Monday, March 8, 2010

Chinese Currency To Dump Dollar Peg?

China – whose "remminbi" (or "Chinese Yuan") has had its value under government rather than market control, most recently by an official policy pegging it to the U.S. dollar – seems to be signaling that it's currency's peg to the U.S. dollar has a definite lifespan. Zhou Xiaochuan, governor of the People's Bank of China, said of China's currency-valuation policies: "Sooner or later, we will exit the policies." He just didn't say when.

Since the dollar peg had kept Chinese currency undervalued relative to the value it would have if freely traded, the end of the peg promises to elevate the value of assets valued in Chinese currency, including the present value of Chinese-currency income streams. This means everything in China could pop, simply as a result of currency conversion rate rationalization.

So, what has the Jaded Consumer thought worthwhile in China?

First, China Armco (Amex:CNAM), which I first invested in just over $3 around the time CNAM had its private offering about a year and a half ago. This company has just launched a steel recycling plant, and its future income will dwarf prior income because it will be engaged in higher-margin business as a producer than it enjoyed as an importer/distributor before it raised the funds to launch its recycling operation. Increased value of growing income is bullish, especially in the face of an impending currency re-valuation. All those facilities just build with U.S. dollars, all being re-valued in an overnight currency conversion ... what excitement!

Second, I've still got China Direct Industries Inc. (NASDAQ:CDII), which seems to have converted its business from primarily helping Chinese companies access U.S. capital markets (for a fee and participation with options and equity) to primarily operating portfolio companies to offer magnesium and basic materials in China (with a consulting sideline advising U.S. companies whose primary businesses are Chinese operations). CDII's portfolio companies make it a major supplier of magnesium in China, and as the US-dollar value of magnesium sales priced in Chinese currency climbs with local currency's price rationalization, the value of this market position will grow. CDII has gone from taking several Chinese companies public in the US every year, and being priced as a financial, to mostly being priced as a magnesium distributor that is still losing money. However, with total liabilities and equity of $77,719,439 and shares outstanding of 27,381,946, the company's book value per share of $2.84 has a long way to go from its current position at $1.76. Moreover, its operational expertise has delivered an enormous reduction in loss compared to its performance in the prior year. Although CDII has a production capacity of approximately 42,000 metric tons of magnesium, the company sold and distributed fewer than 12,000 tons in the 2009 period it describes as "transitional". Since magnesium is the third most commonly used structural material, CDII's magnesium operations should be better able to utilize their capacity as China and the world regain a more normalized construction and consumption pattern. I initially liked this business because it was an opportunity to buy a diversified portfolio of Chinese operations – the portfolio companies – and make money providing financial services while I was at it. The business is now different, in that the financial services no longer appears to dominate the company's future and the primary driver seems to be its consolidating control over various China-situated magnesium facilities. Since I've got it, and the shares appear underpriced both against current book and especially against values following a rationally-priced Chinese yuan, I'm holding in the expectation of significant price improvement (operations, plus currency re-valuation). This business sort of reminds me of the description given of an old value-investor's targets: unsexy businesses that weren't dead yet, old cigar-ends with some puffs left in them, being sold below the value of their constituent tobacco – nothing to make the papers perhaps, but a good buy nonetheless (and perhaps as a consequence).

There's much more in China, but the Jaded Consumer will call it quits here for now and pick it up later. Happy hunting!

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