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Thunder Road Report 14 1st August 2009

Thunder Road Report 14 1st August 2009

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Published by: Steve Netwriter on Oct 26, 2009
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06/01/2010

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report
1st August 2009
Raiders of the false dawn
A calm interlude - buying LVMH
My analogy has been that our central bankers and politicians inthe UK and US are taking us on the economic equivalent of CaptainWillard’s journey up the Nung River in the movie, ApocalypseNow. If you indulge me in this analogy, the question is where are
we now? In the lm, the gun boat emerges from swirling mist
(how apt) and Willard (Martin Sheen), sitting on the bow, seessome buildings up ahead. This is the famous “French Plantation
scene” and is the lm’s calmer interlude. It was cut from the
original movie release, but reinstated in Francis Ford Coppola’s “Redux” version (thanks for this DVD to David V. in NYC).
Assignats - led to the French hyperination of the 1790s
Source: usagold.com
During dinner, the French patriarch, De Marais (played by ChristianMarquand) discusses the French defeats in World War II, in Nigeriaand, in particular, at Diem Bien Phu, which led to the withdrawalfrom Indochina, the separation of Viet Nam into the North andSouth and, subsequently, the disastrous US intervention. There isa poignant moment where one of the diners asks Willard why theUS can’t learn from French mistakes? (the lesson of the excessive
issuance of assignats leading to the French hyperination of the
1790s also came to mind!). The next morning, Willard is back on
Contact/additions to distribution:
This issue:
A calm interlude - buyingLVMH
China - learning the art of 
bubble economics (here)Cycles - a new pretender toMartin Armstrong (here)US house prices - recoverylikely short-lived (here)Gold - more insight on what’sreally going on (here)
 
2
© Thunder Road Report - 1 August 2009
the boat and the mist is even thicker. So much so, that “Chief” wants to stop because he can’t see wherehe’s going. Willard pulls rank and on they go.In the last Thunder Road, I argued that the heavy-handed intervention of politicians and central bankerswas pushing us into a “distorted Kondratieff Winter”. What I meant was that in the normal course of 
events, we would experience a deationary depression for 10-15 years while debt and excess capacity werepurged. However, the intervention, i.e. offsetting inationary policies, are so extreme that the evolution of 
events will be far more complex this time, with more twists and turns along the way. Making money is very
difcult at the moment and even the “Trader Wizard”, Bill Cara, is nding the going so tough he is heavily
in cash and watching from the sidelines:
 “the risks are just too great. When you see a cash ow stable Microsoft drop -10% in a day or a McDonald’s-5%, how can anybody commit 100% of their capital to such a market environment. I know I cannot.” 
I have to invest more aggressively and I’ve put some of the cash I had on the sidelines back into the marketboth a bit before and after the Dow Theory. buy signal which was triggered on 23 July 2009 when boththe Dow Jones and Dow Jones Transportation Index broke through their previous peaks (on the 12 and 11June 2009, respectively) in the current rally. That’s not because I trust this rally, rather I can’t afford to be
left out of a rising market to any signicant degree. As well as adding to my heavily overweight positionsin gold/silver and technology stocks, I bought shares in luxury goods group, LVMH (albeit with a 6% stoploss), after it announced its rst half 2009 results last week.
Why a trade in luxury goods? It struck me that a combination of the recent return of the “bonus culture” 
to parts of the nancial sector, the possibility of a bubble developing in China (discussed further below)
and the likely response of the ultra-rich to the recent stock market rally all bode well for this sector in the
current quarter. At the same time, Japan, which is the biggest market for luxury goods (> 20% of the worldmarket), should benet from recovery in China, its largest export market. Japanese department store sales
have seen double-digit declines in every month bar one since last December and surely some improvementis due?LVMH.is the world’s largest luxury goods play with major brands such as Louis Vuitton, Moet & Chandon,Hennessy (cognac), Christian Dior, Marc Jacobs, Fendi, Donna Karan, Givenchy, Tag Hauer, etc.The H109results were marginally worse than expected due to margin weakness in Wines & Spirits and Watches & Jewelry – it looked to me like analysts underestimated the operational gearing in these divisions.
Despite the worst recession since the Great Depression, organic sales only declined by 7% as the group
saw market share gains across most of its brands, especially Louis Vuitton. Fashion & Leather Goods, which
accounted for 64% of group operating prot, reported organic sales growth in local currencies of 1% overallwith 18% growth in Asia – a remarkable performance in my opinion.
By the way, according to Vogue UK’s August 2009 issue: “The fashion gods have spoken: this autumn, it’s all about the shoulder.” I read it. “black dominates, along with urban gray. However, indigo tones – from smoky teal to luscious purple – arethe shades that mesmerise.” In the second half of 2009, LVMH’s management is expecting more market share gains due to “numerousproduct launches” and further expansion in emerging markets. LVMH has one of the largest exposures
to emerging markets in the luxury goods sector – 32% of sales are outside the US, Europe and Japan,including 24% in “Asia ex-Japan”. Hennessy is the biggest selling cognac in China. At the same time, LVMHis aggressively cutting costs – down Euro163m in H109, equivalent to 10.6% of H108 operating prot fromrecurring operations. It would be even better if they could do more on inventory management. In PE terms,on c. 17x 2009E and 15x 2010E, the stock is only trading in line with the sector average, excluding the very
highly rated Hermes.
 
