How Hong Kong Could Save You From Inflation

About a week ago, I stood in the convening area of a conference room at the Langham Huntington in Pasadena, Calif. It was the second and final day of the Value Investing Congress, one of the preeminent gatherings of value investors. Within these ultra-luxe confines, a bunch of value investors in expensive suits were talking cheap stocks and unconventional thinking. The irony was palpable, but the ideas they were serving were dead serious.

I was about to hear just about the smartest inflation-protection trade I've heard yet, from Michael Kao of Akanthos Capital.

Of inflation and probabilities
A growing and increasingly vociferous chorus has echoed concerns over inflation in recent months, amid the Federal Reserve's near-continuous pump priming.

At least to me, and perhaps to many other investors, most of the prescribed hedges -- including gold and commodities -- seem woefully inadequate. Most commodities are hardly value-priced, and many of the exchange-traded funds design to mimic them, such as United States Oil (NYSE: USO  ) and PowerShares DB Agriculture Fund (NYSE: DBA  ) , can fail to track the underlying commodity itself. Other popular inflation plays, such as ExxonMobil (NYSE: XOM  ) , Pan American Silver (Nasdaq: PAAS  ) , and Cresud (Nasdaq: CRESY  ) , a play on South American farmland, all trade near pre-credit crisis levels.

Gold? Well, that's a whole other story, which I'll get to in a moment.

Michael Kao isn't exactly a household name among value investors. His youthful looks belie his experience. His brain obviously works differently: Kao takes inventory of elaborate probability rings quickly, with a creative but rigorously logical mind-set.

He attributes it, in part, to his programming background:

As a programmer, you're presented with a problem, and there are many ways to solve it. I wanted to design video games when I first got out of college. I didn't know the Dow Jones was, but I've always valued creative thinking.

His hedge fund's investments bear witness to this credo, seeking a collection of unrelated, asymmetric (high upside, and low downside) pay-offs in his investments.

An antidote to gold fever
The value establishment has embraced gold as an inoculation against inflationary risks, but Kao differs. He quipped: "I don't know how to value gold. I don't think anyone in this room does."

I couldn't agree more. Gold adherents argue that the precious metal is a store of value -- a hard commodity with limited supply. While that works in theory, it doesn't always follow suit in practice.

The problem is simple: Because gold has limited industrial uses, its fundamental value is near-impossible to peg. That makes it equally difficult to figure whether owning gold is a worthy investment (or speculation) for value-oriented sorts, or figure the extent to which it's already priced in inflationary expectations. And even if you don't buy that argument, gold's already had a pretty tremendous run, effectively reducing its inflation-inoculating quality.

Kao's solution for those seeking inflation protection: Buy Hong Kong dollars (HKD) by opening a money market account in Hong Kong.

Hong Kong pegs its currency to the U.S. dollar, or USD -- a fancy way of saying it keeps a fixed exchange rate to our currency. In practical terms, that means Hong Kong's letting Ben Bernanke and the good ol' U.S. of A run its monetary policy. Because the Fed's pursued loose monetary policy, so has Hong Kong, by proxy. That, in addition to a host of other factors, has contributed to already-rampant asset inflation within Hong Kong.

Kao believes that Hong Kong might let its dollar float, allowing the market to determine the exchange rate to the USD, to reduce inflationary pressures. If it does, Kao surmises that the Hong Kong dollar will appreciate against the USD pretty dramatically, leaving a single HKD worth more in U.S. dollars than it was before. And if Hong Kong doesn't let the HKD float, your money just sits there and earns the same paltry interest rates it would here. By Kao's logic, your downside is fairly limited -- and the upside, potentially huge.

In a market dominated by pricey stocks and a still-tentative recovery, that seems a very interesting gambit to me.

Michael Olsen owns shares of Cresud and ExxonMobil. He would trade a partial interest in his Argentine farmland for a semi-continuous stream of Argentine beef. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On May 16, 2011, at 3:54 PM, ngaichen wrote:

    As a Hong Kong resident, I can say Mr Kao argument is 100% wrong. Hong Kong dollar will NEVER freely float. HKD will peg to USD for years until China abandon foreign currency control. At that time, HKD will change to peg to RMB.

    It seems that Mr Kao does not know HK's situation well. It's a political problem rather than pure economic decision.

  • Report this Comment On May 25, 2011, at 2:39 PM, bentony wrote:

    Let's assume investing in HK money market funds is a good idea. How does a USA citizen do this with any ease/

  • Report this Comment On June 04, 2011, at 3:19 AM, Waisingrin wrote:

    I think Mr. Kao's idea is dead wrong. It is based on a hope without much supporting inputs from anywhere that HK is thinking about floating the HKD. I was just in HK for 3 weeks, and the SCMP (HK's leading newspaper) had a story about keeping faith in the HKD against fears that the CNY will make it meaningless, but without saying why, as more and more deals with China are being closed with CNY. If I had $100 USD, I'd rather buy SGD or other currencies depending on your premise of whether commodities demand will grow (AUD) or a choice of other currencies. That will be much better than sitting on HKD which currently is hard-barred to the USD and hoping it will float. In the mean time, you'd be losing -8%/yr vs DXY, a basket of other currencies when you could be gaining that much holding currencies within the basket. Nah, I wish GG would do much better analysis than what has been done, to put this mess up as an article.

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