|By Matein Khalid| Habib Bank Ltd is one of the Pakistan’s oldest, biggest retail/corporate banks, privatized last year with a 51% controlling stake held by the Aga Khan Fund for Economic Development. Its recent price fall from 240 to 172 rupees (PKR, not INR!) is a compelling opportunity to own an undervalued, well managed proxy for consumption and credit offtake in a 190 million population country now at one of history’s significant political and financial inflection points. With a market cap of a mere $2.4 billion, a price/earnings ratio of 7.4%, a price/book value of 1.3 and a dividend yield of 8%, I believe Habib Bank is on the precipice of a valuation rerating that could turn this bank’s shares into a frontier market money gusher for us. Why?
One, Pakistan’s GDP growth has begun to revive to 4.5%, largely boosted by consumption and a revival in business confidence/capex. The $6.6 billion IMF loan package has been a macro stabilizer and the fall in crude prices has enabled Pakistan to boost its foreign reserves to above $20 billion. Nawaz Sharif’s pro-business PML government has also embraced the restructuring and privatization of state owned enterprises.
Two, Pakistan’s past “decade of terror” exacted a tragic toll in human lives and led to a fall in the loan/GDP ratio from 27% to a dismal 15% as capex plummeted. Loan/GDP is 30% in both Bangladesh and Sri Lanka. Yet the Pakistan Army’s offensives against the Taliban in South Waziristan have been hugely successful and improved the security/counter-terrorism climate. In fact, the Afghan President has even requested for Pakistani military strikes against the Taliban on the Durand Line.
Three, Pakistan will enjoy both a peace and demographic dividend in the next three years if the TTP and sectarian terrorists are vanquished. Two third of its 190 million citizens are below the age of 30.
Four, while Praetorianism and serial military coups were a recurrent theme in Pakistan’s post Partition history, the PPP government of Asif Zardari completed its term, as will Nawaz Sharif’s PML as well as adhere to the IMF loan program. Pakistan is unique in international politics as the only state that has a geopolitical “too big to fail” put option underwritten by Washington, Beijing, Riyadh and Abu Dhabi.
Five, after a horrific year for emerging markets, Pakistan trades at a valuation of 8 times earnings despite a systemic improvement in its political/financial (interest rates are at 43 year lows) and fiscal risk. I remember Pakistan equities traded as high as 13.8 times earnings during the bull market in the General Musharraf-Shaukat Aziz era and Pakistani banks traded at 2.6 bull market peaks. Habib Bank Ltd. seems inexpensive and unloved to me despite its central role in the $46 billion China economic corridor, its 22% return on equity and 17% capital adequacy ratio. The enforcement order from Uncle Sam against the bank’s New York branch has led to offshore fund manager selling and is an ideal entry point to accumulate its shares.
Six, Habib Bank has a 2.2 trillion rupee balance sheet and current accounts rose 15% to 600 billion rupees in 2015. These constitute 37% of the bank’s 1.6 trillion deposit base and the domestic CASA ratio has improved to 85.6% from 80%. These are dream metrics for an investor in international banking.
Seven, while the bank has high non-performing loans that must be managed, I am optimistic that management slashed coverage at the last earnings conference call by CFO Raymond Kotwal (who I remember as a Grammarian 6 pointer in his Cambridge “O” levels in the lost world of Z.A Bhutto’s Karachi!). True, first quarter earnings were a disappointment due to flat net interest rate margins and mediocre capital markets/fee income growth, but these are short term setbacks. The real silver lining is the 74% sequential decline in provisions and the stellar 90% coverage ratios. Low cost deposits, economies of scale, an Islamic/international/investment/mobile banking franchise all mean Habib Bank Ltd’s return on equity could easily rise to 25% in the next three years. This means a valuation rerating is inevitable, ceteris paribus-though all else rarely remains the same in Pakistan. Dr. Johnson said patriotism is the last refuge of the scoundrel but he forgot to mention deep value investors can also succumb to this emotion!
Macro Ideas – Will silver prices double in 2016?
The last five years were brutal for silver bulls. After a post Nelson Bunker Hunt bubble peak price of 48.50 in April 2011, silver plunged to $13.60 by mid-December 2015 in a bear market that was even more extreme than the epic falls in gold and crude oil. Yet 2016 saw the silver bulls finally rock again as silver surges 20% above $17.68 an ounce. The silver bull market is no longer a springtime fantasy. It is anchored in macroeconomics and the fundamental logic of the world precious metal markets.
