The Oil Anomaly

Anomalies, like some difficult people and risky jokes are where you find information, this is why we like them. The biggest anomaly out there can probably found in the global energy markets. The economic crisis that began in the second half of 2008, triggered a sharp decline in energy prices and consumption.  By the end of that year the price of oil had fallen by 75%, traded coal was down by 62% and the price of natural gas sold in the US, had fallen by 58%. The economic slowdown continued into 2009, and then something strange happened.

While prices for coal and gas continued to fall, the oil price stabilised and then staged a sharp recovery. From a low of $34 in December 2008, the price of oil rose to $71 in June 2009. In the wake of economic recovery the oil price has continued rising and is now over $80. Week in week out pundits attempt to call the oil price and most of the time they seem to call it wrong. The reason it is so difficult is that the energy markets are going through a change and change is always difficult to forecast.

Demand for oil in the OECD countries had started to fall in late 2005, long before the economic crisis broke. It continued dropping through 2006 and into 2007. Since 2007, oil consumption in OECD countries was down by 8%. Yet, in the five years to 2008, the price of oil rose by 370%, traded coal was up 460% and natural gas rose by 120%. For the answer to this anomaly we can largely ignore the machinations of hedge funds and other speculators, instead we should look at what is happening in emerging markets.

The only other time since World War II that prices rose by as much as they have during this decade was in the 1970s. Then demand for oil was driven by growth in the developed world. This time round 90% of the growth in demand for oil is coming from the developing economies.  

Emerging inefficiency

Emerging economies, like China and India, are not efficient consumers of energy.  Therefore, demand for energy exceeds the growth in GDP. At market exchange rates it takes 3.4 barrels of oil equivalent to produce $1000 of GDP in the non-OECD countries, compared to 1.1 barrels of oil equivalent in the OECD. One reason for this inefficiency is that many emerging markets subsidise the price of energy. There is a direct correlation between energy efficiency and energy prices so subsidies are not a helpful distortion if you are worried about carbon emissions. Besides green house gases distortions have other  implications for global economic growth. 

The American consumer represents about $11 trillion of global GDP, compared to about $2 trillion for both China and India. In the US, fuel taxes are low and as a result the price of oil has a more direct impact on the prices that consumers pay at the pump. With demand rocketing in the non OECD, both because of stronger growth and inefficiencies, American consumers are likely to suffer, even as growth in their own country stagnates. Fuel subsidies, therefore, are a distortion that are being felt all around the world. 

Fuel subsidies make the world a more unpredictable place. The other reason that unpredictability is rising is due to the different nature of growth in mature and developing markets. As Christof Ruhl, the chief economist of BP, from whom much of this article is derived, explains: in developed markets economic growth only gradually reshapes the sectoral composition of the GDP and employment; its principal affect is to expand the service sector, which is less energy intensive. In emerging market, growth is radically reshaping economies, making predictions about energy consumption harder to nail down successfully. Hundreds of millions of people have left low-energy-intensive activities, such as agriculture, for energy-intensive activities, such as construction and industry.  In the West, industry is becoming less energy intensive, whereas in emerging markets the drift is the other way.

As discretionary incomes rise in the developing world, due to urbanisation, lifestyles change. Mobility and the need for transportation increases, as we can see by the explosion of car sales into countries, such as China. These changes have shifted the growth in demand outside of the OECD.  Ruhl says that the entire net increase in global oil consumption since 1999, has come from outside of the OECD countries.

This rebalancing of consumption in favour of the emerging economies carries a heavy environmental cost. In the 1990s the growth in carbon emissions slowed, but since the turn of the century it has picked up on the back of emerging market demand.  The carbon intensity of energy itself has increased. From 1970 until the late 1990s, global emissions per unit of energy consumed fell steadily. But then, in 1999, reflecting the increasing share o coal in energy portfolios of the non-OECD countries, carbon emissions per unit of energy began to rise. Since the turn of the century they have increased by two per cent globally and by 3 per cent in the emerging world.

