Huge Chinese First, Pre-Rate Cut Advice, Capital One’s Wallet, and More!

“Personally,” Christopher Hancock chimed in, “I’m amazed this didn’t make the front page of the Financial Times. This is probably the most important financial development in China since the entry into the WTO in 2001.

“This is great news for the Hong Kong market, especially Chinese companies that don’t have either a Shanghai or Shenzhen listing. This also gives Chinese citizens a way to access foreign exchange markets by investing in companies listed in Hong Kong that derive a majority of their profits in other currencies.”

The Hang Seng Index in Hong Kong jumped 6% on the news — the biggest gain in eight years. The Hang Seng China Enterprises Index, which tracks mainland Chinese companies traded in Hong Kong, soared nearly 9%.

This trader thought he was busy dealing with subprime fears last week — wait till he has to deal with $2.2 trillion in domestic Chinese savings. Courtesy, The New York Times

Hong Kong Exchanges and Clearing, the company that runs the Hong Kong stock market, climbed 16% itself.

“Chinese production remains woefully inefficient,” says Christopher Hancock on another related note. As one Chinese official recently said, “To produce goods worth $10,000, we need seven times the resources used by Japan, almost six times the resources used by the U.S. and — a particular source of embarrassment — almost three times the resources used by India.”

“This means two things,” advises Christopher. “First, the Chinese insatiable demand for natural resources shouldn’t be ebbing anytime soon. As Elizabeth Economy points out in her essay ‘The Great Leap Backward?’ in the latest issue of Foreign Affairs, ‘Coal provides about 70% of China’s energy needs: The country consumed some 2.4 billion tons in 2006 — more than the United States, Japan and the United Kingdom combined. In 2000, China anticipated doubling its coal consumption by 2020; it is now expected to have done so by the end of this year.’”

“Second,” says Mr. Hancock, “environmental problems could start to really hamper Chinese stability, both economically and socially. China is literally choking its own people. I can certainly attest to that firsthand. Several studies conducted inside and outside of China estimate that environmental degradation and pollution cost the Chinese economy between 8-12% of GDP annually.” See: Free Market Investor.

Meanwhile, back in Squanderville, more than two-thirds of economists surveyed by USA Today this morning said the Fed will cut rates by 25 basis points at their next meeting in September.

While economists are remarkably good at missing on their Fed rate predictions, there is no denying that majority of investors are expecting to be bailed out by the Fed. Until Mr. Bernanke bequeaths the Fed’s latest choice, expect stocks to continue trading flat.

“If you hold cash right now, then good for you,” advises Byron King. “Patience is a virtue, and in the current market environment, cash may be the next best thing to godliness.” Check out Byron’s “Wealth Insurance” portfolio for details.

As if to prove the point, the Dow closed 0.3% down yesterday, while the S&P gained little more than 1 point.

“Money market fund managers are panicking out of the commercial paper market,” Dan Amoss tells us, “fearing that these securities may contain subprime CDOs — and are piling into 3-month Treasury bills at an alarming, unprecedented rate. The 3-month T-bill yield has plummeted all the way to 2.85%, down from 4.8% just one month ago.

“This is the market’s way of screaming that the Fed needs to cut the target for their fed funds rate quickly and aggressively, perhaps before their next meeting in early September.”

And lest you think the Fed could paper over the CDO crackup, here’s news: Fitch Ratings warned they’re placing $92.1 billion of securities backed by subprime residential mortgages “under analysis” this morning. That’s their first step toward rating downgrades.

Fitch has already hinted that at least $4.2 billion of these bonds are sure to be downgraded, bringing the total this year to over $17 billion in CDO downgrades from Fitch alone. Even if the Fed does accommodate Wall Street ne’er-do-wells, the source of this panic runs deep.

The underlying asset for those damaged CDOs isn’t getting healthier any time soon. Take a look at this chart from our colleagues John Mauldin and RBS Greenwich:

RBS Greenwich anticipates that $27 billion per month of subprime loans will hit their first reset over the next 12 months. That’s $27 billion — per month. Ay yi yi. Financial stocks all over the globe are going to be reeling from this mess for years.

“The carry trade is down, but not out… yet!” exclaims Chuck Butler in this morning’s Daily Pfennig. The yen rallied into the 112-range last week and appeared to be headed higher. But a retreat to 115 overnight has Chuck backpedaling and taking stock.

Investors borrowing in the low-yielding yen and investing in stock markets around the world are back to break-even or slightly underwater after the subprime meltdown. “Longer-term trades that were placed in 2005 and 2006 remain profitable,” says Chuck, “but vulnerable to being cut out, should we see another sell-off in equities.”

Capital One announced the shutdown of GreenPoint Mortgage this week. The mortgage subsidiary specializes in prime, nonconforming and Alt-A mortgages. The closure will sting shareholders to the tune of $860 million. And put nearly 2,000 GreenPoint employees out of work.