3
© Thunder Road Report - 1 August 2009
On the subject of luxury goods, my interest was also piqued by a small piece in Saturday’s Daily Telegraphnoting that:
 “The price of Chateaux Late and Latour, the two most celebrated claret houses, is surging as new investorsdevelop a taste for ne wine. Wine is in for a bumper year say dealers, thanks mostly to Chinese buyers.” 
In relation to wealthy Chinese buyers, Simon Berry of wine merchants, Berry Bros & Rudd, is quoted assaying:
 “They really like the big names – Late and Latour.” 
LVMH has its fair shares of big names in its stable of luxury brands.
China – learning the art of bubble economics
While I remain bearish on the prospects for the US and UK economies, the key question on everybody’s mindis whether China is heading into a bubble. It certainly looks like it to me notwithstanding some restraintby the authorities being inevitable. The economic recovery in China is purely a monetary phenomenon –driven by the government’s stimulus package and aggressive bank lending. While we all know that there
are caveats regarding Chinese data, the reported Q209 GDP growth gure was 7.9% and 7.1% for the rst
half of the year as a whole. Growth must be picking up strongly because China’s power generation rose
5.2% year-on-year in June 2009 after declining by 1.7% during the rst six months of this year.The worrying aspect was the make-up of the H109 GDP growth. Of the 7.1% growth, 6.2% was driven byinvestment, 3.8% was consumption and net exports contributed minus 2.9%. At this point, with plenty
of spare capacity already, it might be preferable to have the numbers for investment and consumption
reversed. What’s more, the amount of newly started xed asset investment projects doubled in H109,
implying a lot more investment is already “baked-in”.Two other data points have prompted much discussion:
B
Chinese bank lending went ballistic in June 2009 with 1.53 trn yuan (US$224bn) which was double theMay gure. This led to the highest rate of money supply growth in 14 years with M2 growing 28.5%
year-on-year; and
B
China’s foreign exchange reserves increased by US$177.9bn in Q209 to US$2,132bn. This was a massiveincrease from the previous quarter’s US$7.7bn and is far bigger than the aggregate of the country’strade surplus and foreign direct investment implying “hot money” owing in from overseas. As Doug
Noland of the Credit Bubble Bulletin pointed out:
 “the most recent quarter exceeded even the US$154bn increase near the height of the ‘hot money’ bubble
period back in early 2007.” While they set the alarm bells ringing, an email sent to Michael Pettis of the China Financial Markets (and aprofessor in Beijing) blog from a fund manager is a must-read. The fund manager had just returned from
looking at real estate in Guiyang, the major city in the Guizhou province in Southern China. While this
relates to one major city, it is hard to believe there aren’t other examples – but here it is: “I thought I’d seen insane excess in the past – 200 thousand square meter malls completely empty next
to apartment complexes with 40 thousand units and 30% occupancy rates, etc. etc. But what we saw overthere is rather hard to fathom. It seems the Guiyang city mayor had the same idea as the Shenzhen mayor
– to move the old downtown to a piece of undeveloped land.Of course Guiyang has a quarter the population and probably a quarter the per capita income of 
Shenzhen. They built sprawling new government buildings about a 20-minute drive north of town. Andthen the residential high rise projects started going up. From driving around the area, we gured well over
100 20+ storey buildings.

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