- October 22, 2012
- Chinese Stocks Looking Like a Bargain
With negative sentiment toward China reaching an extreme in recent months, patient investors have been rewarded with recent news of improving data from the Asian giant.
CLSA Sinology’s Andy Rothman reported that in September, retail sales growth rose 13.2 percent, which was the fastest pace of the year. Real urban disposable income grew nearly 10 percent and real rural disposable income rose more than 12 percent during the first three quarters of the year. And, while export numbers are weak, China has “so far avoided the large-scale export-sector layoffs that led to 2009’s massive stimulus,” says Andy.
There was strength in commodity imports, too. Copper imports into China increased 11 percent compared to the previous month due to increased demand from power infrastructure, white goods restocking and auto production. Iron ore rose a modest 4 percent compared to the previous month, which is encouraging. There was also a sharp rebound in oil imports most likely due to holiday restocking and lower international prices. In fact, Pareto Securities found that Chinese implied oil demand came in at an all-time high of 9.8 million barrels per day in September.
The markets also saw an increase in fixed asset investment (FAI), a measure of capital spending, which grew at “the fastest pace since October 2011,” says CLSA. According to Credit Suisse, “a surge in transportation spending in the month of September [is] starting to reflect the project approvals for highway, rail, airport, and metropolitan transport projects announced in May and June.”
While Credit Suisse says FAI growth was boosted by government investment stimulus, CLSA also notes that fixed asset investment and capital spending by private firms has been rising faster than state-owned firms for 30 of the last 31 months.
Money supply, a key lubricant of the economy and markets, also continued to increase, and this has historically driven Chinese equities. Take a look at the chart below, which shows the year-over-year money supply compared to the MSCI China Index over the past decade. Over the past 10 years, after the supply in money bottomed, stocks soon rebounded.
On January 31, 2012, money supply hit a near decade low of 12.4 percent year-over-year growth. Since then, the number has been creeping higher, rising sharply to 14.8 percent in September, and shortly thereafter, equities responded.
The Wall Street Journal recognized the improvement in Asian stocks and investor sentiment recently, suggesting that the “region’s economy could be nearing the end of a slowdown.” I’ve been trying to temper investors’ expectations of China as weak economic data caused investors to be skittish, telling Investor Alert readers that it wasn’t the time to be bearish. Now, “if the Chinese economy shows sustained signs of stabilizing, it would remove a major overhang of worry for investors in Asia, and may spur more capital raising and other deals as investors become confident enough to switch money out of bonds and back into equity markets,” says The Journal.
This appears to be a good time to be investing in China, as stocks are historically cheap. At the beginning of October, BCA noted that there was a “prevailing pessimism” around China and that the stocks were “currently trading at hefty discounts to world averages and even to euro zone stocks.” The firm indicated that Chinese shares had a forward price-to-earnings ratio of below 9 times; the world and U.S. benchmarks traded at 12 and 13 times, respectively.
Chinese stocks are also cheap compared to emerging markets. In 2007, China traded at a 75 percent premium to emerging markets. Today, Chinese stocks trade at a 20 percent discount. If you look at a comparison of price-to-earnings in China to those in emerging markets, you have to go back to 2006 to find that ratio as low as it is today.
The low price-to-earnings indicates to me that the negativity pendulum has swung too far. “Investors have turned from euphoria at the height of the ‘China mania’ five years ago to extreme pessimism,” says BCA.
Back in April, I listed three trends that global investors should watch in China: A rebound in the liquidity cycle signaling a rally in equity prices, a new leadership with an incentive to maintain growth, and Chinese stocks reverting to their mean, as history appears to favor Chinese stocks landing in the top half of emerging markets. Time will tell.
The MSCI China Index is a capitalization weighted index that monitors the performance of stocks from the country of China. M2 Money Supply is a broad measure of money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds.
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- October 15, 2012
- China’s Pyramid of Power
China celebrated another achievement last week, as Mo Yan became the first Chinese citizen to win a Nobel Prize for literature. The selection of Mo was praised by a Chinese nationalist tabloid as a sign that mainstream China could “no longer be refused by the West for long.”
