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What Is Liquidity? (Part VIII)

Here are some simple propositions on liquidity: Liquidity is positively influenced by the quality of an asset. Liquidity is positively influenced by the simplicity of an asset. Liquidity is negatively influenced by the price momentum of an asset. Liquidity is negatively influenced by the level of fear (or overall market price volatility). Liquidity is negatively influenced by the length of an asset’s cash flow stream. Liquidity is negatively influenced by concentration of the holders of an asset. Liquidity is negatively influenced by the length of the time horizon of the holders of an asset. Liquidity is positively influenced by the amount of information available about an asset, but negatively affected by changes in the information about an asset. Liquidity is negatively influenced by the level of indebtedness of owners and potential buyers of an asset Liquidity is negatively influenced by similarity of trading strategies of owners and potential buyers of an asset. Presently, we have a lot of commentary about how the bond market is supposedly illiquid. One particular example is the so-called flash crash in the Treasury market that took place on October 15th, 2014 . Question: does a moment of illiquidity imply that the US Treasury market is somehow illiquid? My answer is no. Treasuries are high quality assets that are simple. So why did the market become illiquid for a few minutes? One reason is that the base of holders and buyers is more concentrated. Part of this is the Fed holding large amounts of virtually every issue of US Treasury debt from their QE strategy. Another part is increasing concentration on the buyside. Concentration among banks, asset managers, and insurance companies has risen over the last decade. Exchange-traded products have further added to concentration. Other factors include that 10-year Treasuries are long assets. The option of holding to maturity means you will have to wait longer than most can wait, and most institutional investors don’t even have an average 10-year holding period. Also, presumably, at least for a short period of time, investors had similar strategies for trading 10-year Treasuries. So, when the market had a large influx of buyers, aided by computer algorithms, the prices of the bonds rose rapidly. When prices do move rapidly, those that make their money off of brokering trades take some quick losses, and back away. They may still technically be willing to buy or sell, but the transaction sizes drop and the bid/ask spread widens. This is true regardless of the market that is panicking. It takes a while for market players to catch up with a fast market. Who wants to catch a falling (or rising) knife? Given the interconnectedness of many fixed income markets who could be certain who was driving the move, and when the buyers would be sated? For the crisis to end, real money sellers had to show up and sell 10-year Treasuries, and sit on cash. Stuff the buyers full until they can’t bear to buy any more. The real money sellers had to have a longer time horizon, and say, “We know that over the next 10 years, we will be easily able to beat a sub-2% return, and we can live with the mark-to-market risk.” So, though they sold, they were likely expressing a long-term view that interest rates have some logical minimum level. Once the market started moving the other way, it moved back quickly. If anything, traders learning there was no significant new information were willing to sell all the way to levels near the market opening levels. Post-crisis, things returned to “normal.” I wouldn’t make all that much out of this incident. Complex markets can occasionally burp. That is another aspect of a normal market, because it teaches investors not to be complacent. Don’t leave the computer untended. Don’t use market orders, particularly on large trades. Be sure you will be happy getting executed on your limit order, even if the market blows far past that. Graspy regulators and politicians see incidents like this as an opportunity for more regulations. That’s not needed. It wasn’t needed in October 1987, nor in May 2009. It is not needed now. Losses from errors are a great teacher. I’ve suffered my own losses on misplaced market orders and learned from them. Instability in markets is a good thing, even if a lot of price movement is just due to “noise traders.” As for the Treasury market – the yield on the securities will always serve as an aid to mean reversion, and if there is no fundamental change, it will happen quickly. There was no liquidity problem on October 15th. There was a problem of a few players mistrading a fast market with no significant news. By its nature, for a brief amount of time, that will look illiquid. But it is proper for those conditions, and gave way to a normal market, with normal liquidity rapidly. That’s market resilience in the face of some foolish market players. That the foolish players took losses was a good thing. Fundamentals always take over, and businesslike investors profit then. What could be better? One final aside: other articles in this irregular series can be found here .

