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Pradeep Kandasamy
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A sell side broker and an investor for the last 2 years looking to move into buy side.
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  • (Only) Commodities don’t reflect Chinese slowdown risk
    While commodities have performed extremely well post crisis, the risk remains its way too depended on China. Chinese share of global demand for many critical commodities like copper, steel, coal and iron ore have reached over 40%. Thus any slow down or hard landing in China will have adverse impact on commodity prices.
     
    What’s interesting is while commodities market has been strong, other markets have been pricing in problems in China. The major issues debated are inflation and local government debt.
     
    Chinese banks equities pricing in risk
     
    The valuation of Chinese banks stand out distinctly that all is not well in china. The main reason for this comes from their exposure to local government debt. The average PE of the major four Chinese banks based on trailing 12 months earnings is just 8.64 and based on forward EPS is just 7.84.
     
    Bank
    PE
    Est PE
    ICBC
    9.17
    8.21
    Bank of China
    7.05
    6.88
    China Construction Bank
    8.34
    7.56
    Agricultural Bank of China
    9.99
    8.70
    Average
    8.64
    7.84
     
    Compare this with Indian banks, where there average PE is 19.90 and 16.53 based on trailing and forward looking EPS.
     
    Bank
    PE
    Est PE
    HDFC Bank
    29.84
    22.15
    ICICI Bank
    19.69
    18.69
    State Bank of India
    14.69
    12.56
    Axis Bank
    15.39
    12.71
    Average
    19.90
    16.53
     
    Clearly the Chinese banks are pricing in some significant risk at valuations lower than half of Indian banks. If the market is discounting risk to the Chinese banking system, is it possible that economy will go unaffected when that risk materialises? If the answer is “NO”, then commodities prices should also discount the risk.
     
    USD/CNY Options market pricing in risk
     
    Even FX market is showing some red flags. When view on a certain currency is one directional then its priced into the options market. For example, if the market believes that CNY can only appreciate against the USD, the implied volatilities of USD put/CNY call option will be higher than USD call/CNY put option as CNY call writers will charge a premium to write them.
    But this is not happening is USD/CNY options. For example the 25 Delta Risk Reversal (25D RR) is positive and has moved higher for USD/CNY. 25 DD RR is the difference between implied volatilities of 25 Delta USD call/CNY put minus 25 Delta USD put/CNY call.
     
    A positive number means USD call/CNY put is more expensive than USD put/CNY call. This again is not consistent with the secular china growth story. This means market is buying USD call/CNY put options more than USD put/CNY Call options.
     
    The below is the historic chart of 25D USD/CNY RR which moved positive in June and is inching higher.

    Again if FX market is pricing a risk for the currency, should it also have some impact on commodity prices if it materialises.
     
    Commodities don’t seem to care
     
    While equities and FX market is discounting some risk in China, commodities hardly seems to think so. CRB All commodities index is well above 2008 highs and looks fine even after the recent correction.
     
    Should commodity investors ignore the red flags which other asset classes are waving for China?
     
    Chart: Commodity Research Bureau/ Reuters All Commodities Index



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: DBC, DBA, GLD, SLV
    Jul 18 3:37 AM | Link | Comment!
  • S&P 500 is more expensive than it looks
    S&P 500 is currently trading at PE multiple of just over 15. Find below PE graph of S&P 500 since 1950. S&P 500 reached peak valuation of over 30 during the .com bubble in 2000. The lowest valuation since 1950 is around 7.5. Though current valuation of 15 for the index looks fair, a deeper look shows that certain sectors are trading at low multiples compared to history pulling down the average PE for the index.


    The below bar chart plots top 50 sub indices of S&P 500 in terms of weights and their respective PE ratios.


    Financials, Pharmaceuticals/Health Care and Large Cap Technology are cheaper compared to the Index
     
    • Financials (Banks and Insurance Companies) are trading at much cheaper PE multiple to the index. Average PE ratio (weighted by index weights) of all financial sub indices in S&P 500 is 12.45. Financials make up for about 12.38% of S&P 500.
    • Pharmaceuticals and health care related stocks are also trading at lower multiple to the index at 13.51. This block makes up about 10% of S&P 500 Index.
    • Technology is one sector which shows high divergence in valuations. While large cap software (like Oracle, Microsoft) and hardware companies’ (like HP, Dell) trade at multiples below index PE, Internet retailers and application software companies are the most expensive.
    These 3 sectors almost make up 30% of S&P 500 index. PE ratio S&P 500 ex these 3 sectors is almost 18, which might not be that cheap.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: SPY
    May 23 4:23 AM | Link | Comment!
  • Coffee – The next big commodity short?
    Coffee is the third best performing commodity by returns in last 12 months. Coffee has returned just under 100% in the last 12 months. It stands just above silver which has returned 79.34% post crash.


    Though I still think silver is the best short in the commodity complex, Coffee looks interesting after Howard Schultz’s (CEO/Founder of Starbucks) comments couple of days back.
     
    I don’t think anyone knows coffee market better globally than Startbucks.
     
    Key quotes from Howard’s Interview
     
    • “the current spike in the cost of commodities such as coffee and other foodstuffs is "not based on supply and demand" but based on market speculation”
    • “the farmers who actually produce the commodities are receiving a "de minimus" proportion of the price rises”
    • “Right now we are experiencing a very strange and almost inexplicable phenomenon in the commodities market. Without any real supply or demand issues we are witness to the fact that most agricultural food commodities are at record highs at once, and coffee is at a 34-year high”
    • “Through financial speculation – hedge funds, index funds and other ways to manipulate the market – the commodities market is in a very unfortunate position. This has resulted in every coffee company having to pay extraordinarily high prices for coffee”
    • “I don't think, by the way, that this is sustainable, however it is not a good situation for the consumer and I am not convinced that the farmers benefit from this”
     
    With commodities starting to give away their speculative premium, Coffee could be an interesting short. The chart is breaking as well. Find below chart of Arabica near month future price.



    Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in JO over the next 72 hours.
    Tags: JO, SBUX
    May 13 1:48 AM | Link | Comment!
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