Mo grew up in Shandong province in northeastern China, and during the Cultural Revolution, he left school to work in the fields, finishing his education in the army, according to The Guardian. The author draws upon his rural upbringing in his novels, mixing historical perspective with mythical elements. His real name is Guan Moye, but he chose “Mo Yan” as a pen name meaning “don’t speak,” to reflect the culture in which he grew up.
The new Nobel laureate is of the same generation as the new leaders set to take over the Politburo Standing Committee next month after the convening of the 18th National Congress of the Communist Party of China. This group of men (and one female contender) are “old enough to remember the suffering of the Cultural Revolution, but also young enough to fully experience how China has grown through Deng [Xiaoping]’s opening of the economy to market forces,” says CLSA China Strategy research.
They’ve seen vast political reforms take place, transforming China “from a country ruled by the contradictory personal whims of Mao to one ruled through institutions and rules,” says William H. Overholt in The Washington Quarterly. During these decades, “freedoms blossomed, affecting everything from clothing to haircuts to job or marital choices to social and political speech,” says Overholt.
As a result of these policies, they’ve been able to witness China’s incredible growth, with GDP averaging 10 percent per year and more than 500 million people moving out of poverty over the past 30 years.
Now after three decades of tremendous expansion, this new generation of leaders will have to carefully maneuver the country into the next decade, towing the line between maintaining the stability created during the previous Hu-Wen administration and continuing the political and economic reform necessary to adjust to the country’s slowing growth.
China’s pyramid of power is headed by the Politburo Standing Committee (PSC), which will likely have seven to nine new members led by Vice President Xi Jinping and Vice Premier Li Keqiang, selected by a vote of the Central Committee.
Unlike prior committee members who were mostly engineers, the new PSC members have varying liberal arts backgrounds, including history, law and economics, which may help to “address social concerns after decades of focusing mostly on growth,” according to CLSA.
These leaders tend to be more globally aware than their predecessors. They are better traveled, and many have family members, relatives or friends who have gone to school overseas and have foreign residency. “The rapid proliferation of mobile phones, broadband, internet has made unbiased information much easier to access,” says CLSA.
Incoming President Xi Jinping is a princeling who was born into privilege as the son of Xi Zhongxun, who was among the first generation of Chinese leadership and “one of the most liberal leaders under Deng.” His father’s claim to fame was in creating a special economic zone in Shenzhen, which transformed the area from a small village to one of the fastest-growing cities in the world and one of the busiest container ports in China.
Premier Li Keqiang comes from a more common background, as his father, Li Fengsan, was an official of the local government. After the Cultural Revolution, Li was one of the “Class of ’77” when only 273,000 people won admission to universities out of a total of 5.7 million candidates. (By comparison, 58 percent of nine million people in 2007 won admission to universities, according to a 2008 article in The New York Times.) He spent 16 years at the Central Communist Youth League, and then 10 more years in the Henan and Liaoning Provinces before becoming a member of the standing committee.
Underneath the PSC is the Politburo with 25 members, then the Central Committee with 371 members, who then dictate to more than 80 million Communist party members.
So what direction will the next generation of leaders take? This remains a “great enigma,” says Overholt. Xi has been “extremely cautious” about stating his opinions, however, “he has the confidence that comes from being a princeling and from having some military background.” In addition, the other members of the PSC have agendas that are “ambitious and outspoken.” The tensions and inconsistencies that exist within the committee members could be “creatively dynamic or immobilizing,” says Overholt.
CLSA believes that the new leadership will likely push for reform since they will be “forced to adapt to China’s slowing growth.” The research firm says that historically, large reforms successfully occurred after a crisis, including Tiananmen Square and the Asian Financial Crisis.
