Wednesday, September 9, 2009

Rude Awakening - The End of Cheap Water?

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Rude Awakening

The Rude Awakening

Baltimore, Maryland

Tuesday, September 8, 2009


* Markets' meteoric rise flattens, could this be the edge of the next cliff?

* When it comes to investing in China, there's something in the water,

* Avoiding the dubious art of "falling with style" and plenty more...


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Eric Fry, reporting from Laguna Beach, California…

Fans of the 1995 animated movie, "Toy Story," will remember when Buzz Lightyear conducts a series of acrobatic maneuvers that persuades most of the other toys he can fly. But, Woody, the toy cowboy, angrily objects, "That wasn't flying! That was…falling with style!"

Fans of the 2009 rally on Wall Street also seem to believe that the U.S. economy can fly. But that's not flying, dear investor, that's falling with style.

"Airborne" and "aerodynamic" are not synonyms.

If the nation's leading economists are to be believed, the U.S. economy has lifted off from the long, bumpy runway of recession. But your editor suspects that this liftoff might last only slightly longer than the Wright Brothers' 12-second flight at Kittyhawk.

The problem is that government credit is lousy jet fuel. Only private capital can power long-distance flights. For a short time, governmental efforts can send an economy airborne. But these flights of fancy almost always end quickly…and badly…unless private capital returns to the venue.

So far, private capital has shown little inclination to resume investing in anything riskier than T-bills. Financing remains scarce for most of the small and mid-sized businesses that comprise the heart and soul of the American economy. [Every single small- to mid- size businessperson with whom your editor has spoken during the last few months has reported that lack of credit is hobbling business. If any Rude readers would like to corroborate or refute this anecdotal impression, please email your firsthand accounts to Joel]. In the meantime, many of the most visible indicators of economy vitality remain unmistakably downbeat.

Given the related facts that private capital is conspicuously absent from the economy and that government stimulus programs are notoriously ineffective, the U.S. economy might struggle to remain aloft.

The nearby chart shows that the Institute for Supply management's Index of U.S. service sector industries has improved a bit of late. Apparently, this segment of the economy has gained a little altitude. But remember, airborne is not aerodynamic.

"If we have a recovery at all, it isn't sustainable," predicts Kevin Harrington, managing director at the hedge fund group, Clarium Capital Management LLC. "This is more likely a ski-jump recession, with short-term stimulus creating a bump that will ultimately lead to a more precipitous decline later."

Paul Tudor Jones, one of the most successful hedge fund managers in America, holds a similarly dour outlook. Accordingly, he distrusts this year's big rally on Wall Street that has lifted all the major averages 50% or more. This was merely a "bear market rally," Tudor declared in an August 4th letter to his firm's clients. Interestingly, all the major U.S. stock market indices are flat since August 4th.

This recent lackluster performance does not prove Tudor is correct, but it does prove that he isn't wrong…at least not yet. In other words, his bearish outlook may not be right, but it is probably justified.

The very same stock market that has been going up for most of the last six months – and that Abby Joseph Cohen, the robotically bullish strategist at Goldman Sachs, predicts will continue to go up – is the same stock market that may begin going down…simply because the underlying economic realities fail to support rising stock prices.

Not all stocks deserve to be sold, of course. In fact, some types of stocks are probably worth buying right now…

In the column below, Chris Mayer, editor of Mayer's Special Situations, revisits one of his favorite long-term investment opportunities…

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The End of Cheap Water?
By Chris Mayer

The price of water is starting to rise in a big way, at least in China. I've expected this for a few years.

Water rates in China have been so far below the global average it's ridiculous. Especially when you consider the severe water problems in China. The Chinese are water-poor. They are sucking their aquifers dry. It is particularly bad in the north of China. The groundwater under the North China Plains is draining away quickly. By some estimates, China will exhaust this water supply in the next ten years.

You probably know that the city of Venice is sinking a fraction of an inch per year. But that's nothing compared to what is going on in Beijing. Parts of Beijing are sinking 8 inches a year! According to Andrew Lees (The Right Game), it is the world's largest cone of depression (an underground hole created by a depleted water table) at over 15,000 square miles. The second largest cone of depression is around Shanghai.

