markets. And it’s fun. But for those who can’t marry their computer screens or who do not have a degree in economics, buy-and-hold is the great equalizer. Buying stocks of excellent companies at times of great pessimism, and holding them until times of great enthusiasm, is a moneymaking strategy par excellence.
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“Cash combined with courage in a crisis is priceless.”
Warren Buffett