A nearly 500-page document by the World Bank and China’s Development Research Center of the State Council may give “promising insight into China’s future policy,” says CLSA. The comprehensive report called China 2030 identifies a long-term strategy for Chinese policymakers. The report says that “after more than 30 years of rapid growth, China has reached another turning point in its development path when a second strategic, and no less fundamental, shift is called for.”
It irons out six areas that need to be addressed:
- Structural reforms to strengthen the foundation for a market-based economy need to be implemented
- Innovations need to be accelerated
- The country should pursue “green” opportunities
- All citizens need opportunities and social security
- The fiscal system needs to be strengthened
- China needs to seek mutually beneficial relations with the world
The report concludes by saying that “a successful outcome will require strong leadership and commitment, steady implementation with a determined will, coordination across ministries and agencies, and sensitive yet effective management of a consultation process” that encourages the support of the public. The potential for China to be a “modern, harmonious, and creative high-income society” is there, however, “achieving this objective will not be easy,” says the report.
In November, the U.S. will be focused on its own political situation as Americans head to the polls. While staying active and involved in national politics is important, I believe it’s just as vital to pay close attention to how the leadership change will unfold in the second-largest economy in the world.
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- October 10, 2012
- Infectious Ideas for a Connected World
With a greater international exchange of ideas, goods, services, and talent today, our world has never been more wired and connected. Globalization has wholly transformed how people across continents absorb information and interact with each other. I believe it also has subtly changed how we think and act as individuals.
Take the unfortunate consequence of globalization after the anti-Muslim “movie” was posted online. Middle East violence against the U.S. erupted because of drastically conflicting ideas between freedom of speech and derogatory insults against a religion. In a recent Foreign Policy blog, Abdulaziz H. Al-Fahad calls for mutual tolerance in our “shrinking world,” explaining, “The world is increasingly pulled together by the relentless push of modern technology and integrated economic systems on the one hand, and simmering conflicts periodically manifested on the cultural realm, on the other.”
Events need not be so significant to make a difference. I recently revisited the ideas from one of my favorite business books, The Tipping Point, in which bestselling author Malcolm Gladwell uses real-world examples of little things that spread like wildfire. He says that “the best way to understand the emergence of fashion trends, the ebb and flow of crime waves … or any number of the other mysterious changes that mark everyday life is to think of them as epidemics.”
Facebook has been incredibly infectious. Since its miniscule beginnings at Harvard eight years ago, the social media site’s popularity as an online place to connect and exchange ideas and photos has proliferated, attracting 1 billion monthly active users today. This figure is nearly 15 percent of the world and three times the size of the population of the United States.
According to ITU World Telecommunication, 2.3 billion people worldwide were using the Internet at the end of 2011—that means that a significant portion of the online world has a Facebook account.
The Super S-Curve in global population is also significantly affecting our ideas, opinions and ways of life. While it took about 150 years for the world population to grow from 1 billion to 3 billion people, it took less than 15 years to add the next subsequent billion. Now there are 7 billion of us, with many people on the planet acquiring a little more wealth every year. The World Bank said that about 1.3 billion people around the world live on less than a $1.25 a day. This is the lowest number of people ever.
Back when the world only contained 3 billion people, the economic and political footprint of India and China did not exist. Now the two most populous countries in the world are pursuing policies that are encouraging economic growth and improving standards of lives for their residents. I believe these countries are creating a domino chain of reaction felt around the world.
In The Washington Quarterly, William Overholt from Harvard’s Kennedy School of Government outlined his view on how China’s economy will develop as the pyramid of power shifts to new leadership. He says many see China as a “successor to British and U.S. leadership through globalization,” and one final step in that global direction is to develop a “globalization of talent” in the country.
To that end, China insists that all residents must take seven years of English before graduating from high school. Many elite families in the country have children in Ivy League universities, and Chinese vice ministers much spend a semester at Harvard “to ensure their understanding of global best practice.”
In addition, more than 70 percent of Chinese university presidents and research lab heads obtained Ph.D.s from foreign institutions, says Overholt.
