The latest installment of our Shareholder Report has just been released and this issue is filled with interesting facts and observations about global markets our investment team gathered as we traveled the world searching for opportunities. As you can see from the cover image, gold’s growing appeal to a rising middle class of citizens in China and Asia is significantly reshaping the gold market as we know it.

The region has long carried an emotional attachment to gold. In fact, gold was one of China’s earliest forms of currency way back in 1091 B.C. With rising average incomes and wealth levels leading a new of age of prosperity in China, citizens are snatching up gold at an unbelievable rate. According to the Beijing Municipal Commission of Commerce, sales of precious metals jumped nearly 50 percent from the same time last year during China’s week-long New Year’s holiday in January.

This type of momentum is a catalyst for gold prices to remain strong in 2012.

This is one aspect of the American Dream Trade I discuss in my letter for the Report. There’s also an informative Q&A with China analyst Xian Liang who talks about the dramatic transformation his hometown of Shanghai has undergone over the past 20 years.

Check out the Shareholder Report page to view the full contents of the report. If you would like to request your own copy, send your name and address to editor@usfunds.com.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

The Economist put together a comprehensive dateline, charting which year China overtook or will overtake the U.S., using 21 indicators of consumption, GDP or spending.

It summarizes the significant milestones reached over the last decade or so, reminding us how far China has come. One significant milestone marking the road of economic growth began when China became the largest consumer of steel, then shortly after, copper and energy, as the government focused on its massive buildout of infrastructure projects to support expected urbanization growth and rising incomes.

By 2001, China was buying more mobile phones than the U.S. as Chinese consumers spent rising discretionary income on the latest technology. Spending in mobile computing has also continued, as China also has the largest number of Internet users, the biggest personal-computer market and the largest smartphone market.

Looking into the next decade, The Economist also plots an estimation of when China’s GDP will be larger than that of the U.S. Using the assumptions of an average real GDP growth of 7.75 percent in China and 2.5 percent in America, inflation averaging 4 percent and 1.5 percent in China and the U.S., respectively, and yuan appreciation of 3 percent per year, China stands to be the largest economy by 2018.

However, if China grows faster with all the other factors remaining the same, the country’s GDP could be larger than the U.S.’s GDP by 2017. The magazine lets you change these assumptions for yourself so you can see when China will be the world’s largest economy. Go there now.

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.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

My debate last week with Gordon Chang on China’s future at the Vancouver Resource Investment Conference was a stimulating, intellectual exercise. A healthy market needs a compromise between the bid and ask, and a discussion between people who strongly disagree is a great way to promote critical thinking.

Critical thinking is vital to our investment process as a means to ensure that we question assumptions. One way our portfolio management team practices a critical-thinking process is through a weekly S.W.O.T. (Strengths-Weaknesses-Opportunities-Threats) analysis of key factors influencing global markets. By hammering out the positives and negatives, we can paint an accurate picture of the realities we face. The S.W.O.T. model allows us to avoid pitfalls by weighing the evidence.

Lack of critical thinking sometimes leads to bubbles, such as the one taking place in the parabolic rise in the number of articles foretelling China will experience a “hard landing.” Last fall, more than 1,000 articles questioned the possibility of a “China crash,” according to data from BCA Research. This is twice as high as the number in 2004, when fear articles reached 500. Gordon’s bearish pronouncements only added to the extreme negativity groupthink surrounding China’s economy.

Investment strategist Keith Fitz-Gerald, a long-time friend of mine, wrote an excellent article comparing today’s doomsday sentiment of China to the naysayers who forecasted the demise of the U.S. during the market bottom of March 2009.

Throughout the past century, U.S. stocks went through many secular bear markets. Keith points to the 1929–1932 period when the Dow Jones Industrial Average declined by nearly 90 percent, along with pointing out the Dow’s loss of more than 52 percent from 1937 to 1942. Also, beginning in 1901, 1906, 1916 and 1973, there were four “40+ percent declines,” says Keith.

Americans have also endured two world wars, the Great Depression, presidential assassinations and the deadliest terrorist attack ever seen on U.S. soil. What’s important for investors to remember was that each significant market decline presented a “great buying opportunity” with U.S. stocks rising double-, or in some cases, triple-digits, writes Keith.

And, over the past 100 years, the Dow gained an outstanding 24,000 percent.

So despite setbacks including inflation, Tiananmen Square protests, the Asian financial crisis of 1997, and the SARS scare, over the last 30 years, China’s average annual real GDP has grown 10 percent.

With rising incomes and increasing urbanization, we believe China is pursuing the American Dream, and the government has shown great determination to build the necessary infrastructure along with a robust urban labor market. On a purchasing power parity basis, China’s share of world GDP has risen significantly, from around 3 percent in 1985 to a current world share of nearly 16 percent.

