Feb 17 FT Rare Earth, Mortgage Relief, Semicon balance, 5G and more


18 Feb

Front page
Myanmar pain. Junta hardens online controls
Surging commodity prices deliver cash bonanza for mining investors
• Hotspot in growth after pandemic lows • BHP, Rio and Glencore promise big payouts
Rio announced record results today too. But the miners are returning cash to shareholder rather than putting capex into new projects. The positive outlook is driven by the expectation that the US will start infrastructure spending under the Biden administration which would drive a new commodity cycle.
Buyers rush to tap €10bn Italian bond offer on faith in prospects with Draghi.  Good demand as investors view the prospect of Draghi as Prime Minister being good for the country.

Inside
China explores curbs on rare earth exports to US (Page 2)
Trade limits on minerals used in defence industry could backfire on Beijing
'The Ministry of Industry and Information Technology (MIIT) last month proposed draft controls on the production and export of 17 rare earth minerals in China, which controls about 80 per cent of global supply.’
Some of those are used in the manufacture of US F-35 jets and other weaponry. They are also used in a range of other industries; Electric vehicles, smart phone and wind turbines. Beijing is trying to see if it can disrupt US industrial needs or whether the US can source the rare earths from other sources.
Essentially Beijing is searching for negotiation leverage as US/China relations remain fraught. The US and others have been aware of the issue for some time. In the past China has used its dominance to flood the market and crush prices as new mining ventures were looking to set up. But now the issue is becoming more strategic and the Pentagon has already signed new contracts with domestic and Australian suppliers and it is expected that in time China’s dominance be reduced.
But whilst the US can source the raw material China’s dominance comes in refining; as the US currently has no refining capacity at present. It seems likely that will change but refining is a very dirty business with the use of polluting chemicals and China’s acceptance of that solution is what gives it the edge. The article also highlights that China’s own domestic demand exceeds its current supply and it relies on imports from the US and Myanmar. It quotes an executive from Gold Dragon Rare Earth Co in Fujian province who said “China’s planners have failed to predict the surge in rare earth consumption,”
For investors, the miners in Hong Kong yesterday saw a big rally on the news. In addition to the defence uses the fact that they are being used in electric vehicles, small phones and wind turbines means that demand is going to increase going forward; which should support their valuations.

US extends mortgage relief by three months (page 4)
A sign that the Biden administration is concerned that the US recovery could be sluggish and hence the move to extend the mortgage relief to June. The article cites the latest data from the US Census Bureau from late January, that showed nearly 12m Americans either have no confidence, or just slight confidence, in their ability to make next month’s mortgage payment.
They have also extended the window for struggling borrowers to apply for forbearance on their home loans, as well as the duration of those reprieves. According to the Mortgage Bankers Association, 2.7m US homeowners were in forbearance plans.
It shows the uneven nature of the recovery in the US and I think underlines that the US consumer is likely to remain cautious through this year.

Companies and Markets
Semiconductor cycle out of balance after customers stock up
Looks at how the sector is struggles to find a balance between supply and demand. Notes the recent shortages of chips being seen in the auto sector and how that has knock on effects to other sectors. The key being that auto makers were cutting orders and relying on ‘just in time’ deliveries with little tolerance for delays. Whilst other customers were building inventories.
Last year was exceptional; there were supply chain disruptions due to the US/China dispute coupled with increased demand for electronics both due to the pandemic. The reality is that with the US/China trade friction set in motion a change to how the sector worked. The situation was then exacerbated by the pandemic, which triggered an huge and unexpected demand for personal electronics. At the same time as there was a concerted move by auto makers to electric vehicles which itself has created a huge new demand. That gave the chip makers little time to react, the industry was already operating a high capacity utilisation levels and so had little scope to factor in new supply.
Just as the car manufacturers and others don’t want to have to carry high levels of inventory the chip makers don’t want to have idol capacity. The answer I think was highlighted by last week’s article on Toyota and the other Japanese auto makers who are facing less problems because they have closer co-operation with the chip makers and keep them informed of their requirements up to three years in advance in Toyota’s case. No one expected lock downs and the huge increase in demand for personal electronics but closer co-operation between customer and supplier seems to be the logical solution. Meantime the outlook for the likes of TSMC, Samsung and others looks to remain good; as chips are finding more and more applications.

Supercell sales sub-par despite boom in gaming. Tencent holds a majority stake in the company. Looks at the recent results which showed its profits fell by 20% due to a lack of new hit games during the lockdown boom.  It still remains more profitable than a number of its competitors due to employing less staff but this was the forth year of declining profits. It has launched some good games but they have failed to find large enough audiences.
The key seems to me to be that there are a lot more games being released, many are short term hits and relatively cheap to build and launch. Whereas the larger format games are struggling to stand out and attract long term interest. Supercall remains amongst the top 10 most successful publishers but the sector is changing its historic business model may need to change too.