Look To Taiwan For Stability And Low Valuation

Summary The iShares MSCI Taiwan ETF has extremely low valuation at the moment. Taiwan experienced a large drop in exports in June, while exports are expected to begin increasing in the 3rd quarter of 2015; this has created a buy opportunity. Taiwan is a very stable country to invest in; there has been conservative economic growth, low inflation, consistent trade surpluses, and negligible exchange rate movements. In previous articles, I have mentioned investment opportunities into fast growing economies such as the Phillipines and Indonesia through ETFs, and believe these regions have ample potential. However, Taiwan presents itself as a more stable investment option, and valuation is extremely attractive at the moment. I have decided to turn my attention to the iShares MSCI Taiwan ETF (NYSEARCA: EWT ), as a means for investors to gain exposure to Taiwan. GDP Growth GDP growth in Taiwan can be characterized as very consistent and moderate. Future projections provide the same results more or less, with a slightly more beneficial outlook; GDP growth is expected to rise 2.7% year on year until 2019 . Other forecasts, after assessing China’s threat to Taiwan’s exports, have lowered GDP growth projections from 3.78% to 3.28% in 2015 . The benefit with Taiwan thus can be characterized as stability, coupled with moderate and consistent growth projected for the future. (click to enlarge) Source: Trading Economics. FX Risks One benefit of investing in Taiwan is its extremely stable currency and low inflation rate. The exchange rate movement for this currency has been negligent, with an average rate of 31.25 since 1979, and has most recently been consistently close to 30 in recent years. Inflation has also been very low, and has mostly recently been -0.56% in June 2015. Towards the end of 2015, inflation averaged between 0.6% to 2%. Taiwan has the comparative advantage of low inflation and negligent exchange rate movement, when compared to other countries in Asia. The rise of Taiwan’s currency, which is rising faster than Japan, South Korea, and China, does present a threat to its tech exports , as this contributes vastly to its economy. Consistent Trade Surplus As a strong tech export country, it is favorable to note that Taiwan’s balance of trade has been on the rise in recent years. Projection for future balance of trade in Taiwan provides mixed results: Demand from developed markets continues to improve, mainly in the USA and Europe. This is balanced with caution, as the demand from emerging countries such as China has been decreasing. June has been a particularly challenging month for Taiwan, as export demands decreased by 13.9% , the largest decrease since February of 2015. (click to enlarge) Source: Trading Economics. Exports in Taiwan are projected to grow at a moderate rate for the next year. TWD Million Last Q3 2015 Q4 2015 Q1 2016 Q2 2016 Exports 709,860 752,876 755,280 754,089 751,775 Investors wishing to profit off of growth in exports, may find it beneficial to develop a short strategy, by waiting until the 4th quarter of 2015 when exports increase by 6.4%. While exports do not have substantial potential for growth based on these projections, having moderate growth in an export heavy country, with a stable currency and low inflation, makes this investment very conservative. Moreover, the valuation is incredibly low, and investors may determine it beneficial to hold this stock longer, and to choose a higher exit P/E. Economic Cooperation Framework Agreement The Economic Cooperation Framework Agreement , a significant trade deal completed with China in 2010, has already proved to be a catalyst for economic growth; the agreement has not been able to expand beyond its initial stages, due to protests beginning in March last year. The agreement was created to reduce tariffs and commercial barriers between the two countries. Currently, statistics have shown that the trade agreement has saved Taiwan $2.4 billion on tariffs and could boost the country’s GDP by 1.5% if fully implemented. With decreased demand from China and high dependency on exports for revenue, the full implementation of this agreement clearly has the ability to give Taiwan’s economy the boost necessary to achieve further growth. Taiwan Stock Market One last benefit of investment in Taiwan has been the consistent rise of the stock market since late 2014, coupled with the recent index plunge beginning in May of 2015. The Taiwan Stock Market is expected to increase to 9,390.06 points in 2016 , which represents a 5.3% increase. A moderate increase in the TSWE will be attractive, especially after examining the fast financial performance of the fund’s holdings later in this article. (click to enlarge) Source: Trading Economics. Diverse Growth Taiwan has had substantial growth in a wide variety of industries and areas