Yet, China is only in the middle of its supercycle with several stages to come. Supercycles, or what we call S-curves, are long, continuous waves of boom and bust inherent in human history. While the overall trend is up, periods of volatility are an intrinsic part of this supergrowth. Not every down period is a sign of demise—even a broken clock is right twice a day. It’s the wise active manager who learns to manage expectations by understanding the difference between short-term corrections and secular long-term bear markets.

While “risks certainly cannot be taken lightly,” BCA Research believes that the risk of a China crash is “exaggerated.” For example, bears often point to “shadow” banking practices to support their case.

Keith believes Beijing was “deliberately tapping on the brakes,” in 2009, when the central bank increased the reserve required ratio for commercial banks, effectively reducing the amount of money banks could loan. This resulted in a sharp decrease in the amount of credit available and significantly increased rates from 4.78 percent to 8.06 percent, according to BCA.

One negative consequence of China’s quantitative tightening was that it forced some private firms unable to gain loans from state-controlled banks to seek credit from “loan sharks at sometimes deathly high borrowing costs,” says BCA.

We sent our research analyst to his home country of China to find out how prevalent this problem was. The Shanghai-native Xian Liang joined an investigative tour led by research firm China International Capital Corporation (CICC) to the Zhejiang Province. His group had access to executives from banks, private lenders and local government agencies, many of which he found knowledgeable and shrewd.

During his research trip, he learned about an extensive survey done by Alibaba of 2,800 smaller and medium enterprises, which showed that half of the enterprises needed external financing, and the companies that currently borrow from banks—only 13 percent of Alibaba’s sample—faced pretty stringent risk management practices.

For example, one commercial bank that lends primarily to smaller companies checks the electric and water meters of the businesses to make sure they are actually using energy. They delve into the personal habits of the private entrepreneurs to gauge if the executives are creditworthy and financially sound, as it is believed that character has a lot to do with one’s willingness and ability to repay.

Overall, Xian understood the alleged systemic credit risks in the banking system to be manageable at this point. The government had been prudent to not only raise interest rates six times, but it also increased the reserve limit banks must set aside against loans.

BCA identified an additional unintended consequence of the tightening. Some banks tried to bypass tight regulatory controls so they could extend credit, leading to an “increase in off-balance-sheet activities,” according to BCA. This activity was recognized by the government, and the central bank has “increased its oversight of off-balance-sheet items.”

BCA says that in a way, “‘shadow’ banking activity can be viewed as an attempt by market participants to create more market-driven interest rates.”

In a report of Asian banks, CLSA Asia-Pacific Markets found that non-performing loans (NPL)—those assets not yet delinquent but that have fallen behind schedule—remain near a 12-year low in China, and the NPL-to-loan ratio is under 1 percent. This default rate is extremely low compared to the 1999–2002 timeframe, and it is believed that no large debt defaults are expected due to China’s ability to create liquidity.

Keith Fitz-Gerald says the government has an abundance of liquidity. It has set aside $3.2 trillion in reserves, amounting to half of the country’s entire GDP. Keith says this could potentially be spent on recapitalizing its banking sector, with “plenty of money to spare.”

Besides the reserves, China has more fiscal and monetary firepower than several emerging markets. The Economist analyzed 27 emerging markets and ranked the country’s ability to ease monetary policy, taking into consideration inflation, excess credit, real interest rates, currency movements and current-account balances. Then it created a “fiscal-flexibility index” which included government debt and the budget deficit. A score of 100 means a country has no flexibility to ease policies; a score near zero means a greater ability to “let out the throttle.”

This chart “suggests that China, Indonesia and Saudi Arabia have the greatest capacity to use monetary and fiscal policies to support growth,” compared to other listed emerging markets, says The Economist.

Many bearish articles that appeared last fall relied on generalities taken out of context. They offer anecdotes of ghost cities, empty shopping malls, robber barons, worker suicides and citizen protests as reasons the country as a whole is headed for a crash. These efforts to highlight China’s economic imperfections are akin to saying the U.S. is a poor nation because impoverished areas still exist. As analysts, it is our job to research and make a rational determination whether the facts are material or superfluous.

“China is merely going through the first uncomfortable growing pains of its adolescence,” Keith says, and he does not believe it’s the end of the world if China goes through a market correction. What he’ll be doing instead is investing.

As our team continuously weighs the evidence of China’s economy, I agree with my friend. Moments such as these offer buying opportunities for global investors.

We believe China is a buying opportunity.

I’ve covered this topic often in recent weeks. Take a moment to read my other positive observations on China:

• Filling an Energy Order with Chinese Takeouts
• It May Take a Dragon to Breathe Fire into Markets
• The Great Urban Migration of China
• Have Winds Shifted to Provide Relief to Investors?

Past performance does not guarantee future results. 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 Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry.

None of U.S. Global Investors Funds held any of the securities mentioned as of 12/31/11.