The Role of Opec

As we have just seen, the rise of the emerging markets is making it more difficult to predict energy consumption. However, as we saw above, the price of oil rose sharply while other energy sources, such as gas and coal were more directly correlated to the overall economic growth. The rise for the divergence is due to Opec. The oil price is supported by a cartel, whereas coal and gas are not. 

By 2008, the average annual price of crude had increased for 7 consecutive years, this had never happened before. One reason for this rally can be laid at the door of price fall, when the price for crude began to retreat from $80  a barrel, which was then a record high. To stop the decline, OPEC stepped in and cut production twice, in late 2006 and early 2007, by almost one million barrels a day. Crude oil then rallied from $50 to $147 in July 2008, their highest level ever, in both real and nominal terms.

What is extraordinary about this rise is that production was only cut by 1m barrels a day, where as daily consumption is 81m a day! Ruhl explains that like any complex system, the global oil market needs a degree of redundancy to operate smoothly. In the short term, inventories can provide this safety cushion; in the longer term, it is provided by spare production capacity. Following strong demand growth in 2003 and 2004, spare capacityin the global oil market was hovering around record lows, at little more than two percent of global production. Even after the OPEC cuts of 2006 and 2007, the global oil market was running at above 97 percent of capacity. At such a high level it is impossible to guarantee any meaningful stability in prices.

As growth picked up, an already tight market became tighter and prices exploded. As crude prices cruised through $120, Saudi Arabia unilaterally decided to increase production in an effort to help out the US, its largest customer. Curiously,  oil prices jumped on heels of both announcements; the market believed  that Saudi could not deliver the increase. The market was wrong. Not only was production increased in the Kingdom, it was rose from other Persian Gulf producers too. The timing could not have been worse because it coincided with the Great Recession. Prices fell from $147 a barrel in the summer to $34 by late December.

Production was cut by 4.2m barrels and by the first quarter of 2009, OPEC’s cuts finally met the fall in global demand. 

Where are we today?

Ruhl estimates that the oil market now has 6 m barrels a day spare capacity. He calculates that it would take three years to burn through this capacity and wind markets up as tight as they were last year. Now hear this: prices are not expected to spike over the next two or three years.

Stability may be a dream because it assumes that the deep structural changes that affect the oil market comply. Three factors are worth keeping in mind. The first is that OPEC retains inordinate power over the oil market, even though it only controls 40% of crude output. The main reason for this is that there has been barely increase in supply from non OPEC regions, despite the strong rise in the price between 2002 and 2008.

The second reason, as we have discussed, is that emerging economies now drive the price of oil. The last structural change in the oil market is energy efficiency. The entire increase in global oil consumption this century has come from outside of the OECD in countries where its price is subsidised. Estimates of future shifts in demand will therefore have to determine how subsidies are likely to affect demand outside the OECD countries, for example, in China or the Middle East.

Coal and Gas

Global coal consumption is led by China, which consumes 43% of global supply and represents 85% of the growth in coal consumption.  The market for coal is a lot less concentrated that that for oil. Coal trades internationally in smaller but highly competitive markets. During 2008, the price of coal rose and then collapsed as the Great Recession hit demand. It fell longer and further than oil because there is no cartel supporting the price.  The market has also become more competitive: in response to higher transport costs, Europe substituted coal from the Indian Ocean with imports from the US.

Another factor is that fact that coal can be substituted by cheaper natural gas, which is what happened in the European Union. Electricity production from gas rose by 8 percent, compared to a 9 percent drop in electricity production from coal. 

Natural gas got hit by the same one two punch that hit oil. Production increased just as economic growth went into a tailspin. The increase in gas production was partly due to technological advances in the US. Chief among these is horizontal drilling and hydraulic fracturing, which uses water pressure to release gas from hard rocks. Improvements in technology have led to an increase in the production of non-conventional gases.  Production of non-conventional gases, such as coal bed methane, tight gas and shale gas has doubled over the last decade. The share of these gas deposits in total US gas production has reached about 50 percent.  Like unconventional opinions unconventional gas is becoming the new normal.

As the technology that was pioneered in the US spreads the production of unconventional gases will increase. This is important because deposits of gas are less concentrated than those of oil.