in 2015: Taiwan’s industrial production index gained 6.49% year on year in March of 2015. During this time, construction also grew by 15.06%, and manufacturing of electronic components rose by 11.41%. Machinery and Equipment grew by 14.4% and chemical materials rose by 13.6%. Food services and retail both gained 1.9% and 1.3% respectively. Consumer spending has been significantly increasing since 2012, with a most recent annual increase of 2% in the 1st quarter of 2015. Taiwan’s manufacturing sector also reached an all time high in 2014, with a 3.5% year on year increase in revenue . Increased consumption and exports from Taiwan’s tech sectors have all contributed to the country’s economic growth. Moreover, increased wages has also been a catalyst for increased consumer spending, further contributing to economic growth. Taiwan has a strong advantage as a high tech export company, that domestically also has a very favorable outlook. While it is certainly not at its most strategic growth point, there is still growth ahead, and investors can feel confident regarding the country’s past economic performance. Moreover, the growth in manufacturing in Taiwan is crucial, as this will be another factor that will boost the economy and increase consumer’s confidence. Buy Opportunity EWT data by YCharts Things started to look less favorable in Taiwan beginning in June, when industrial production dropped -3.18%, as oppose to the 1.21% gain anticipated. As previously mentioned exports also decreased substantially during this month, at a two year record low. Poor performance in June attributed to the drop in the fund price; this creates a short term opportunity for the anticipated increase in exports and also an opportunity for long term investors to take advantage of the low valuation this has created. Price/Earnings 12.93 Price/Book 1.74 Price/Sales 0.94 Source: Yahoo Finance . Conclusion While Taiwan certainly has major threats ahead and will be no means among the fastest growing economies, the country can be characterized as a conservative country to invest in, that has acceptable levels of growth ahead. The current valuation of this fund is a key reason to invest in Taiwan at the moment, while investing in equity in Taiwan with higher valuation is not a very strategic investment objective; the economic environment in Taiwan is favorable, but there is not enough growth ahead to justify investing in companies with moderate or high valuation. Therefore, the investment approach to Taiwan should be considered accordingly, as it may not be the best environment for long term investment. Unless there is a considerable boost in Taiwan’s position as a tech export country, with increased exports to emerging countries specifically, it is best to sell this fund once the valuation is high or even average. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Tough Times Ahead For REC Silicon ASA

REC Silicon posted yet another abysmal quarter with no respite in sight. As predicted, the company’s inventory build plan backfired, and the company raised capital through debt and equity offerings in the last 24 hours. We believe the management is too optimistic, and as such do not see much joy for shareholders for quite some time to come. REC Silicon ( OTCPK:RNWEF ), as we forecasted , reported horrendous second quarter results on Tuesday. While revenues of $93M is an improvement over $74.4M from Q1, they come at a steep cost to the company in terms of plummeting ASPs. As a result of the plummeting ASPs, EBITDA declined again from $24.8M in Q1 to $5.8 million in Q2. The process-in-trade loophole, through which the company has been shipping polysilicon to China in the recent past is no longer available to the company, and effectively a big part of the company’s customers disappeared overnight. Against this backdrop, the company built another 1248 MT of inventory as it was unable to sell its poly production in the market. This inventory build in a downward pricing environment sapped the company’s cash flow, and the company has now come to the realization that its current business vector is not sustainable. However, as we wrote earlier, this handwriting was on the wall when the company decided to build inventories instead of selling product due to low ASPs in Q1. In the face of further declining prices and balance sheet stress, the company opted to sell product at distressed prices. While the FBR poly produced by REC Silicon has typically commanded lower ASPs than Siemens poly that most of the industry produces, the gap between the prices has increased dramatically in the recent quarters. This gap opened up further at the end of Q2 (see chart below). We believe there are two reasons for this widening gap. The first is that instead of withholding selling at the low prices as the company did in Q1, the company sold product at artificially low price to raise