“This has little to do with subprime and everything to do with a frozen secondary market for nonconforming mortgage securities,” Dan Amoss tells us. “Nonconforming” mortgages are those that are too big for Fannie Mae to gobble up. In its statement, Capital One said, “Current conditions in the secondary mortgage markets create significant near-term profitability challenges, given the company’s ‘originate and sell’ business model.”

“This is the same problem plaguing the entire mortgage industry, including Countrywide Financial,” says Dan. “Most companies involved in the mortgage ‘originate and sell’ business have announced huge job cuts and branch closures. Tens of thousands of brokers working for the likes of New Century have been laid off. So not only has this credit crunch eliminated the housing ‘wealth effect’ that’s been boosting consumer spending… it will also hurt employment.”

Hurricane Dean has officially passed through the Yucatan Peninsula and remains on target to strike mainland Mexico this week. Despite the hurricane’s Category 5 rating, the Yucatan fared well… the brunt of the storm hit a region devoid of significant population or industrial ventures.

Dean, the third most powerful Atlantic hurricane to touch land since 1850, is currently barreling over the Bay of Campeche, home to over 100 offshore drilling rigs owned almost entirely by Petroleos Mexicanos. Pemex has now evacuated 14,000 workers and has cut oil production down 2.7 million barrels per day. As Dean touches down in mainland Mexico, production will most likely be hampered further.

Yet oil prices remain low. Currently trading at $69 per barrel, the market for light sweet crude has been unfazed by Mother Nature’s latest offering.

“That is utterly insane,” wrote a reader with close ties to Chinese Buddhism, “but totally fitting with the notion of a ‘Heavenly Bureaucracy’ that was developed in China over 1,000 years ago.” You’ll recall yesterday we reported the Chinese government passed a law forbidding monks from reincarnating without permission from the government.

“In order to assure a happy afterlife or advantageous reincarnation for their relatives,” our reader continues, “Chinese people had to register their whole households not only with the earthly imperial bureaucracy, but with Heaven’s censors as well. What’s striking is the absolute facade of communism that the totalitarian regime insists on maintaining.

“As far as I’m concerned, the mainland Chinese government’s actions in the past are comparable to the humanitarian terrors that ensued during the rule of the infamous Qin Shi Huang, or the ‘First Emperor’ of the Qin Dynasty. Our best consolation is that history moves in cycles, and periods of striking inhumanity will eventually dissolve into periods of cultural restoration and progression — just as the Qin Dynasty was once succeeded by the illustrious Han.

“All the same, because transitions sometimes happen very slowly, it’s wise of the Dalai Lama to reincarnate elsewhere for now…”

The 5 responds: Yeah, that does seem like a wise move.

“I live in Sublette, Kansas and have farmed for 35 years,” writes a reader. “I enjoy reading what you print and agree with you most of the time.

“But I am tired of one-sided reporting by you and those who don’t understand the business of farming. While ethanol is not the total answer to our energy problems, it is a short-term solution to help. It doesn’t pollute the environment and it doesn’t take as much energy to produce it as the people say.

“Farmers have the ability to grow more corn, wheat and soybeans than the United States needs without hurting the environment. The government has been subsidizing the cattle industry for years with its cheap corn farm programs. Corn has been grown at or below the cost of production for years with the farmer living off the government payments. Also, the government has been subsidizing the rest of the world, as we export grain produced below the cost of production.

“Every dollar we send overseas to OPEC is used against the United States. The Muslim world hates us and will fund worldwide terror with the oil dollars we send them. I would rather see the government subsidize ethanol for a short period until we can wean ourselves from oil. Ethanol creates jobs in rural America and keeps the money in the United States.

“The world is running out of oil, and we have to use many other energy forms, but that takes time. Ethanol plants can be built quickly and can help ease the shortages. It is also false reporting about the food value of distiller’s grain. Many feedlots swear by it and they are learning how to feed it.

“Let the free market work for a change — farmers will raise enough grain to depress prices quicker than anyone believes they can. The price of grain has stayed the same for 40 years, while everything else has risen dramatically. Higher grain prices will bring huge crop production. There already isn’t nearly enough storage for this fall’s corn crop; it is a huge problem.”

The 5 responds: Unfortunately, we have to disagree. Huge subsidies from the federal government and a marketing push in the president’s State of the Union address don’t add up to free market at all.

You are right that corn prices are likely to tumble. But gloomy as it sounds, any benefit that may have been derived from ethanol will be lost to the carnage of overplanting and retooling to cash in on the hollow boom. We respect farming as a way of life, and you’re right — we don’t know much about the mechanics of it all. Put us in a John Deere and we’d likely run you over on the way to the field. But we are fairly certain of one thing: Farmers by nature are just as susceptible to the siren song of free money as any character Homer could dream up.

Cheers,

Addison Wiggin,
The 5 Min. Forecast

P.S. Let’s say that there is one product we believe in … the kind we always want to produce, whether we make money on the subscriptions or not, because it garners that much of our respect, and it’s of the quality that we want to set as our benchmark. Would you be interested?

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