China & Investment Process

China has obviously been playing an increasingly larger role in the world economic order which has caused a lot of excitement about the country as an investment destination. The results from investing in China have ebbed and flowed of course with the general perception that there is a lot of promise but also a lot of imbalances and excesses that could offset that promise. Yesterday I found one article that I would describe as addressing the problems and another addressing the promise.

On the problem side of the ledger was this from Bloomberg that noted China's GDP now surpassing that of Japan (on a quarterly basis anyway). This was probably more of a formality or eventuality and now come the projections of when China will surpass the US' GDP (the Bloomberg article quoted Jim O'Neil from GS as saying 2027). While I think predicting such a thing is very difficult due to how many variables can beset anything over such a long period of time and it is very unlikely that the US' GDP will implode--more like slower growth IMO. Whatever the reality we do know that China's GDP is growing much faster than the US disirregardless (hat tip to my buddy Mike) of when China becomes the largest economy.

Anyone interested in owning China in their portfolio has to understand the obstacles that the country faces; some of which are cited in the Bloomberg article. Surpluses are a great thing but there are consequences when they get too large which appears to be the case due in part to lack of domestic consumption. There are over capacity problems in terms of real estate and other parts of the economy. There are threats from over indebtedness on several fronts including off balance sheet debt on the part of various municipalities.

These need to be studied and factored in to any investment decisions. I believe all of this ties in with the bigger picture point I made years ago when I first disclosed owning China via Sinopec (SNP) which is that the growth will happen, money will be spent on certain things but there will be mistakes along the way that will be felt by the equity markets. While I think this falls under the category of obvious observation there are investors that lose sight of the downside.

To get a handle on the promise side of the equation was this post from Farmland Forecast (I tried to load the website but was unable to so the link is to the post as it appeared on Seeking Alpha). It focuses on the dynamics of food demand, the extent to which China has been transitioning from exporter to importer in several crops (corn and soybeans) and some interesting numbers including the expectation of 40% of each new dollar of GDP going toward diet. I can't vouch for any of the numbers but the idea that more Chinese will ascend to something akin to a middleclass lifestyle including a better diet and better living conditions is only logical. Again this too will ebb and flow in terms of the movement of stock prices but the driver (middleclass ascendancy) has been happening and will continue to do so.

Of some interest was this particular quote;

Mr. Li expects that meat consumption per capita will grow 6.9% by 2015, and milk consumption will grow by more than 50% over the same period. Rural areas will drive meat demand, while urban centers will drive milk demand.

This circles back to New Zealand. I used to own New Zealand Telecom (NZT) across the board and did well with it. I sold years ago now but continue to pay attention to the country as I expect to invest in NZ at some point in the future. The cited passage ties in to the free trade agreement that China has with New Zealand. NZ is often called a commodity country but it is more like an agricultural commodity. Fonterra is a co-op specializing in diary, is the largest company in NZ but is private. Should it ever IPO, which has been talked about off and on for a long time, it would be a way to benefit from, not capture, the Chinese middle class ascendancy--probably.

The point here about process, I have made this point before with this example, is the need to keep tabs on a country even if it is not investment-worthy at the moment. I sold NZT early in 2006 and continue to believe I will buy back in one way or another at some point. Note this is an example for me you should apply this to whatever countries interest you.

Back to China, for now we are out of the country. We were in years ago with Sinopec, out for a while, back in with China Mobile (CHL) but sold that a while ago. The right way in for us (anyone else needs to figure their own right way in) will be to capture the middleclass ascendancy but not via the financial sector. One option could be the GlobalX Consumer ETF (CHIQ). Some of the narrower China funds are very interesting under the hood but the volume is not great. CHIQ averages 187,000 shares per day which is promising. Anything to do with energy is promising but the Energy ETF (CHIE) has no volume so going that route means an individual stock.

Ditto industrials and infrastructure; interesting segments with illiquid ETFs. Here I would note that the volume is ok for an individual needing a few hundred shares, I wouldn't worry about that liquidity but to the extent this site is about sharing process the volume on some funds takes on a different type of risk beyond the merits of the investment. I continue to like the toll road stocks but again volume makes them look dicey in terms of buying tens of thousands of shares and again we are a small firm. This should evolve for the better but will take time.

On a related NZ note, a week ago Saturday we went to the Portland Saturday Market (an outdoor market situation) and among other things stumbled across a couple of guys from New Zealand selling ice cream imported from New Zealand.

For anyone who's been, it will make sense that I got the Hokey Pokey flavor which is vanilla with little butterscotch bits in it.