August 20, 2006 –
When I was young and foolish, I used to speculate a lot, sure that my next speculation would pay for my next vacation in Tahiti. And I made some big mistakes with my money ten years ago because of that. There’s a difference between smart speculation and dumb speculation. And i wasn’t even engaging in the smart variety back then. I was engaging in the brash, I can’t miss though I missed the last three times kind of speculation.
Speculation may reward you with lots of money but speculation more likely will cause you to engage in dumber speculation and seek out the black jack tables at Las Vegas trying to recoup that money that you lost by being so stupid the first time around.
For example, there have been many Russian stocks that have returned 100%, 300%, 600%, and even more than a 1000% in just the last one or two years. Yet even though I’ve been very aware of these stocks I have yet to take the plunge. And even with Rosneft’s recent IPO, I still may sit on the sidelines.
Why?
Because Russia is a country with high political risk where a simple decision by the government could cause your great stock to become worthless almost overnight.
In fact, this situation has already happened with Russian company Yukos oil, which went from a USD $90 a share stock to being worthless when Russian President Putin drew up what many believed to be trumped-up charges against Yukos Oil of $28 billion of backtaxes. Why did this happen? Most people believe it was due to Yukos Oil CEO’s Mikhail Khodorkovsky’s political ambitions. After concocting these charges, Putin used the military to seize the assets of Yukos Oil, threw Khodorkovsky in jail in Siberia, and then broke up the company into smaller parts, handing the choicest parts to his friends from his St. Petersberg days.
Investors in Yukos oil lost 97% of their money in a year and a half, and Group Menatep, one of the largest shareholders in Yukos oil, saw their holdings plummet from a worth of UDS $17 billion to about USD $500,000. And it’s not just Russian companies that are susceptible to such foul play. Foreign companies operating in Russia are also susceptible. In 2005, Japan Tobacco was hit with a USD $79 million back tax claim and mobile phone company Vimpelcolm was hit with a USD $157 million back tax claim by the Russian government. In fact, Roseneft is a company that was formed out of the Yukos oil seizure and sell-off.
And Russia isn’t the only country susceptible to such dramatic actions. Don’t think for one second that China has forgotten about the U.S. Congress’s led actions to block China National Offshore Oil Corporation’s (CNOOC) bid to purchase oil giant Unocal in June, 2005. And don’t think that China won’t look to repay this blocked bid with retaliatory actions of their own in the future. In fact, we’ve already possibly seen some of the repercussions of the blocked Unocal bid come to light already. In October 2005, the media reported that the very powerful Carlyle group had successfully placed a USD $375 million bid for the assets of one of China’s largest construction equipment manufacturer, Xugong group. After the media reported that this was a done deal, the Chinese government intervened, stating that a foreign country should not have control over such important national assets and blocked the transaction.
And they did this with the Carlyle group, one of the most powerful private equity groups in the world. As of the writing of this blog in July, 2006, Carlyle’s bid for Xugong is still in limbo, with Carlyle’s spokepeople stating their confidence that the deal will still get done.
It still may get done, but remember that if the deal is consummated, this will only happen due to the weight of influence from the most influential people in the world. But very few companies have the pull of the Carlyle Group. Sometime in the future, the Chinese government may elect to go one step further and nationalize the assets of a foreign company doing business in China.
So many times all people look at are soaring stock prices when deciding to make the plunge and the decision to buy significant amounts of a certain stock. But if they don’t dig deep down the rabbit hole and look at how unstable political environments may potentially turn a soaring stock into a worthless one, then there will be many investors that get blindsided by such actions.
As further example of the importance of politics to economics, recently Ecuador seized and nationalized the assets of U.S. oil company Occidental Petroleum with no plans of compensating Occidental for any of the assets they seized. In addition, Phelps Dodge’s largest copper mine in Peru was just days away from possibly being seized as well earlier this year.
Fortunately for those invested in Phelps Dodge, the candidate extolling nationalization of Peru’s assets lost the election. Even with this close call, many investors did not even know that their Phelp’s Dodge stock holdings narrowly missed a potential sharp, very steep plunge in price. So as more and more investors chase Gazprom, the largest natural gas company in the world, the only thing that has kept me away at this point is the unpredictability of the Russian government. And I won’t buy this stock, even though I still believe that it is still highly undervalued, until I can become comfortable with the politics behind the company. If I can get to this point, I’ll jump right in.
So never ignore politics. Without understanding the politics of a country, even with such a popular investment target such as China, outstanding stocks that have rewarded investors could easily turn an investor’s screams of joy into weeps of sorrow overnight.
Until next entry, follow the MoneyMites to Make More Money.
There’s a principle that all U.S. Navy SEALs abide by. And that’s “Never make the same mistake twice.” If a SEAL makes the same mistake twice, it may very well get him killed. If an investor makes the same mistake twice, it may earn him or her a good scolding by his or her spouse. And we don’t even want to mention if he or she makes the same mistake three times. But that’s the normal pattern in speculation. You suffer heavy losses the first time around, so you make a second very speculative bet in an attempt to make up the lost money. Only that one doesn’t work out so you make a third even riskier speculative bet.
Believe it or not, even major banks have been known to engage in this behavior. Their first set of risky high interest loans lead to a high percentage of NPLs (Non-Performing Loans) so they make a second set of higher interest, higher risk loans to try to cover the first set of bad loans (yes, my partner isn’t the only one that knows more than just triangle chokes and arm bars). So speculation isn’t a very wise thing to engage heavily in. Sure speculation (and SMART speculation) with 5% to 10% of your portfolio is okay. But any more than that, and most likely I’ll find you in the liquor store searching for the largest bottle of Don Julio Anejo that you can find.
Thanks JKIM