some much-needed cash. Secondly, customers sensing the upcoming changes to Process-in-Trade, and the company’s financial position, appear to have negotiated hard and gotten steeper discounts than usual. While the company sold a significant amount of polysilicon at low prices in the quarter, the production continued to be ahead of sales. The resulting 1248 MT inventory build in the quarter has now increased the company’s inventory to approximately 6000 MT – approximately 4 months of sales. Finally, the company decided that it cannot keep building inventory and has decided to cut its production at its Moses Lake facility. This reduced the company’s manufacturing capacity by about 2000 MT. The company also decided to put on hold its expansion plans. REC Silicon had previously planned 3000 MT of new capacity using its updated FBR-B process. This new process could have helped the company further improve cost structure but is now being halted with an eye towards a future restart. The company is conducting an orderly shutdown process and expects to be able to bring the facility to production within a year once it decides to restart the work. With these production moves, the company is dramatically reducing its capacity and expects that it will deplete its current inventory by 1500 MT in Q3. This would help generate some much needed cash flow for the company. The company also made an equity offering last night and sold about 10% of the company shares. REC Silicon allocated 230,000,000 new ordinary shares at a price of NOK 1.55 per share in the Private Placement to existing shareholders and new investors, with gross proceeds of NOK 356.5 million (approx. $43M). The company also announced Thursday morning that it also has sold or agreed to sell a nominal value of NOK 155,000,000 (approx. $19M) of bonds held in treasury to investors to raise additional money. These moves dramatically strengthen the company’s balance sheet and reduce the fears of possible default of debt payments coming up in 2016. In the earnings call this morning , management commented that the adversity is temporary and caused by the tariff war between US and China, and that the company expected the trade situation to be resolved by early 2016. Over the short term, the company sees Korean manufacturers supplying 60% of China import needs, German manufacturers supplying 30% of the needs, and the US poly manufacturers essentially shut out of the market. With the tariffs, the company expects that Korea production will mostly go to China leaving the US producers to chase Malaysia, Taiwan and other countries. REC management contends that the current low polysilicon prices are due to tariffs and Chinese government subsidies will not prevail in the long term. The company’s worst case plan involves shipping product to countries outside of China and continuing with interim measures such as tolling until the Company’s Yulin JV enters production, at which time, the company expects to be able to serve the China market. REC sees polysilicon becoming the choke point in PV production and expects poly prices to recover. The company, with over a billion dollars in assets, is not taking any impairment charges in spite of these developments because it expects the trade situation to be resolved by the beginning of 2016. We see the management’s view, even the most pessimistic version, as likely too optimistic. We do not see any indication that the tariffs are likely to go away quickly and we do not see an end to production from China’s SOEs and other heavily subsidized Chinese manufacturers. We also do not buy the commentary that a long-term shortage of poly will develop and that the poly prices will move up meaningfully. Even a more moderate set of assumptions would suggest that the company’s thesis that the current market economics will not work and the prices will go up over time is highly speculative. Unfortunately for the company, the reduction of production means the fixed cost absorption will be a problem and the company will have an inferior cost structure going forward. The company’s manufacturing roadmap, which relied on the lower cost FBR-B production, is now problematic. Because of these factors, we believe it is highly likely that the company’s assets are severely impaired. The company’s silicon gas sales, which do not depend on the polysilicon business, provide a respite to the company. However, this product line offers no significant long-term growth benefit to the company’s story. While the management presents itself as planning for worst case, we believe the company is far too optimistic. Given the tariff uncertainty, likely low polysilicon prices, impending new capacity, and commodity nature of the industry, investors in the company may not have much to celebrate for a long time to come. Our view on RNWEF: Avoid. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.