What do you make of the sell-off in China stocks so far this year?
China year-to-date has given back a lot of the gains from last year. The Shanghai Composite is down quite dramatically and actually 50% off its all-time high. So, we've had a pretty big correction and reversal off a very strong late 2006 and 2007 run here in 2008.
I think it's important for our readers to recognize that there will be periods of consolidation in these markets. As the China indexes provide 100% returns in a particular year, we can't expect that to continue in a straight line up. When thinking about China we have to think about the tremendous growth opportunities the country itself provides and the specific growth opportunities that the consumer stories provide. As that large population gets richer and changes their way of life, they get more involved in new consumer products and services, and those are the kind of investments that our China Investment Opportunities newsletter, with analysts on the ground in China, really focuses on.
What are some specific opportunities?
You've heard us talk about online gaming and telecom. You've heard us talk about advertising. All of these are plays on the continued growth in wealth among the Chinese people. They're not plays on industrial growth as much as they are plays on changes in people's cycles of consumption. So, while the headlines may show weakness in some of the indexes, we can still find plenty of ways to make money.
Look back to some of our recent recommendations, including Giant Interactive (NYSE: GA, Bullboard), one of the online gaming companies we like. We recommended it a couple months ago at about 11, and we think it's worth at least 15. We're seeing a very strong move in the stock the last couple days, as people come to recognize what we've known for some time, which is that their new online game, called ZT, is going to be very successful and proving very popular with users. These kind of opportunities do provide good ways to make money no matter what the index itself is doing.
Why will consumer plays do better than industrial plays in the near term?
In China that there's been a huge amount of industrial investment over the last 10 years. The building of roads and railroads and dams and airports has resulted in huge consumption in China of concrete and steel that has really driven the commodity prices that we've seen in recent years -- copper prices as well as fuel prices. When the government in China looks to slow down its economy in the next year or so, those are the types of projects they're going to cut down on, as those are the types of projects they have control of.
How concerned is the China government about inflationary pressure?
Very concerned. We've all seen the global headlines about food price inflation and of course fuel inflation, which hits all of us at the pumps as oil prices head towards $120/barrel. In China this is a very real concern. Because of the high growth of the economy there, inflationary pressures are exaggerated. Combine that with the growth in the consumer sector as people change their diet and start consuming more meat and more dairy -- that really drives commodity prices higher in terms of grains and food price inflation. So, inflation is really on the front burner for the Chinese government, and they're going to do anything they can to try to slow down the economy a little bit. We've seen that recently with some increases in the reserve ratios at the banks, and I think you're going to continue to see that with some pullback on large industrial projects. But that's not going to change the trend in terms of consumers changing their quality of life and the types of goods and services they consume.
Any shorting opportunities from these cutbacks?
There's a Chinese oil company called CNOOC Ltd. (NYSE: CEO, Bullboard), which I would be short. I would actually do it as a pair trade -- long PetroChina (NYSE: PTR, Bullboard) and short CEO, just because of a mis-pricing of those two stocks. But that's not as much of a play on the trend I'm talking about here, which is the cutback in industrials. Many of those shorts are found in markets outside of China, where you might want to be light on certain industrial commodities, including iron ore and steel on a global basis because of a potential pullback in China's demand. So it's not so much shorting Chinese companies, but shorting the suppliers of some of those raw materials globally.
One of those is Companhia Vale Ads (NYSE: RIO, Bullboard), a Brazilian iron ore play, which is the major supplier of iron ore globally. The stock has been extremely strong. We would think that's going to pullback here in the last couple of weeks and months as the outlook for demand globally becomes more clear and more negative.
Will there also be a cutback in industrial production to clean the air prior to the upcoming Olympics? And how will that impact the economy?
They're going to stop coal-fired power plants and industrial plants in three provinces surrounding Beijing for 30 days before the Olympics begin on August 8 and through the whole Olympic games, which end on August 24. Interestingly, while Beijing is the heartland of Chinese politics, it's not the heartland of Chinese industrial capacity. So it's not a huge shutdown of capacity and will not have a huge impact on their economy. But it is certainly something to keep an eye on.
The thing I would be concerned about towards the end of the year, and our readers are going to hear more about this in the coming issues, is the potential for dramatic appreciation of the Chinese currency. We have some very specific insights into why that's going to happen and how that's going to happen, and we're going to give our readers some ways to play this in the coming months.
Fluent in Chinese and Thai, David Riedel has been active in Southeast Asian equities since 1992, including eight years with Salomon Smith Barney as a telecom analyst in Thailand and small-cap analyst in New York. He now runs New York City-based Riedel Research Group specializing in Asian equity research for institutions, and is editor of China Investment Opportunities, a monthly newsletter that gives retail investors an opportunity to access his institutional-quality research on China. Sign up for the FREE 30-Day Trial today!
David does not have a position in stocks mentioned in this article.