Another change has been the development of an integrated market for LNG. About 8% of all internationally traded gas today is LNG. Traditionally, the relationship between LNG producers and consumers has mirrored that between piped-gas producers and consumers, which are connected by pipelines.  This system is now changing. Spot markets have been emerging, thanks to buyers who have tried to secure additional LNG by purchasing single cargoes. 

The emergence of a competitive market for LNG has the obvious effect of  linking prices between regional gas markets in Asia, Europe, and North America, which have historically been segmented. The second consequence is that with long-term contract pricing under pressure, competition will increase and efficiency will improve. Consumers will benefit if the price of natural gas is increasingly delinked from the pice of crude. Finally, the advent of a globally integrated LNG market will improve energy security by fostering diversification. 

We can already see the consequences of this: Russian and Central Asian gas deliveries to Europe are being affected by LNG prices. Whether the changes in the natural gas markets will have strategic significance will depend on two factors. The fist is whether more unconventional gas resources can be developed and where this occurs. The reason that coal is so popular is that it is available where it is needed - primarily, in China and India. By contrast, natural gas is, like oil, geologically concentrated: 60 percent of natural gas is consumed in regions that only control 14 percent of the reserves. Now if unconventional gases can be produced in places such as China, which currently are heavy users of coal, it could become the local fuel of choice, which would benefit carbon emissions. One kilowatt-hour of electricity with natural gas emits a little more than half the amount of carbon that producing the same amount of energy with coal does. 

Conclusion

What we have learned is that no matter how severe the current recession, its effects on global energy markets are likely to be dwarfed by the long-term impact of the industrialisation of the emerging-market economies. The pressure on energy and commodity markets may have been relieved for the short term, but over the medium and long terms, the need for greater energy efficiency is paramount.  Today, oil accounts for 35% of global primary energy consumption, coal for 29% and gas for 24%. Renewable energies, other than hydro and nuclear, are less than one percent.  It’s time to wake up and smell the methane, it will be decades before alternative energies ever have a meaningful impact on global energy consumption and carbon emissions. Where we can make an impact is through improved efficiencies. 

In the West industry has led the way in becoming more efficient.  As consumers in both the developed and developing world show an increased desire for electronic goods, such as flat screen TVs, lighting, computers, music players, video cameras and digital still cameras, the ability to deliver greater energy efficiency becomes more prized. This is one reason the share prices of companies involved in such technologies as LEDs will continue to outperform solar, wind or any other alternative energy in future. 

The Smart Paradigm comes to Asia

After the great moderation comes the great rebalancing. If OECD economies are to reduce the amount of debt in both the public sector and within households, then saving has to increase. Just as falling interest rates and the decline in economic volatility, combined with a rise in credit, defined the world since 1982, the need to pay off debt in the OECD will define the coming decades.

Co-ordinated government stimulus and low interest rates have postponed the dreaded day that this will happen but investors can hear the clock ticking. One of the key elements of this great rebalancing will be that Asian consumers will have pick up the slack as consumers in the West consume less. Today, the US consumer represents $10.35 trillion in spending, compared to roughly $2 trillion for both India and China. However, Asia will represent an ever greater proportion of the growth in demand. This has long been the case for computers and, as Apple’s numbers demonstrate, it is now beginning to drive smartphone sales.  

Asia is becoming the greatest markets for tech goods but how should an investor play it? First off, ignore analysts who continue to focus on the corporate PC market. Better still,  sack them because they are in gross dereliction of their duty. Second, be suspicious of analysts who focus on networking equipment.

As Microsoft again affirmed, in its latest results, consumers continue to power sales, not corporates. As we have argued before, the super cycle that we are in the midst of is the networking of the private and public space. The mainframe and PC cycles of IT expenditure were about the networking of the corporate space. The life that is lived by ordinary people is of movement, in geographic and temporal terms it takes place in 360 degrees and not at a desk top within a corporate building. 

