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Every trading day I wake up and read four newspapers and seven websites. Then I evaluate data from about a dozen different public and private sources. Then I start writing and analyzing the markets as I assess potential trades.
Never before have I seen so much noise that doesn't matter to the market. On the flip side of that coin, never before have I seen so many genuine threats go ignored because they clash with a certain narrative or fail to generate sufficient clicks.
This severe lack of actionable information for the public gives you events like we saw this March, when the markets crashed and sharply rebounded.
Millions of regular investors were wiped out – many are still wiped out because they had no dry powder ready to redeploy, or they were simply paralyzed with fear, unable to move as momentum returned to the market.
You know who wasn't wiped out? Insiders. Hedge fund players. They scooped up stocks like kids in a candy shop because they knew for an absolute certainty that the Fed would ride to the rescue, dumping loads of money out of helicopters like the 1st Air Cav.
Well, I see another "globally significant" event unfolding halfway around the world from here in Hong Kong.
I'm not going to call it a black swan… but it's a very, very suspicious-looking egg.
Trading events like this is always cheap, and the payoff is usually astronomical. Sure enough, the two trades I like for this are radically underpriced right now.
Here's the Real Problem in Hong Kong
Scan the news right now, and you'll see the president selling Goya beans. You'll see people furious about that, and people who think it's terrific.
You'll see the media cheerleading the U.S. Federal Reserve. You'll hear about the coronavirus swamping the southern and western United States.
You'll read about anger at China over COVID-19. You might even get oblique references to the on-hold trade war that fueled markets in 2019… but you won't learn what you really need to know about China right now.
I mean Hong Kong, the former British Crown Colony turned Chinese Special Autonomous Region.
Under the terms of the Sino-British Joint Declaration concerning the 1997 handover from the United Kingdom to China, Hong Kong was supposed to maintain its Basic Law, its freedoms, and its unique, separate legal system – a legal system distinct from mainland China and that did a great deal to safeguard press freedom, the rule of law, and human rights.
This "one country, two systems" arrangement was supposed to last until at least 2047, 50 years after the handover.
Communist Party honchos back in Beijing have radically shortened the timetable. They passed a "national security" law that profoundly undermines Hong Kong's "one country, two systems" existence.
The law is a haymaker blow to democracy, free press, and free-thinking people.
As a result, President Trump has pushed back against China by ending Hong Kong's preferential trading status and could press for new sanctions on leaders and companies, including banks, in the area.
Now, here's where it gets interesting.
Hong Kong has its own currency, the Hong Kong dollar. This dollar has been pegged to the U.S. dollar since 1983 and trades in a range of HK$7.75 to HK$7.85 per U.S. dollar.
Hong Kong's interest rates track the monetary policy of the United States to maintain that peg. However, the Trump administration has threatened to prevent Hong Kong banks from access to U.S. dollars. This could undermine the peg between the two currencies.
If that peg were to break – which I believe it could happen by 2022 – it would undermine Hong Kong's influential financial market and hurt the global economy.
For proof of this, we can look to Switzerland which, back in 2015, severed the franc's link with the euro. This sent the franc through the roof and jolted savers and capital markets.
Hong Kong is systemically more important than Switzerland. Any currency shock there could have big, "unpleasant" implications worldwide.
What's more, there are valid reasons for China, Hong Kong, and/or the United States to make that break happen, and those reasons are going ignored.
I want to stress that a lot of people are saying that this won't happen.
But I also want to remind you that at the height of protests across Hong Kong, several leading Chinese economists warned that the Hong Kong dollar could depeg from the U.S. dollar. At the time, it made sense, given the sharp decline in the region's economic health. The Financial Times said that Hong Kong might not have any choice but to break the peg and follow its own monetary policy goals.
Looking at the political crisis, I wouldn't expect there to be an actual free-float of the Hong Kong dollar against the U.S. dollar, but a "reset" of the existing peg in a new range could have a dramatic impact on certain trades that have very little volume – and very attractive prices right now.
The Long of It: an Asia-Pacific Fund on Sale
I'm a big fan of closed-end funds (CEFs). These "cousins" of mutual funds trade on the open market, and prices swing based on the bull and bear sentiment of the market, not on the underlying securities and net asset value.
I always highlight the Boulder Income & Growth Fund Inc. (NYSE: BIF) as a perfect example of the benefits offered by closed-end funds. This fund is a portfolio of Berkshire Hathaway Inc. (NYSE: BRK.B) stock and the rest of Warren Buffett's holdings. It trades at a discount to its net asset value and pays a massive dividend of 8.3%.
