Why Hong Kong could be set to soar

Hong Kong's stock market has a very close relationship with US interest rates. As rates go down, the Hang Seng goes up. And with US interest rates near zero, stocks could take off in Hong Kong.

Ben Bernanke has cut short-term interest rates in the US to essentially zero, the lowest rate we've ever seen. He's doing this, of course, to 'juice' the economy to give it a jumpstart. He doesn't know (or care, actually) that this action will inadvertently (but undoubtedly) cause one particular stock market to go absolutely nuts.

This stock market I'm talking about is Hong Kong. Today, we have the ultimate recipe for stocks in Hong Kong to skyrocket. The Fed has cut interest rates to essentially zero (causing Hong Kong rates to be next to zero in its unique money system). And yet Hong Kong stocks are incredibly cheap. They bottomed a month ago at a single-digit price-to-earnings (P/E) ratio.

We've seen this before:

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In 1992-1993, the Hang Seng Index shot from 5,500 to 12,000. At that time, the Fed had cut interest rates below the rate of inflation. So 'real' interest rates were below zero.

The Fed did it again from 2003-2005. And in that time, the Hang Seng Index jumped nearly 7,000 points, from a low of 8,600 to 15,500. (It continued to rise, peaking over 30,000 in 2007. That's four times your money from 2003 to 2007.)

And it's happening again, right now. The Fed has cut interest rates to zero, and the uptrend in Hong Kong has arrived. It's time to get in.

While Ben Bernanke is trying to help the US, he's unwittingly creating havoc on the other side of the globe.

Hong Kong is quite an incredible place. With no natural resources, the standard of living has gone from subsistence wages to one of the highest in the world in just a few decades.

I believe two things contributed to Hong Kong's boom:

1) Hong Kong has been for decades one of the 'freest' markets in the world, allowing entrepreneurs to succeed or fail.

2) Hong Kong has had a stable currency, thanks to its unique currency system. For the last 25 years, the Hong Kong dollar has been worth about US$7.80, give or take a few pennies.

Hong Kong's unique currency system is called a currency board. A country that has a true currency board has one US dollar in the bank for every dollar of its own currency that it prints. How does it keep the exchange rate equal? Through interest rates.

Interest rates in Hong Kong dollars are always higher than in the US. Depositors are willing to 'take the risk' on the Hong Kong dollar for the slightly higher yield. As a result, Bernanke essentially controls interest rates in Hong Kong. Whether Hong Kong is in a boom or a bust, he doesn't care. So Bernanke could be raising or cutting interest rates at precisely the wrong time in Hong Kong's business cycle.

Therefore, Hong Kong's stock market is subject to wild booms and busts, based on what the US Fed is doing with interest rates.

As I said, today we have the ultimate recipe for stocks to skyrocket in Hong Kong. Interest rates are next to zero. And Hong Kong stocks are cheap, hitting single-digit P/E ratios a month ago.

I have two nearly-guaranteed 'rules' for making money in Hong Kong:

First is the 'Hong Kong Can't Help It Rule'. That's when the US Fed cuts interest rates below the 'market' rate. This means 'real' interest rates are below zero. When this happens, buy Hong Kong. It can't help it. It soars.

The second rule is the '20/10 Rule'. In short, you want to be a buyer of stocks in Hong Kong when the P/E ratio falls below ten. And you want to be a seller when the ratio rises above 20.

Hong Kong stocks often soar by hundreds of percent after they fall below a P/E of ten. And often they lose half their value soon after they rise above a P/E of 20.

Right now is an extraordinary moment. Both rules are in play AND we have an uptrend in Hong Kong stocks that started last month. You should consider buying Hong Kong shares now. Triple-digit gains are possible... and you can limit your downside risk by using a trailing stop. Those are my kind of odds!

This article was written by Dr. Steve Sjuggerud for the free investment newsletter DailyWealth