The blue line represents PC sales, the purple  line is mobile, the red lap tops and the green smartphone. All in hundreds of billions of dollars. Source: Cykepartners.com

The arrow of time in tech points to mobility becoming increasingly dominant. Mobile phone revenues overtook fixed line revenues around the mid point of the last decade, and lap top PC sales have been the fastest point of growth in the PC market for about 10 years. Tablet computers will accelerate the trend, particularly in Asia and emerging markets. Soon there will be a generation of young people. in emerging economies whose first experience of text has either come from a mobile phone or a small computer. In the first quarter of this year smartphone sales increased at 50%, if that rate were to continue there would be close to five hundred million on sale by 2011, by which point it will probably be outselling PCs.

Unlike the PC, smartphones are something of a fashion item, they are badges that we use to signal something of our selfhood. There appearance confirms what could be described as a super cycle. The first waves of technology were all about networking the corporate space. Smartphones, like tablets, netbooks, and notebooks play to networking of private and public spaces, in other words, society in 360 degrees.

A few years ago it was estimated that the average western home had twenty-six electronic devices. One trend, that is at an early stage, is that more of these devices will be linked to the internet. With this in mind, Ericsson estimates that by 2020 there will be 50 billion devices connected to the internet. Within the home there will computers, lap tops, netbooks, tablet computers, numerous phones, digital music systems and a TV. There may be something called a home media gate way, a server computer that stores digital media that can then be streamed around the home.

The simplistic way to play this trend is to buy Taiwanese companies, such as Gemtek, Realtek and Zyxel. The problem is that these companies have little pricing power. Networks are built using international standards, so it is difficult to add any value. Cisco might be a networking equipment company but its market position is built upon a proprietary operating system,.Like Apple, Cisco is not primarily a hard ware company. Some of the Taiwanese networking names might enjoy a moment in the sun, as sales take off but it will not last long.

The rise of the Asian consumer will, in many ways, be a reprise of the world that was dominated by the personal computer. Therefore, the Asian hardware companies that mainly win will be the ones who dominate the PC world now: Hon Hai, Samsung, TSMC, with the addition of newer names, such as Mediatek, would be a good place to start  

A Media Centric Age

In an age when billions of devices are linked to the internet, and when most of them are mobile, what we have is the mother of all networks. Increasingly, these devices and the internet will be used for communication and the creation of communities. This pattern has been under way for some years and is already affecting which brands consumers value. Yet it may be have its profoundest impact upon the consumption of media. Look at the following chart, which comes from the Silicon Alley Insider website. It analyses Amazon’s sales, which for the first time are now dominated, not by books or CDs, but by digital products.

The network is being built, rapidly it is being populated by devices, as our various charts illustrate. The next step is that networks and devices have to do something. Increasingly, what they will be used for is the consumption of content. This is one of the articles of faith behind our theme of the Smart Paradigm.

The future just happened. In 2009 mobile data, for the first time, outstripped mobile voice. Yet there are only 400m mobile broadband connections, compared to 4.3 billion mobile phone subscribers. By 2013, more than 90% of global consumer data traffic will be video on demand and TV. Today, Youtube traffic is greater than that of the entire internet during much of last decade. Each minute 24 hours of video are uploaded to Youtube.

Asia’s influence is rising, and as the power of the region’s consumers increases, then Asian   media companies and internet names, such as NC Soft, NHN, CTrip, Tencent, Baidu will continue to prosper. Over the coming weeks we will examine this theme further because there are obviously opportunities to be had within the Indian media scene. 

However, let us not forget the West. American culture shaped the 20th Century, there is something about the American sense of fantasy that is seductive. This may have something to do with the fact that capitalism is making us more infantile. Therefore, American and some other Western media giants, such as Disney, Time Warner and News Corp, will among the winners from the digitalisation of Asia. Apple would be the other name we would focus on. Our hunch is that Apple may be the Western company that benefits most from the rise of Asia. By contrast, Microsoft, like Nokia, is likely to be among the Western losers. 

The Pepsi Paradox

Right now, the hottest area of science is focused on the brain, understanding consciousness, perception and the sub-conscious mind.  Over the last decade interest in the field has been revolutionised by improvements in new scanning equipment, particular fMRI - functional magnetic resonance imaging - machines. The new tools allow scientists to monitor what is happening in the brain as it goes through certain tasks. In other words, we can see what is happening in the brain in real time.