Ericsson highlights Europe 5G troubles
‘Non-functioning’ market means playing catch-up with US sector, says bossKey is “The problem is that the guys that are supposed to build out that infrastructure don’t make any money. There is a very big cost to waiting.”
Borje Ekholm, chief executive of Ericsson rightly says that without 5G Europe will continue to fall behind China and the US and businesses will suffer long term.It notes that Europe has a large number of telecom operators but consolidation has often been blocked by Brussels on competition concerns; meaning that profitably suffers due to lack of scale.
The main issue is who pays for the infrastructure and that is likely to become more important as 5G and 6G become more a more integral part of our daily lives. The companies that benefit most short-term are the app makers but businesses and industry also benefit finding a workable way of paying for the infrastructure will be key.

Big Pharma ‘missing in action’ as vaccine battle honours go to innovative upstarts
Adoption of mRNA technology sees Moderna, BioNTech and peers leap ahead of GSK, Merck and SanofiKey “The ones who rushed into this were not the big vaccine companies. They were companies that were interested in accelerating their technology.”
The big companies relied on their tried and trusted methods in their approach to finding a vaccine.
It also notes that the large pharma groups were aware of the risks and potential for either failure or the fact that the covid situation would have run its course before they had found vaccine; which is likely to have impacted their approach.
It notes how the share prices have also reflected the importance of vaccines.'Since the start of 2020, Novavax is up 6,400 per cent, Moderna 850 per cent and BioNTech 190 per cent. GSK, Merck and Sanofi shares have fallen between 13 and 30 per cent.’
The use of mRNA technology has been a game changer, in its ability to speed up the production of a new vaccine.The outlook has changed an no doubt drug companies will now put more importance on vaccines especially as covid with its ability to mutate so quickly looks to be staying with us for some time.

Brookfield seeks to smooth New York’s path back to the office
Real estate group provides example to tenants with rules allowing return of most staff
An interesting read that notes the some practical steps; from a mobile app for self assessment to be completed daily before coming to the office, temperature screening devices that guard access to the lifts, improved office cleaning and the air conditioning system. It has also arranged a ride sharing app for those worried about using public transport. It has an onsite covid testing facility and will help with the vaccination roll out.
Real estate groups have a vested interest in getting people back to the office and it will be important for them to do so not least because of the loans and mortgages associated with their portfolios. But I thought it interesting that Brookfield is upgrading the air conditioning to a system that uses technology used in hospitals. Daikin in Japan has seen its share price rally strongly this year as air-conditioning is seen as important in fighting the covid virus, it is currently seeing resistance at Yen 24,000 but worth accumulating on weakness.

Moscow bourse woos China by opening forex and derivatives trading earlier. The latest effort to try and develop more business between the two countries.  It notes that over the past five years 'trades involving roubles and renminbi on the Moscow Exchange have risen 27 per cent but are still dwarfed by dollar trades. Last year, the exchange handled Rbs986bn ($13.4bn) worth of trades between the rouble and the renminbi, and Rbs266.6tn worth of trades between the rouble and the dollar.
Comes as Russia and China are finding themselves increasingly isolated from the international community but I doubt if it is really going to make a significant difference.

Markets Insight
Stock price is still the best forecaster even with Tesla gains. By Gerard O’Reilly is co-chief executive of Dimensional Fund Advisors.
'Stock prices are set by the trading between buyers and sellers. Competition ensures that new information is reflected the instant buyers and sellers begin trading on it. This process makes stock prices our best prediction of the future.’
That price compensates buyers for the uncertainty of the future. There has and always will be disruption and new technology generates uncertainty about which companies will be successful. That is reflected in the valuation and the discount rate applied to future cashflows.
He says 'I expect investors to continue to apply different discount rates to stocks with different exposure to uncertainty. This is the intuition behind the value premium. Value stocks are those with low prices relative to some fundamental measure of firm value or forecast net cash flows. Empirical research using almost 100 years of data supports this; the average annual return of value stocks is 3-4 per cent higher than that of growth stocks.’
He draws research from Professor Kenneth French “Investment returns have two parts: the expected return and the unexpected return. The expected return is the best guess of what will happen based on all the information currently available. The unexpected return is the surprise, the difference between what does happen and what was expected.”
He states that 'This is important as stock prices, acting as the market shock absorbers, adjust continually so investors get adequate expected returns as news unfolds.’
Looking at Tesla he notes that we can’t be certain about why a stock price changes but can infer two things with confidence
1 An eightfold return is unexpected. The stock returns accrue to the seller not the buyer and as Tesla was selling its stock frequently it obviously wasn’t expecting such a dramatic rise.
2. If you viewed Tesla as a growth stock at the start of 2020 it is reasonable to assume that you would view it 'as an even lower expected return growth stock after such a big price rise.’
He concludes 'While previously unknown information and changes in investor preferences will change prices and determine realised returns each day, the data strongly support the view that the longer the investment horizon, the higher the probability that value stocks will outperform growth stocks.
This effect would disappear if the expected return of all stocks was the same. Some things are certain in investing: the future is uncertain and the level of uncertainty is not the same for all stocks.’

FT BIG READ. US ECONOMY Biden’s huge ‘acting big’ gamble
For four decades, governments around the world have feared inflation and 1970s-style stagnation. The new US administration is hoping that its massive coronavirus recovery plan will prove them wrong.
An interesting read.

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