Time will only tell whether China takes over as the world’s largest economic superpower. What’s important for investors is to be aware of the ideas and behaviors that are catching, and how our social networks can be contagions, as suggested by Harvard’s Nicholas Christakis in a recent TED Talk.
Likewise, Gladwell shows how minor changes in our external environment can have a dramatic effect on how we behave and who we are.
Next time you read a headline on your TV, phone or newspaper, I hope you are inspired to think of ways that local and global biases and opinions infiltrate your world.
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- September 10, 2012
- China’s Next Act
The ECB calmed the markets—will China act next?
After Mario Draghi announced the European Central Bank’s new bond buying program, I was the first guest on CNBC Asia’s Squawk Box to weigh in on this decision. I reiterated my stance that the endgame for Europe would be to print money, which will eventually lead to currency wars. These actions are positive for gold and also for increased economic activity.
China too has kept investors on the edge of their seats, as we wait for some monetary or fiscal action. Everyday that goes by with no significant policy decisions from the Asian giant causes the market to lose confidence in its ability to steer its ship. Even the most optimistic bull can be vulnerable to a loss of confidence.
It often helps to gain a different perspective, which is what a business trip halfway around the world can provide.
I’ve been traveling in Singapore and Hong Kong and I continue to be amazed by the juxtaposition of the vibrancy of the Asian continent compared to investor sentiment in the States. It’s a subtle difference, but you can see it in the faces of people walking the cities, you can feel it when talking with local entrepreneurs and you can read it in a speech from local government leaders.
Singapore’s Prime Minister Lee Hsien Loong provided a beam of light to a Beijing audience only days ago. During his speech at the Central Party School, the prime minister discussed China’s significance in the world as it relates to political relations, government policies, and world trade. He also touched on his country’s role in facilitating a solid relationship between the Asian giant and the world’s largest economy.
By nature, public speeches are meant to be uplifting, as they tend to reflect on a long period of history and focus on positive solutions. However, I believe new opportunities cannot be found when all hope is believed to be lost.
The prime minister acknowledges China’s “serious and complex challenges” that it is facing after decades of significant growth. He says that its economic, social and political reforms are difficult for any nation to handle, “let alone one the size of China.” He believes it’s to be expected that “China’s leaders are preoccupied with these domestic priorities.”
However, China will not be tackling this alone, as the world has become so “inter-connected and inter-dependent,” with growing world trade, interlinked financial markets, and the growth of the Internet bringing one third of the world online today.
You can see how synchronized world economies are today by comparing manufacturing output. In August, China’s Government Purchasing Manufacturing Index (PMI) crossed below 50 for the first time since November 2011. (Remember that a reading of 50 marks the critical line delineating expansion from contraction.)
The U.S. ISM Manufacturing PMI also crossed below 50, with a reading of 49.6 in August. JP Morgan’s Global PMI came in at 48.1, and it’s been below 50 for the last three months.
Over the past decade, China has experienced incredible growth because of globalization. On one measure alone, the prime minister pointed out that more than one billion line workers, engineers, scientists and entrepreneurs are joining the international economy to develop, serve and produce goods for markets around the world.
Stephen Roach, a senior fellow at Yale University and author of The Next Asia, says China’s “grand plan” is to move from the “producer model, which worked brilliantly for 30 years” to one that needs to provide higher-paying, less labor intensive jobs, in new fully functional cities to the 350 million who are estimated to move to an urban area in China over the next 15 years. To paraphrase Marshall Goldsmith’s self-improvement book for business executives, what got China here, won’t get China there.
The Asian giant can take a few lessons from its developed neighbors, says BCA Research. China has already experienced a tremendous population shift from its farms and rural areas to the cities in search of higher paying jobs. But there comes a tipping point when labor supply in the cities goes from “feast to famine,” says BCA.
The research firm says in the previous cases of Japan, Korea and Taiwan, there have been similar employment phases. First, when industrialization just begins, “demand for labor is strong, but wages are low because of plentiful supply.”
Then, wages grow faster than labor demand. This is what we have been seeing in China today, as urban per capita income far exceeds rural incomes.