Every breakthrough has a downside.Scientific revolutions usually start life as highly reductive. Remember the early days of genetic research, when we were told that a gene had been found for this or that, as though life was little more than a printed circuit board where components and transistors did specific tasks? The same is in danger of happening in brain research today. In particular, we should be wary of a new breed of neuro-economists who are recruiting the new research to support some of their own pet theories.

However, research into how the brain operates is beginning to reveal some surprising things about what drives us. There is an excellent survey of the latest research in a book called Mindfield, written by Lone Frank, a Danish neuroscientist. On reading her book I am tempted to say that we now live in the era of the medial prefrontal cortex and the mirror neurone.

Let’s take the medial pre-frontal cortex first. Decades of blind tastings have found that   when presented with Coke or Pepsi, most people prefer Pepsi. All the same, Pepsi has a market capitalisation of $104bn whereas Coke, plus its bottling businesses, which were spun off, has a combined capitalisation of more than $170bn.In marketing circles this is known as the Pepsi Paradox.

In 2004, Read Montegue of Houston’s Baylor College of Medicine, finally nailed what was going on in the brain when consumers taste the two colas.  Just under 70 volunteers were first asked to take part in a blind tasting. Just as so often before, Pepsi was the clear winner.  What the MRI machine saw was that Pepsi set off greater activity in the ventral putamen area of the brain, compared to Coca-Cola. The putamen is an area cradled deep within the brain in the striatum, which is, among other things, a component of the reward system. In other words, those who drank Pepsi felt just as you would expect them to when sipping sugared water.

In the next series of tests the subjects tasted colas with visible labels. This time round most of volunteers preferred Coca-Cola. This shift in attitude followed an important change in the brain - this time, the medial prefrontal cortex kicked into action. The cortex was the last area of the brain to develop, it houses our higher cognitive processes. When people tasted Coke this region of the brain overrode immediate feelings of reward evoked by the taste impression.  In particular, the medial prefrontal cortex is where elements of our awareness of self and identity are housed. Literally, when you say, “this is so me,” it is your  medial prefrontal cortex that is lighting up. Products, such as iPhones, BMWs, Prada bags, trophy wives and certain types of music, light up our medial prefrontal cortex like a pin ball machine. 

In the early stages of economic growth capitalism is focused on supplying our basic needs. This is why it makes sense to have a portfolio loaded up with consumer staples when investing in primitively developed economic markets. When you pass a certain point, which is probably when per capita income is close to $4000, capitalism enters its medial prefrontal cortex stage. In other words, it becomes increasingly concerned with satisfying our ever shifting sense of self. In a really poor country, very basic mobile phones will be what the market demands. Then, as incomes rise, we lust over an iPhone. At first all we can afford might be a cheap copycat iPhone from a Chinese white-box manufacturer but the goal will always be to buy the real article.

The Theatre of Envy

There is another force at work here and that is the recently discovered mirror neurone. Our brains are peppered with them. Humans and other animals are programmed to copy. The discovery of mirror neurones chimes with a theory long championed by Rene Girard, a famous literary critic. Twenty years ago, Girard published an highly influential book called, The Theatre of Envy. Girard’s big idea, made before the discovery of mirror neurones, is that our passions and desires are the result of mimicry. Girard identified Shakespeare as one of leading writers who recognised this basic human truth: if our friend falls hopelessly in love with a woman and starts regaling us with how marvellous she is, the chances are we will also fall in love with her too. There, in a nut shell, is the comedy of human relations and investment bubbles. The discovery of mirror neurones, and into which there is a considerable amount of research being directed, is revealing why the passions and dislikes of others have such an influence over us.

Within the next two or three years, around 3 billion of us - close to half the population of the world - will be connected to the internet. We will leave it to our readers to reflect on what will happen when passions, preferences and dislikes can be transmitted to millions of people at the speed of light. Now you know why Facebook has just overtaken Google as the most frequently visited web site on the internet. 