One, there is no silver glut in the world. Most of the world’s supply of the white metal does not even come from dedicated silver mines but is a by product of copper, gold and lead extraction. Given the savage bear market in both industrial metals and gold, less silver is mined in 2016 even as its industrial demand rises. Silver output will actually fall 5% in 2016.
Two, Chinese investors are accumulating silver futures on both the Shanghai Futures Exchange and the London Metals Exchange. Beijing bought an incredible 345 metric tons of silver in the first three months of 2016 and Chinese reserves has now risen almost 180%. China’s fascination with silver goes back centuries. Even the Tang and Han dynasty emperors of the Middle Kingdom hoarded their imperial treasury with silver bullion and coins.
Three, it is still unattractive for silver producers to hedge their output. Unlike oil, there is no near term cap on silver prices.
Four, flows in the silver exchange traded funds have begun to rise and the holdings are now above 19900 metric tons, just below the all time peak.
Five, silver bulls are increasing their long positions on the Chicago futures markets, a vote of non-confidence in the Yellen Fed’s inflation fighting credentials. This is a dangerous omen of a future speculative bubble. After all, the Global X Silver Miner index fund (symbol SIL) has risen from 15 in mid January to 35 now. Something. This silver ETF was up 3% on Friday as Wall Street tanked after the Bank of Japan did squat on asset purchases. This is an amazing turnaround since spot silver fell 15% in 2015. However, the Federal Reserve’s successful attempt to talk down the US dollar and defer monetary tightening has led to a bull run in both gold and silver. Gold has risen a fabulous 19% in 2016 as mediocre first quarter GDP growth in the US, Italy’s debt woes and China’s Ponzi scale credit bubble combine to trigger subliminal fears about stress in the international banking system. Easy money in Washington has led to $17.60 silver and $1268 gold.
Silver’s epic boom and bust cycles are deeply etched in my psyche. As I was a schoolboy in Dubai, I saw a Pakistani gold wholesaler in the Deira souk make a fortune in the silver futures market as the price soared from $6 to $49 in the last four months of 1979 as Nelson Bunker Hunt, then Texas’s richest oil magnate, tried to corner the silver market before the Volcker Fed devastated the biggest silver bubble in modern history via its monetary squeeze and change in margin rules “Beyond greed” taught me more about economics and investing than Keynes’s General Theory or Von Hayek’s Road to Serfdom.
As actual silver usage outstrips mine supply, I expect silver to rise at least $25 an ounce by end 2016. Silver scrap sales and Russian selling has also abated, the reason for the market’s consistent strong bid since March. Global stockpiles of silver have now plummeted to only 20 million ounces, ten days of silver demand. It is entirely rational for owners of scrap silver to suspend sales, now at a 13 year low. The world’s investment demand in silver has grown steadily after such recent shocks as Lehman’s failure, the Greek sovereign debt crisis, Putin’s invasion of Crimea, serial terrorist outrages and multiple civil wars in the Middle East. “Poor man’s gold” is actually a far better store of wealth than paper money in a world where central banks compete to devalue currency.
Industrial demand for silver is at least 40% of usage, in batteries, catalysts, medical devices, cell phones and solar cells etc. Industrial demand for silver is relatively price insensitive, as are bullion hoarders among the global tribe of silver bulls! The ghosts of Nelson Bunker Hunt and Paul Erdman, my boyhood heroes, would love to ride the silver El Torro in ’16!
Currencies – Central bank shocks in Washington and Tokyo!
The Federal Reserve is gently warning the financial market that a June interest rate rise is possible. So far Wall Street has not staged a August 2015/January 2016, let alone May 2013 style, “taper tantrum”, since the FOMC statement was so predictably dovish, but I would accumulate volatility since I believe risk assets are overdue for another “tantrum” hit if the Fed moves in June. The FOMC projects two rate moves in 2016 but the Chicago Fed Fund futures market projects barely one move late this autumn. Humpty Dumpty is heading for another great fall if he continues to straddle the “greed is good” wall.
It is significant that the FOMC statement dropped its reference to global economic and financial risk. After all, the US Dollar Index has fallen from its mid-December highs of 100 to below 94 now while Brent crude has surged from its $27 lows to $45 now. The Chinese Politburo and People’s Bank have stabilized the yuan and Shanghai equities via massive credit stimulus. This means that the Federal Reserve can finally tighten without the risk of a global recession. Does the Volatility Index at 14 price this Fed hike scenario? Absolutely not, even though this is the summer of Brexit, Trump and Putin.
