The Hedges are Working

FALLS CHURCH, Va.– The market’s deterioration remains problematic. Western financial institutions continue to report more balance-sheet trouble. Selling pressure is strong right now, even more so in Asian markets because the rally there from the August lows was spectacular. In other words, there are real profits to be booked.

Unlike in the past, however, funds aren’t being redirected to the so-called safe haven of the US stock market. After all, the US economy and its securitization industry is the source of the current problems.

Seeking safe haven in a stock market with a slowing economy and a financial system coping with significant new challenges is bizarre. But if you don’t want to put your money to work in the “high risk” markets of the East, buy gold and short the US consumer instead.

Asia will suffer in the event of a US-led economic recession, and the region’s stock markets will be affected even more than the region’s economies because they remain in almost total synchronization with Wall Street.

But looking beyond the current situation, Asia is the region of choice for serious long-term investors. It’s leading a great global economic transformation and will be the engine of growth for years to come. And Asia ex-Japan is still enjoying a long-term bull market that commenced at the bottom of the 1998 Asian Crisis.

The events of 10 years ago have proven a fortunate catharsis for Asian economies. The long-term Asia story is founded on the economic reforms, moves toward privatization and commitment to free trade that emerged from the crisis. Asian governments and the region’s economic establishment have since been redefined.

Hedging Updates

Market sentiment remains grim, but the Portfolio hedges are in full swing and are generating positive results.

As I noted last week, the best-case scenario is to lose money on the hedges, especially the new short recommendations. If you’re stopped out from the short positions, the bull market will have resumed and our long positions will be advancing.

If you followed the Nov. 13 China Life Insurance Co (NYSE: LFC) recommendation, you should have been able to short it at around 85. If you were able to short China Life Insurance Co at around 85, your stop-loss should now be at 93.

In last week’s Flash Alert, I recommended putting more money to work in the Alternative Holdings-Permanent Hedges. Investors long the Silk Portfolio should always have at least some exposure to those hedges.

Both the Consumer Discretionary SPDR (AMEX: XLY) short recommendation and the iShares Lehman 7-10 Year Treasury Bond (NYSE: IEF) long recommendation are up since last week. And they’ve both generated double-digit returns since their initial recommendations.

Continue to short Consumer Discretionary SPDR and buy iShares Lehman 7-10 Year Treasury Bond.

Company Updates

Temasek Holdings, Singapore Telecom’s (Singapore: ST, OTC: SGAPY) parent company, was ordered by Indonesia’s competition regulator to sell its indirect stake in either PT Telekomunikasi Selular or PT Indosat, the country’s two biggest mobile phone companies, within two years.

Temasek owns 56 percent of SingTel, which holds 35 percent of TelkomSel. Through another company, Singapore Technologies Telemedia, Temasek holds 75 percent of Asia Mobile Holdings, which owns 40 percent of Indosat.

The current weakness in SingTel’s stock price reflects an overreaction to the news; no one knows what Temasek will choose to do. Weakness presents an opportunity to buy a well-run company that offers good exposure to Asia’s fast-growing telecommunication industry.

Temasek will appeal the decision, and because SingTel is one of its highest-profile holdings it would be difficult for Temasek to allow it to lose this very lucrative investment. Singapore Telecom remains a buy.

Bio-Treat Technologies (Singapore: BIOT, OTC: BOTRF) reported a 28 percent year-over-year profit increase. The company’s order book remains solid. Bio-Treat continues to concentrate its wastewater treatment proprietary technology in second- and third-tier cities in China that have high tariffs, good economic conditions, rapid development and stable governments.

Bio-Treat is a small operator in the industry and is a leveraged play on the water theme outlined last spring. (See Silk, 23 May 2007, Real Thirst. The stock is currently trading at attractive valuations as of this writing; the price-to-earnings ratio is 9.8, the price-to-book is 1.6 and its return on equity is 18.3 percent. Bio-Treat Technologies remains a buy.

Long-Term Holding BOCHK (Hong Kong: 2388, OTC: BHKLY) said it bought a 4.94 percent stake in Bank of East Asia (Hong Kong’s third-largest bank by assets) for USD507 million. This as a positive development for BOCHK because it helps expand its investments.