What's smart about IT

Some people always face the wrong way. Take the case of the average IT analyst. Many come from an industry background, and as a result they cannot but help see the world through the lens of desktop PCs, servers, outsourcing and enterprise software systems. This is unfortunate, because over the last decade corporate IT growth has been meager and the prospects do not look that much brighter.

In 2000, $371 billion was spent on PC hardware. By last year, this had shrunk to $326 billion, according to estimates from Gartner, a US based market researcher. This number includes the value of PCs, servers, printers and storage. For further confirmation, I suggests you examine the 10-year price charts for Microsoft (MSFT), Dell (DELL), or Intel (INTC). They are not quite flatlining, but the pulse is weak.

By contrast, where we have seen growth is in emerging markets, consumers and mobile telephony: A decade ago consumers represented 33% of desktop computer sales; by last year this had risen to 38% of the total. In the notebook segment, the contrast between business and consumer is even more striking: A decade ago consumers represented 32% of total sales; by last year this had risen to 56%.

Mobility and consumers are what drives the IT market. This trend is accelerating as smartphone shipments overtake computer hardware sales over the next two to three years. This is the single most important fact in technology investing. Missing it is rather like wandering past Mount Everest in the fog.

The catalyst for the long awaited pick-up in IT expenditure is said to be the PC replacement cycle. By 2011, it is estimated that 84% of desktop computers used by business will be five years old. In addition, corporate IT sales are expected to get a boost from Microsoft's recently released Windows 7 operating system. There is merit to this argument, just as there was merit to it during the last decade, but don’t hold your breath.

Most of the profits from the PC market go to Intel and Microsoft. Both companies have a better grip on the computer market than any analyst. When speaking in January, Paul Otellini, Intel’s chief, answered a question about a likely pick-up in enterprise spending by stating that growth would continue to be dominated by emerging markets and consumers. Both trends, as Otellini pointed out, lead to lower average selling prices.

Over at Microsoft, the picture was similar. Peter Klein, the company’s CFO said, that growth had been driven largely by strong consumer demand. He went on to say, “While consumer growth remained healthy, we have not seen a return of enterprise spending growth." The problem with IT is that the price of hardware tumbles each year. You can best see this by comparing unit shipments to sales: in 2000, 146 million PCs were shipped; by last year this had risen to 306m. Over that time revenues between the two data points had fallen 12%. Then, when you examine the trends that so enamour the average IT analyst, it looks suspiciously as though they will add to deflation. First, off, Windows 7 needs less memory and raw computing power than its predecessor, Vista; second, cloud computing itself requires less hardware.

My gripe with the whole PC upgrade cycle argument is that it has not worked for more than a decade. The reason it has not appeared in all that time is that corporate IT stopped being innovative sometime back in the 1990s. The truly last innovative piece of software that businesses needed to buy were enterprise resource planning (ERP) systems, which required the move to client server computing. This move, coincided with the launch of Windows 95 and the Unix/Linux operating systems and was the reason that stocks like Dell rose several thousand percent over the course of the 1990s. As if the move to client server were not enough, after 1995 the rise of the internet and the Y2K problem added momentum to what was already a strong trend.

Nothing like that exists anymore.

Where you do see a strong product cycle is, of course, in the area of mobility and the internet. Last year around 200m smart phones were sold. A new research report just out from ABI estimates that smartphone shipments increased 30% in Q4 over Q3. Our recent visit to Asia suggests that the smartphone trend has just taken hold there too, which may cause further surprises for analysts following this market.

At some point over the next two to three years these devices will outsell personal computers. Looked at in terms of revenue, last year the pure PC market, net of servers, printers and storage, was worth $224 billion, compared to $165 billion for the handset market. With smartphones now the fastest growing part of the mobile phone market, they will soon over take PCs in value as well as in unit terms.

This rise is the confirmation of the single biggest trend taking place in technology: mobile internet access. In turn this is generating colossal demand for content, as we can see from the rise in video traffic, which is more than doubling each year. Cisco (CSCO) estimates that by 2013, video traffic will represent 70% of the volume on mobile networks. YouTube has just announced that 24 hours of video is uploaded to its site each minute of the day, compared to 20 hours of video six months ago.

