Friday, November 26, 2010

If you don't know the rules, maybe you shouldn't play

A couple of days ago, I read this interesting article on the front page of, talking about how the TSX is looking to expand into China to attract more Chinese companies to go IPO in Canadian public markets.  This scares the heck out of me.  People have a hard enough time making investment decisions and lose their shirts all the time.  If Chinese companies truly do see the Canadian public markets as a viable platform to go public, I worry for the shirts of many Canadian investors.  Spurred on by the hype surrounding China, they'd have the ability to easily apply their same poor decision-making abilities on companies where it is much harder to do due diligence due to distance and foreign-based ignorance.

The fact is that China is still maturing in terms of its economic behaviour.  I don't want to sound like I'm discriminating against China unfairly.  They have huge growth potential that I like, but lots to learn.  Scams exist in western nations too.  Just look at Bernie Madoff and the like.  Whether or not China has a higher incidence of corruption and scams than the West is irrelevant.  What's relevant is that there is bad stuff that goes down in China, and you sitting across the ocean would have a very difficult time sniffing it out in your investment due diligence analysis, especially since the rules may be different in China.  Let's look at this fascinating example of the Universal Travel Group, who some people accuse of being a scam listed on the NYSE.  This guy's due diligence analysis goes deep, really deep, to the point where he has local people carrying out tasks for him.  Spoiler: the conclusion is that the company really doesn't look good.

If you want to trade a Chinese company listed on the TSX, would you be able to go to the same level of due diligence to make sure you didn't make a poor investment?  While the TSX no doubt has standards and processes to ensure that only legitimate companies can go public on its exchanges, it can't catch everything.  So when an inexperienced ignorant trader sees the reported financials for a Chinese company that is supposed to be growing like a weed in quite possibly the most significant growth market in the world, why would he not buy?  Emerging markets, especially China, are hot.  The stage may be set for a beehive of activity that causes a huge letdown, unless China can take control of their inflation issues:
The U.S. monetary policy and domestic asset market conditions are the most important factors in attracting hot money. When speculators take money to emerging markets, they expect massive gains like 100 percent in a couple of years. Such returns are possible only in a bubbly environment and, of course, one must have the skills to leave before the bubble bursts. The loose U.S. monetary condition is a necessary condition for an emerging market bubble. Hot money is the ammunition to make it happen. But, emerging economies must be receptive in the bubble game. If a government is determined to go against a bubble, it cannot happen, regardless how loose the Fed's monetary policy is and how enthusiastic the speculators are. When an emerging economy shows resolve to fight a bubble by raising interest rates, the hot money tends to leave. When China raised interest rates unexpectedly last time, the yuan forward price in the offshore NDF market fell. It is one piece of evidence that the hot money would leave rather than flood in when China raises interest rates.

Investing is all about buy low, sell high.  I lost thousands trying to make a buck in the mining bull run back in 2007, especially in uranium.  My money's starting to come back thanks to uranium getting hotter again and my favourite stock URC (up 119% since I bought back in August!), but quite frankly, I know I don't know what I'm doing.  My friend Kyle knows what he's doing.

Kyle:  "Hey, hey, guess how much money I made today!"  
Me:  "No."
Kyle:  "Come on, guess!"
Me:  "$20,000."
Kyle:  "Nope!  Guess again!"
Me:  "40,000."
Kyle:  "No man, $80,000!  I killed it today!"

Every week he goes in, he says he expects to lose money 4 days of the week.  But if he plays it right, the 5th day will more than make up for all his losses.  And as he told me, "You either have what it takes or you don't."  But the other thing he does is not go into something he feels is risky or he feels he doesn't understand.  Amateur traders don't understand this part.  The good guys know what they're doing.  The rest are the suckers who take the losses that make profits possible for the winners.

I think Chinese companies listing abroad is a good thing.  It enables access to capital markets easier, and spreads the risk around (but hopefully not too much, ala subprime).  But frankly, I wouldn't know where to even start to make sure I'm making a good investment decision.  So I'm doing the sensible thing.  I'm staying out.  If you want to dive into investing in anything, let alone China, go in at your own risk and don't risk more than you can afford to lose.  It may still look like a grass field to you, but there's a reason why there's no quarterback in a game of rugby.  The rules are just different, even if the ball looks similar, and you better be up to date on how to play.

On a side note, here's why I'm bullish about uranium again, even if the economy turns sour, causing a lower demand in energy.  Peak oil and peak coal.  Let's face it, solar and wind power just aren't there yet.  The only thing even remotely capable of supplying our energy needs sufficiently in the short term are all those nuclear power plants that are being built.  So far, the market has a consensus on this thought.  Yay.  And I'd say apparent dangers wouldn't disappear if we decided to put a ban on nuclear power plants.  That's like saying mobs will stop using hitmen because guns are illegal.  No, I think they'll still find a way to get their guns.  If there's something positive to be gained from uranium, let's by all means grab it.  Just remember, I'm only a clueless amateur.

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