Well, there are closed-end funds that dabble in foreign bonds as well. The one that sticks out in this situation is the Aberdeen Asia-Pacific Income Fund Inc. (NYSE: FAX).
This fund is comprised of bonds from diverse Asia-Pacific nations like Australia, Indonesia, India, Thailand, Vietnam, Singapore, Malaysia, and… Hong Kong.
I expect that while the 2.49% of the portfolio in Hong Kong bonds would take a hit, we'd see an appreciation of the other currencies around it and an opportunity to tap into beaten-down international income opportunities.
If you're worried about frothy equity markets, the opportunity to generate income and enjoy appreciation upside is ripe in this fund.
The closed-end fund currently trades at a 15.7% discount to its net asset value and pays a hefty 8.5% dividend.
That discount is significant. Very significant: It signals that people are not in on this trade and aren't thinking about it over the long term. That reflects the investment reality that Asia-Pacific funds have fallen out of favor for now, but with U.S. interest rates falling (and half of Europe now facing negative rates), this is a clean way to pull in income.
When we see foreign markets generate interest from investors again, we will look for that discount window between the share price and the NAV to close and press the value of shares higher. This sort of contrarian approach is how you position yourself and get there early before the world wakes up to a new and very different reality.
The Short of It: an Inexpensive Way to Speculate
I do not know how and when the United States and Hong Kong peg will end. But I am confident that it will, given the current economic environment and the lack of de-escalation on both sides.
A second Trump term would encourage the president to take dramatic steps to rachet up pressure on China. But a Biden presidency doesn't appear to place much focus on the current state of affairs between the two nations.
Biden's entire economic plan partially mirrors Trump's – a stiff shot of economic populism.
It places a significant focus on "Buy American," the return or "reshoring" of manufacturing from places like China, the use of domestic technologies to address climate change, and a commitment to rebuilding American infrastructure with American equipment.
In other words, both parties are looking inward at the economy, which will effectively reduce reliance on China out of political and security necessity.
Here's what I recommend. Buy puts on the iShares MSCI Hong Kong ETF (NYSEArca: EWH) with a two-year time horizon. Yes, I said two years, but you won't be looking to stay in this trade the entire time, just until the volatility picks up. In particular, I like the EWH January 2022 $20 put, purchased at $2.25 or better.
The total cost of a single trade would start at $225. The implied volatility (IV) of these contracts is sitting at 31, which is stunningly low, and another signal that no one is really in on this trade.
This is a fantastic "parking spot" for capital right now.
Looking at some options calculators from the CBOE, if the IV were to increase to 80, the value of this contract jumps to $7. If the IV increases beyond that, and this fund drops to around $18 (from $21.73 today), the value of this contract will surge to $8, giving us profits of anywhere between 211% and 255%.
I don't know if we're going to reach those levels, but I'm looking for at least a 100% gain on this play. If and when the contract doubles, sell half and enjoy the free ride.
(I just have to take a second here to emphasize that the profit potential in options trading is simply incredible. I think my friend Andrew Keene is one of the best trading experts. He hosts a live trading room – full of his top research – once a week, every week for his subscribers. He also sends weekly S.C.A.N. alerts to let his subscribers know about new potential trade opportunities. Click here to check out what he has to say about his system.)
You hear the term "black swan" tossed around a lot – maybe too much. By their very nature, black swans can only blink into existence if no one sees them coming.
We certainly do, but no one on Wall Street seems to believe the extremely likely – perhaps even imminent – scenarios I've just described will ever come to pass, despite openly hostile rhetoric and definitive moves in this direction.
If things really get ugly in Hong Kong – and we're just one headline away from that happening – you're going to see people pouring into short bets in Hong Kong. And we'll be able to profit handsomely when the time comes.
About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, and consultant with degrees from Northwestern, Johns Hopkins, Purdue, and Indiana University. He is a seasoned financial and political risk analyst, with a focus on stocks, hedge funds, private equity, blockchain, and housing policy. He has conducted risk assessment projects for clients in 27 countries, and consulted on policy and financial operations for some of the nation's largest financial institutions, including a $1.5 trillion credit fund, a $43 billion credit and auto loan giant, as well as two of the largest Wall Street banks by assets under management.
Garrett joined Money Map Press as an economist and researcher in 2011, specializing in alternative strategies with an emphasis on fundamental and technical analysis.