In a recent report from Chetan Sharma Consulting, it has been estimated that there were 7 billion software application and content downloads to mobile phones last year and that this will rise to 50 billion by 2012. By then the market for applications supplied to smartphones is expected to be of the order of $17 billion. This market barely existed a couple of years ago. This is a tsunami that will result in surprisingly strong profit growth and share price gains for a number of device and component makers and maybe some software companies, such as Sybase (SY). Google (GOOG) and Facebook will also win from this trend, as advertisers will pay more for mobile viewers.

The next place that this move to mobile computing will manifest itself is in the rise of the tablet computer. On this score, investors might like to monitor what is happening with estimates for Apple’s (AAPL) iPad computer. When first announced, most analysts seemed rather underwhelmed. The range was somewhere around 4 million units.

More recently, at least one major US investment bank has increased its estimate to 6 million units. Meanwhile, the buzz in Taiwan, among component suppliers, is that Apple is looking at 10 million units. If this device proves a success, it will be emulated by other device makers.

ARM (ARMH), the UK chip company, is the leading European beneficiary of this trend, as is Imagination Technologies (IGNMF.PK), which provides graphics chip intellectual property. CSR plc [LON:CSR], the Bluetooth and Wi-Fi chip maker, should also benefit. Infineon (IFNNY.PK) and STM (STM) in Germany and France, as providers of radio and baseband chips, will also see some impact. In Taiwan, outside of obvious names such as Hon Hai (HNHAF.PK) and Foxconn (FXCNY.PK), investors ought to look at touch screen makers, such as Wintek (WNTSF.PK). The LED supply chain, which will provide the backlighting for these devices, will also gain. In America, this would include Cypress Semiconductor (CY) and Synaptics (SYNA).

So, the next time an IT analyst tells you that the Windows 7 PC upgrade cycle or the move to Cloud computing are the main events in the IT market, hit him over the head with your smartphone.

Taiwanese component makers looking at 10m iPad sales

Some Taiwanese component makers who are supplying Apple say the company has ordered enough parts for  10m units of the iPad over the coming year.  If  correct, these numbers suggest that there is plenty of room for upside surprises in Apple's results. Over the last month estimates for  iPad shipments have been edging up. The initial estimate was for around 4m units, but more recently Goldman has published a 6m number and some other analysts are forecasting 8m units.

The other area where Apple could beat forecasts is with sales into Asia.  In the company's last reported numbers, Asian sales were remarkably strong. Sales to both Taiwan and Japan had increased several fold and more recently, sales of the iPhone into South Korea have exploded. Apple has always struggled in Asia, but by the fourth quarter last year the region was contributing 20% of profits - double what it represented a year earlier.

I have just returned from a 9 trip to Singapore and Hong Kong and iPhones can be seen everywhere. Only a year ago you seldom saw any Apple products across Asia.  In Hong Kong, I counted four Apple resellers in the Central region, compared to one 18 months ago when I last visited the island. A leading phone retailer in Singapore told me that smartphones now represent 70% of handset sales in the city state, with the iPhone being far and away the market leader.

The Revolution Will Be Televised

Demand for internet TV  continues to gain momentum in the US. The latest numbers from iSuppli, the market research firm, found that one fourth of TVs purchased by Americans in January were connected to the Web, either through integrated technology or an external device.

The researcher found that of the new sets purchased in January, 27.5% indicated their sets were connected to the internet. In December the number was 24.3%. Cisco estimates that video traffic is growing at 132% compound, making it the fastest growing type of data over the internet.

Latest numbers from DirecTV, a leading US pay TV service, with operations throughout South America, highlight the growing attraction of mobile connectivity. In the third quarter last year DirecTV saw twice as many connections to its service through the iPhone as in the entire year over personal computers. Since then DirecTV has signed up 2m mobile customers who schedule their DTVs from their iphones.  As well as internet and mobile enabled TV companies like DirecTV are also benefitting from increased interest in 3D television.