BOCHK is a Hong Kong subsidiary of the Bank of China (BoC), one of the Big Four state-owned commercial banks in China, with total assets of USD683 billion as of the end of last year. Buy BOCHK.

Fresh Money Buys

Because the investment process is constant, if you’d like to add to your positions in portfolio recommendations or allocate new funds in a diversified way, focus on the following markets (consult the Portfolio pages on the left of your screen for details), in order (for both countries and sectors):
  • Singapore (banking, telecommunications, industrial)

  • South Korea (electric power, banking)

  • Hong Kong (banking, real estate, infrastructure, publishing)

  • India (pharmaceuticals)

  • China (consumer, coal, power, oil, water, e-commerce)

  • Russia (telecommunications, energy)

  • The Philippines (Telecommunications, Real Estate)

  • Malaysia (ETF)

  • Taiwan (technology, telecommunications)

  • Europe (pharmaceuticals, industrials, communications equipment)

  • Japan (banking, industrials)

  • Macau (gaming)

How Silk Works

The Silk Portfolio has been constructed around the view that domestic economic demand and investment are driving Asia’s economic ascent.

The Portfolio should be viewed as a whole rather than an assortment of stocks. It’s my hard-earned assumption that investors seldom follow such advice, so I also offer some direction in an effort to assist with the decision-making process in the Fresh Money Buys section.

In this section, readers can find a guide as to how I rank countries and sectors at any point in time. The ranking changes often, so pay attention.

The ranking starts with the countries I prefer and then lists specific sectors you should look into. When I mention a sector, it’s assumed that the first pick will be from the Long-Term Holdings and then, if more exposure is warranted, from the Alternative Holdings part of the Portfolio. Of course if a country isn’t represented in the Long-Term Holdings, refer to the Alternative Holdings for a selection (as is the case for Macau).

Portfolio recommendations should be taken at face value, in the sense that if a stock is recommended as a buy and trades below the price indicated in the Portfolio tables, the recommendation stands for newcomers as well as longer-term readers.

Occasionally, I recommend that long-term readers take profits off the table by booking any gains while letting the initial capital invested.

In other words, I expect investors to look at their profits (i.e., how much money they’ve made above the initial investment) and then calculate how many shares they needed to sell in order to take those profits off the table.

If you’re not a “long-term reader,” chances are you probably don’t have profits to take from the specific stock; you’re unaffected by the recommendation. The fact that I haven’t advised selling the stock outright indicates that it remains a good, long-term holding.

Silk has one main portfolio, the Long-Term Holdings, and an alternative, the Alternative Holdings-Permanent Hedges. Look first to the Long-Term Holdings for asset allocation in the markets covered here.

In the Alternative Holdings-Permanent Hedges Portfolio, readers can track permanent hedges and shorter-term recommendations. It also includes companies I’ve recommended for longer-term or more fundamental reasons, and they represent additional exposure to favored investment themes. For example, Lukoil (OTC: LUKOY) provides extra exposure to a favored theme–Russia and energy.

On the left-hand side of the Web site’s main page, under Portfolio Performance, you can get a snapshot of the Portfolio’s return compared to other major indexes.

On the Portfolio page, you can click on the asterisk next to each holding to review the original commentary and recommendation. I plan to enhance the Portfolio table with extra features and welcome comments and suggestions.

Many new readers have also asked, “What do we do when the market drops substantially?”

Since Silk’s inception, I’ve been skillful and lucky enough to have booked profits before precipitous falls, in which case I recommended sitting still through the turmoil. I will also get word to you via a Flash Alert if events turn too quickly.

Silk is built around a set of core themes. I often revisit those themes or certain analyses through a link to a previous article or by reproducing relevant paragraphs. You can also read previous issues in the Archives to gain an understanding of the investment philosophy of the publication.

Or you can ignore my advice and try to find the next big hitter the Portfolio will produce. You may succeed, but be aware that I don’t play that game; “fast guns” are wasting their time with this publication, as well as Asia and the rest of the international markets as an asset class.