The last stage of this development that other Asian nations have experienced is when “wage growth accelerated and the wage gaps between the manufacturing and agriculture sectors disappeared,” according to BCA. Their research shows that cheap labor in manufacturing ends while growth of wages accelerates in both cities and farms.
It’s only a guess when China will make that labor shift to the stage where manufacturing sector competes with agriculture for jobs. BCA compared manufacturing employment to agriculture employment of Japan, Korea and Taiwan, looking at when these countries’ ratio rose above 1. In Japan, manufacturing labor shortages started in the early 1960s, for South Korea, it was around 1975-1976. Taiwan began experiencing this phenomenon around 1970.
Based on this ratio, it’s estimated that labor shortages could become more common around 2014-2015 for China, says BCA.
Until that tipping point is reached, China “will continue to need higher value-added, less labor-intensive production to sustain exports; policy and productivity will be critical to a continuation of the ‘growth miracle,’” according to BCA.
The way China will accomplish this is through good relations with the U.S., as well as taking an interest in making sure Asia is stable and prosperous. Loong believes the Chinese economy “depends on an open, inclusive and fair global trade system to thrive. It needs a stable external environment, and good relations with other countries, so that it can focus on economic development,” says Singapore’s leader. In Loong’s view, “China is no longer an isolated, self-sufficient Middle Kingdom.”
One example of how China will be engaging the world in its future growth is through its current energy policies. While 70 percent of the country’s energy consumption is coal, oil is the second source of energy, at nearly 20 percent of total energy consumption, according to the U.S. Energy Information Administration (EIA). In 2010, the country consumed an estimated 10 million barrels per day.
China only produces about 4 million barrels per day, and imports the remaining amount, making the Asian giant the second largest importer of oil, says the EIA. The largest importer of oil in the world has been the U.S., with an intake of 8.7 million barrels per day, according to the EIA. Japan imports the third most oil, at 4.3 million barrels per day.
The country currently has a diverse variety of sources from which it receives its oil, with most of the crude oil imports coming from Saudi Arabia, followed by Angola, Iran and Russia.
The country’s energy policies appear to be focused on three goals: 1) fulfill its growing demand for oil and reliance on oil imports, 2) diversify import sources to reduce its risk of supply disruption, and 3) develop technical expertise in unconventional resources. One way to accomplish these goals is through overseas acquisitions, which we’ve previously discussed. “China is taking advantage of the economic downturn to step up its global acquisitions and use its vast foreign exchange reserves (estimated at over $3 trillion in 2012) to help purchase equity in projects or acquire stakes in energy companies,” says the EIA.
A Hint of Action Arrives
World markets may not have to wait much longer for Chinese policymakers to act, as the government recently announced new infrastructure projects. According to Bloomberg, China approved 25 new subway construction projects, with related investments estimated to be more than 840 billion yuan. Railway, subway and construction stocks in China increased on the news.
Stephen Roach concludes his discussion about China this way: “A growth slowdown is hardly shocking for an export-led economy. But China is in much better shape than the rest of the world. A powerful rebalancing strategy offers the structural and cyclical support that will allow it to avoid a hard landing.”
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link above, you will be directed to a third-party website. U.S. Global Investors does not endorse all information supplied by this website and is not responsible for its content.
The J.P. Morgan Global Purchasing Manager’s Index is an indicator of the economic health of the global manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.
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- August 20, 2012
- Love Trade Cools as Central Banks’ Gold Demand Heats Up
The two largest gold buyers in the world that largely drive the Love Trade, China and India, underwhelmed the metals market with their subdued demand for the yellow metal during the second quarter of this year.
According to the World Gold Council’s (WGC) quarterly Gold Demand Trends report, total demand was 990 tons, which was about 7 percent lower compared to the second quarter of 2011. When you break down demand and look at the jewelry sector, you can see that Chindia remains about 50 percent of the world’s total gold demand. However, this quarter’s jewelry demand of a little more than 400 tons makes it one of the weakest periods in two years.