Speaking at the company’s most recent results, Mike White, DirecTV’s president and ceo said: “ I think it's fair to say that increasingly our consumers expect us to be even more of a full video provider and they also expect to access that content whenever and wherever they want.” 

He added that DirecTV, which has an alliance with AT&T, is working on ways to ensure that  its customers will be able to watch the same programs they currently view on their TV on their mobile phones and other devices, such as Apple’s forthcoming iPad. DirecTV noted that its coverage of the US National Football League -NFL- was particularly popular with iPhone and other mobile device owners. Sport will therefore form an integral part of the company’s plans to attract mobile users.

As we have pointed out in the last couple of issues of the Mash, interest in content companies is increasing, both because of rising advertising traffic, but also the growing awareness that content in an age of mobile devices, may have a higher value than many at first thought.

The pay TV business in the US is mature but a number of technological trends are now infusing the sector with new life. Besides mobile internet access, which has only just begun, the sector is seeing increased interest in Digital Video Recorders -DVR, high definition TV - HD and now 3D and internet enabled TV. The growth  in DirecTV’s subscribers who are taking HD and DVR has doubled over the last year. 

Later this year the company plans to launch a 3D film and program service. Interest in 3D is high following the unprecedented success of Avatar, which has become the biggest grossing movie of all time.  A number of other 3D film launches are expected this year.

Besides the technological angle to DirecTV the company a great deal of exposure to the rapidly growing Latin American market, where its sales rose by 47% over the year. DirecTV has operations in Mexico, Venezuela, Brazil and Argentina. 

Over the last quarter Tiger Global, a leading US hedge fund, in which the legendary money manager Julian Robertson has invested, emerged as the largest institutional investor in DirecTV, taking an 11.4% stake.

As we highlighted in Mash 35, Vizio, the American based flat screen TV maker is the leading supplier of LCD TVs in the US. Vizio - in which Amtran of Taiwan is one of the leading investors - saw shipments increase 92% over the year to 5.9m. 

iSupply found that nearly 42% of Web-surfing TVs in the US had integrated connectivity, which means that they can be accessed from other devices, such as PCs. Another 20% were connected through video-game consoles; 13% through Blu-ray players; PCs and stand alone boxes tied at around 12% each.

Message from Beijing

I have just had an interesting chat with someone I know who has just moved from Taipei to Beijing. He is English but has, after a ten year stint in Taiwan, learnt Mandarin Chinese. His overall impression of Beijing is that there isn't much for the wealthy Chinese to spend their money on.

In America the rich, and certainly the super rich, can buy a ranch in Wyoming, or a Condo in Florida; maybe a town house in New York, or San Fran. They can dabble in art, wine, private equity and of course, stocks and shares.

By contrast, the rich Chinese have limited options. The property market is tight and by common consent is a bubble and  most of the cities have little to commend them.  There are few opportunities for private equity. They can certainly buy local art, which is becoming popular in the West and the Chinese are developing a taste for expensive wines. They have a penchant for mixing their vintage cabinet sauvignon with coco cola. I'm sure the French growers don't mind, as long as they are paid.

The point is, from a western perspective Asia and other emerging markets look like the place to be. However, if you are rich and live there then the West, and in particular, America is still the place with the most opportunity.

Besides, the brutal truth is that much of Asia is pretty un pleasant. Hong Kong is a beautiful and vibrant city but there isn't much of interest culture wise. Like most of Asia, Hong Kong finance types with little interest in creating a rich culture. Seoul is awful and the locals can be difficult. However, you at least see some interesting experimentation in clothes and films, such as Old Boy, demonstrate a streak of brilliance you don't find elsewhere in Asia, with the exception of Japan.

Taipei is a bomb site - there has been very little investment over the years, though you can find great Sushi. Singapore is clean and works but it has as much get up and go as a supermarket check out. You would be hard pressed to find a more spookily soulless place on earth. The high point - fish head curry on Race Track road. There is an underlying atmosphere of hysteria in Singapore that is really quite unsettling.

Off to Singapore to night so best not say anymore. In Hong Kong over the week end.