As I watch the ten year Uncle Sam note yield hit 1.85%, I believe the US dollar could be bottoming near £1.1400 on relative growth, interest rate spreads, systemic banking and geopolitical risks. Dr. Janet Yellen has tranquilized King Dollar but not dethroned the world’s reserve currency. A “data dependent” Fed will be forced to hike rates in June as job growth is on a roll and inflation hits 2%. Even the Obama White House and Dr. Yellen cannot ignore the constitutional “dual mandate” of the Fed. There is an open revolt on the FOMC that will force the Fed to turn hawkish at the next 250,000 jobs number. No major global central bank other than the Fed will raise rates in 2016. King Dollar is down but surely not out.
The Bank of Japan’s failure to ease policy lead to a global run on dollar/yen as the pair slumped to 107. Haruhiko Kuroda has been unable to reflate Japan’s economy despite negative interest rates and the most aggressive quantitative easing program relative to GDP on the planet. As the yen surges, the Nikkei/Topix is in free fall as $50 billion gaijin money exits Marunouchi loan growth is mediocre and the economy sinks into deflation, not the supply side nirvana Abenomics was supposed to deliver.
As the Chicago futures positioning data attest, the global smart money has lost confidence in Kuroda and bet on a higher yen in 2016, a bet amplified by Japan’s current account surplus with the world and the Yellen FOMC’s dovish monetary guidance. Expect a tsunami of foreign stock/debt buying by Japanese investors but their dollar hedges have only added to yen demand since early March.
Kuroda-san obviously hopes that Fed rate hikes from June will break the strong yen spiral and the Shanghai G-20 summit post political pressure on the Bank of Japan not to engage in the competitive devaluation that marked the first stage of Abenomics. So the neutral FOMC statement and the Bank of Japan’s inaction after their respective monetary conclaves are both interlinked. The fact that the Bank of Japan cut its growth forecasts to 1.2%, shows monetary easing will happen as it must when Asia’s second largest economy posts negative 0.1% CPI relative to a 2% Bank of Japan target. The bad news is that the two “lost decades” of Japanese deflation are not over. The good news is that is time to position for a peak in the resurgent yen, if its near term momentum carries it to 104. The time will come to go to long dollar/yen since Kuroda and Abe have no real choice but to fire their fiscal and monetary bazookas as Japan slips back into its deflation nightmare. Yet that time is not now at 107 yen.
Sterling’s rise to its 10 week high at 1.46 coincides with massive short covering, a surge in the British Remain camp (Ladbroke Remain odds spike to 74%!) momentum and President Obama’s state visit to the sceptered isle. This is the time to be long, not short, sterling even if High Street/growth data is awful. Sterling option volatility from its extreme 16 levels and cable trades above its 100 day moving average. Sterling will retest the February highs at 1.4680 before the ichimoku clouds darken again!
Mr. Matein Khalid serves as Head of Capital Markets and Advisor to the Chairman at Bin Zayed Group LLC. Mr. Khalid serves as the Chief Investment Officer of Salama. He manages Bin Zayed's global equities portfolios in the US, Russia, Latin America, Europe and the Far East. He is responsible for the Bin Zayed's hedge funds / private equities portfolios and external fund manager selection. He also advises the Chairman and board on investment banking relationships, financing and new issues in the international debt markets and merger/acquisition deal flow. Mr. Khalid has 20 years experience in the international capital markets and has worked with investment banks, private banks and securities firms in New York, London, Chicago, Geneva, Abu Dhabi and Dubai. He is an adjunct professor of banking and finance at the American College of Dubai, where he is also a member of the Board of Directors. Mr. Khalid writes on global financial markets and Middle East studies for newspapers and magazines in the UAE, Bahrain, Oman, Qatar and the United States. He has also taught courses on capital markets at J.P. Morgan Chase, (New York), SP Jain and Emirates Institute of Banking (Dubai). He has also taught at capital market seminars at Morgan Stanley (London), Chase Manhattan Bank (Geneva) and Barclays Capital (Hong Kong). Mr. Khalid has briefed ASEAN finance ministers and ultra high net worth investors in Hong Kong at the invitation of the chairman of Barclays Capital. He holds an MBA in finance and BS in Economics from the Wharton Business School and a BA/MA in international relations from the University of Pennsylvania in the US.