There are two types of people. Those who need things to be neat and ordered; black and white. And those who accept and live with the mess that is the world.
If you have young children and you’re the first type, you’ll find the process stressful. But over time, you learn to accept that a towel on the floor is not the end of the world. That a box of toys strewn across the lounge can be tidied up once the little one is asleep.
Right now, the global economy is starting to reveal a mess. It feels like a cupboard jammed shut, loaded with too much stuff. Open it up and stock markets will tumble, jobs will evaporate, and leaner, hungrier times will plunge the world into instability.
Flashpoints
The US versus China trade war seemed, at the outset, an easy win for the US. China exports far more to the US. America can close the door, leaving a smaller opening. In time, America ramps up its own production.
It’s hard on the markets. Big American exporters like General Motors [NYSE:GM] who sell at scale into China suffer. The stock market pulls down. But the public markets are only one part of an economy. And as other business activity ramps up domestically, they find their feet again.
At least that’s the feeling you get watching the indexes. They rise and fall heavy on the trade war updates. Any sign of positive turnaround boosts them. Indicators of a protracted dispute leads to sell-offs. Maybe you could do OK buying and selling the dips and peaks. But that’s not my strategy — I’m looking to hold promising opportunities for the long-run.
The Western problem
Trump is perhaps right pulling up China on years of predatory trade practices. You reach a point where too much of your productive base gets carried out offshore and swathes of workers in your own country are left abandoned.
The problem is with the CEOs and accountants that play too great a role in Western business and take too much of the payroll.
They are black-and-white people looking at spreadsheets and numbers. Factory or division not stacking up on the spreadsheet? Cut it. Close it. With little consideration for the community or people that can drive real long-term value.
That sort of thinking plays into China’s hands. Careless, short-term, stock-price focused CEOs are partially responsible for closing factories, sending jobs offshore and crushing local communities and their spirit.
Trump understands this. And that’s why — despite his unpresidential manner at times — he finds wide support.
Yet one area where things could unhinge comes in the form of China’s threat to curtail rare-earth exports.
Rare-earth threat
President Xi made a visit to China’s rare-earth mining base in Jiangxi province. There, metals and alloys are mined that have magnetic and optical properties used in electronic components, cell phones and, strategically, missiles and fighter jets.
Rare-earth mining is highly pollutive. It can lead to radioactive pollution and health problems like infant deaths, congenital disease, leukaemia, and lead poisoning in surrounding areas. Not too many countries in the world want to do it. One of the few other plants in the world is based in Malaysia, and that faces regulatory issues.
It seems the US is now moving to build their own plants to produce rare earth. Blue Line Corporation, a US company, and Lynas Corp., an Australian miner, are proposing to build the first rare-earth plants in the US in years.
It is said that replacing the 80% portion of the rare-earth supply chain derived from China could take years.
There’s much scaremongering in the media that China could escalate the trade war and deliver a ‘sucker punch’ to America with a rare-earth retaliation. Crippling tech and military production in the US.
Sometimes the Chinese appear overly strategic. A rare-earth ban could, in fact, backfire. Until the 1980s, the US dominated rare-earth production with a mine at Mountain Pass in California. Toxic waste water ended up closing the mine in 1998.
The mine is now back in operation.
Rare earths are not so rare. They’re moderately abundant in the earth’s crust. Although China holds an estimated 40% of the global deposits, there are significant reserves concentrated in the US and in Brazil, Canada, Australia, and India. [openx slug=inpost]
A surging stock
Since Chinese media alluded to the rare-earth threat in mid-May, the Lynas Corp. [ASX:LYC] stock price has shot up from $1.56 to $2.76. That’s a 77% increase and appears to have tipped when Lynas revealed plans to build a new processing plant in Texas.
Lynas is currently the only large-scale producer of rare earths outside of China.
As I monitor market depth for Lynas, there appear significantly more buyers than sellers.
It would be a speculative buy. But with Chinese cards on the table, possibly a strategic one.
Rio Tinto [LSE:RIO] is also involved with rare-earth mining, albeit to a much lesser degree. It is currently exploring a lithium deposit in Jadar, Serbia, which may contain some of the largest lithium deposits in the world.
At the time of writing, Rio’s stock price is up over 6%, from 4,368 pence in mid-May to 4,647 pence at time of writing.
Europe
The other messy cupboard threatening to burst and explode is Europe.
Brexit moderate Theresa May is out, paving the way for a more sceptical approach to the EU in frontrunner Boris Johnson.
Italy remains an EU rebel. The European Commission may commence disciplinary procedures against the country soon for breaking EU debt rules.
The EU requires members to keep their deficit below 3% of GDP and debt under 60% of GDP. Italy’s debt is more than twice that limit.
Deputy Prime Minister Matteo Salvini has just won strong support in the European elections. He represents a rising wave of nationalism in Europe. The left-leaning EU is seen to have failed. Many nationalists want to leave the euro and blame the EU for uncontrolled immigration that is destroying Europe.
In France, the far-right National Rally Party just won the largest share of the vote, with leader and Salvini ally Marine Le Pen declaring confirmation of ‘the new divide between nationalism and globalisation.’
As in Trump’s America, Europe’s far right finds enormous support in areas deindustrialised due to globalisation.
Navigating as investors
There’s no doubt we’re in for some rough seas. Big, developed economies remain on low interest-rate life support following the global financial crisis. And, as Ms Le Pen pointed out, there’s a new form of politics at play — nationalism versus globalisation.
Nationalism was a significant factor stoking the fires that led to World War II.
One lesson from that war is that the stock market can spike upward during the darkest days.
After the attack on Pearl Harbour, investors realised the US was mobilising for war and could win. The Fed had dropped interest rates to nearly zero. And a bull market commenced that would carry the Dow up 130% in just four years.
History repeats. We’re not at the darkest point yet in the nationalism-versus-globalisation tussle that is currently being fought on trade and immigration tracks. As we reach it, there will be volatility.
Then it’s time to bet on the winning side. The winning stocks. Prepare for quite a ride. And don’t be afraid of the mess. There’s profit in mess.
Regards,
Simon Angelo
Analyst, Money Morning New Zealand
Important disclosures
Simon Angelo owns shares in Rio Tinto [LSE:RIO] via wealth manager Vistafolio.