Total bar and coin demand was also weak in China and India compared with the rest of the world.
As we discussed earlier this year, India has been facing a number of economic challenges, resulting in a dramatic decrease of 30 percent in jewelry demand for the country over the second quarter compared to this time last year. The country’s “unsupportive environment” for gold included a slowing GDP growth, record high gold prices because of its currency, rising domestic inflation, high interest rates, and fears of a poor monsoon season, says the WGC.
China’s gold demand has been affected by a slowing economy as well as a “lack of clear direction in the gold price,” says the WGC. However, during the WGC’s conference call, Managing Director of Investment Marcus Grubb said it would be wrong to think that China is entering a period of extended weakness. If you look at Chinese demand for gold over the first half of 2012, the level was 410 tons—about the level that it was this time last year over the same period.
As we enter the Love Season for gold, we’ll look for any indications from government policies that might spur the continuation of the long-standing tradition of gold buying for weddings and Diwali in India, along with gold gifts for weddings and births that take place in China during this auspicious Year of the Dragon.
Although the Love Trade is on ice for the period, a relatively new gold buyer has been warming up to gold.
The official sector continued its gold buying spree this quarter. The WGC reported that central bank purchases hit a record high since the official sector became gold buyers three years ago. According to Mr. Grubb, if this trend continues over the remainder of 2012, central banks will be entering a “new territory” of gold buying that has not been seen since the early 1960s and since the end of the Bretton Woods System in 1971.
According to the firm’s quarter-end data, official sector institutions purchased 158 tons of gold in the second quarter—or about 16 percent of the quarter’s total gold demand. During the first half of 2012, central banks have acquired 254 tons of the metal, which is about 25 percent higher than the same period last year, says WGC.
Central banks from developing markets led the buying trend once again. The WGC says Kazakhstan indicated that it is “targeting an allocation to gold of 15 percent of its foreign exchange reserves” and one way it plans to build up its allocation is to purchase “the country’s entire domestic production over the next two to three years.”
Other emerging countries with central banks increasing their allocations to gold include Mexico, the Philippines, Russia, Turkey and Ukraine. According to Mr. Grubb, central banks have been motivated to add gold mainly as a currency hedge. Central banks want to increase their weightings in reserve asset portfolios and diversify away their dependence on U.S. dollars—and possibly the euro. There’s also a belief that sovereign debt is no longer considered to be a “risk-free” asset, says the WGC.
During his quarterly conference call, Mr. Grubb elaborated on this up-and-coming trend that we’ve been watching take place over the past 12 to 18 months. He believes gold is being “reintegrated into the fabric of the financial system” as a use of collateral. Mr. Grubb noted how “many exchanges are making gold eligible, with a haircut somewhere between sovereign debt and equities, as a collateral asset in all kinds of financial transactions.” The CME Group in the U.S. has already accepted gold as collateral, and just today, the European clearing house, the CME Clearing Europe, announced that gold bullion is now considered an “eligible collateral type.”
When it comes to collateral and capital requirements, “gold is being brought back into the fold as an important asset,” says Mr. Grubb.
Strike While Gold’s Not Hot?
There’s been a lot of discussion from market pundits wondering where gold is heading. I say investors should use math to their advantage. Similar to card counting strategies used by blackjack players, count historical trends to discover inflection points.
Gold appears to be at one of those inflection points right now. Using the last 10 years of data, if you plot the 12-month rolling return, you can see that gold has reached an extreme low, registering a -2 sigma.
The last time gold reached this point was in August 2008. You can see below the yellow metal’s significant climb after hitting that standard deviation low.
Just recently, the gold price has moved above its 50-day and 100-day moving averages, which is another indication of potential strength for the metal and an additional reason to believe that gold may be an attractive entry point.
I’ll be talking about gold and natural resources at the Chicago Hard Assets Investment Conference on September 21. If you’d like to learn more about attending the free event and when I’ll be speaking, send me a note at firstname.lastname@example.org.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility.
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