So finally, many cities are raising the price of water. The WSJ points out several places where water prices could rise 25-48%. Shanghai, for instance, raised water rates 25% in June and plans another 22% increase next year.

The second event that caught my eye was the collaboration between China and India to monitor the health of Himalayan glaciers. This area is very important to both countries. They fought a war over it in 1962. So, the fact that they are getting together on the Himalayan glaciers is meaningful.

Here is why it is so important: Seven of the world's largest rivers, including the Ganges and the Yangtze, are fed by the glaciers of the Himalayas. They supply water to about 40 per cent of the world's population.

Well, those glaciers are shrinking. The Indian Space Research Organization, using satellite images, has studied the changes in 466 glaciers. It found they had lost more than 20% of their size between 1962 and 2001.

This melting increases the water flow at first, but eventually slows dramatically as the glaciers either melt completely or reform. These observations have given rise to a kind of "Peak Himalaya" theory where people wonder if we have not seen the maximum water flow from the mountains.

We know the current run rate on demand is already well above what is sustainable given annual rainfall and river flows. That's why you have those depressions under Beijing and Shanghai. That explains the depleted aquifers and the rivers that don't reach the sea. Now throw into that ugly brew a decline in water supply from the Himalayas. The situation is worse than it seems, if that is possible, because much of the existing fresh water in both countries is so polluted it is unfit for human consumption.

As if all of that weren't bad enough, the demand for water is still rising rapidly in China and India. The water use per capita in China and India are still well below global averages. As these countries industrialize, they'll consume exponentially more water. It takes water to make just about everything. For example, to make a 1 tonne passenger car takes more than 100,000 gallons of water. Just to make a cotton shirt takes over 1,000 gallons of water. And most of our water goes into making our food.

So, population growth by itself guarantees increased water demand. (Globally, water consumption increases at more than twice the rate of population growth.) These two countries already have big populations and both will get bigger. When you look at demographic trends, China and India alone will add close to 600 million people over the next 30 years. That's two present-day United States.

Fresh water, like oil, is getting a lot harder to find for 40% of the world's population. It will get worse before it gets better. The days when we think of water as a cheap resource are coming to a close. That's especially true for China and India.

Bottom line: We need to create more fresh water. You do that by finding new sources either through new supplies (drilling deeper, desalination, etc.) or by using existing supplies more efficiently (irrigation and other efficiency gains).

All of that takes time and energy. Desalination is energy intensive. Drilling deeper for water or going to more distant source requires energy to pump and move the water. Replacing older, less efficient plants and equipment takes time and energy again. (Detect a theme here?)

Countries, companies and people will find ways to make this transition. The companies that can solve these problems will do well.

Joel's Note: … and, odds are, those companies will – if they haven't already – find their way into the Mayer's Special Situations portfolio. For a complete rundown on this excellent research service and access to his favorite resource plays, continue reading here.

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[Rude Endnote: Whatever happens in the future, if it happens for long enough, will come to be known as "normal." As we all know, normal can differ vastly from country to country, generation to generation. What is normal for a child in the Sudan is not likely to resemble any kind of normal for a Goldman Sachs executive, for instance.

Still, everyone we talk to seems contended with the assumption that things, economically speaking, seem to be "returning to normal." We wonder what that actually means? Yesterday we asked readers what they thought the "New Normal" might look like.

"I don't like what I perceive as the coming 'new normal,'" writes reader, Jim. "It consists of higher unemployment, tighter credit, belt-tightening everywhere, increased homelessness, agitated, fearful, and frustrated citizens, combined with a squirrely set of politicians making things worse as they muck around pretending that they know how to fix a broken system."

Reader Thomas B opines, "The abnormal 'new normal' is happening as it is because the Government Market Controllers have achieved some sort of control over the whole system....enough so that the market moves the way they want it to, when they want it to, for as long as they want it to....and I expect it to continue this [an] irrational, abnormal way that [will] define the 'new normal'."

We'll have more thoughts from the irrepressible Rude readership throughout the week. If you want to comment what you think the "New Normal" might look like, simply drop us a line below.

Until next time...


Joel Bowman

The Rude Awakening

Special Reports

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