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October 27, 2009

*****Numbers vs. People

*****What China Needs

*****U.S. Dollar Rally

Fellow Investor,

I hope you’ve enjoyed my running commentary on China over the past few issues. These "travel pieces" provide the opportunity to step back from the daily action in the market. It is always important to take a moment to consider the macro-trends that are playing out around the globe.

I find the cultural differences between the U.S. and China fascinating. And I also believe that by gaining an understanding of the Chinese culture, and the perspective of its people, we will become better investors in Chinese companies.

After all, economies are made of people, not numbers. It’s how we interact, it’s how our fears and expectations of the future affect our behavior that drives growth (or lack thereof).

In the U.S., when we are optimistic, we spend money because we feel confident that our future will be better. We will make more money, and we will retire in comfort. American companies produce more to meet rising consumer demand. They hire new workers – and the numbers move higher.

The low savings rate in the U.S. is a cultural thing. In the wake of the financial crisis, the savings rate has risen from a negative number to something like 5%. And that 5% is considered a sea-change for America, a cultural shift.

But it’s not. 5% is still an alarmingly low level. 5% is not much of a safety net when things go bad. But at least, that 5% savings rate shows that Americans believe things can actually go wrong. That’s a far cry from where we were a couple years ago.

Still, Americans remain confident, even over-confident, that our system will take care of us, that Social Security will be there supplement our retirement savings.

*****Clearly, China’s culture is in transition. And this is a slow process. The aftermath of Tiananmen Square, when neighbors were reporting participants to the authorities, was the result of deep-seeded suspicion of youth movements left over from the Cultural Revolution.

China’s savings rate is reported to be 39%. And this number is very telling about the psyche of the Chinese citizen. Among other things, it says the Chinese are not convinced their economic system will afford them a better life in the future.

And this has profound implications for what China’s next moves must be…

*****For starters, China has no security net like Social Security. And that means the average Chinese must prepare for his or her retirement through personal savings accumulating from years of thrift and diligent saving. A major catalyst for increasing consumer spending, establishing domestic demand and moving China away from its export oriented economy will be the establishment of some form of social security. Watch for it – this will be a big investment event.

China must instill a sense of confidence in its economic system so Chinese will spend more. So don’t look for stimulus actions cease anytime soon. And don’t expect China to start dumping T-bills and U.S. dollars, either.

I know this flies in the face of much of what we hear from the financial media. But in my opinion, China is every bit as dependent on the U.S. as we are on it.

China pegs its currency, the yuan, to the U.S. dollar. So a weak dollar gives the China’s exports a competitive advantage. China needs to move away from being just an export economy. But that transition will take years. And we can expect China to continue to lend to the U.S. to support our deficits. They basically have to, as the alternative (a bankrupt U.S. consumer) would cripple its economy and cause massive social and political upheaval.

*****For this same reason, China will not reel in its stimulus policies any time soon. For one, it has the cash reserves to support its economy. It doesn’t have to go into debt to spend. And second, China must continue to create jobs and raise its standard of living if it wants to its people happy (and not fomenting revolutionary or democratic ideas).

*****Why are we seeing stocks reverse lately? Here’s the U.S. Dollar Index chart we’ve looked at a few times…

The dollar has bounced strongly in recent days. That’s bad for commodities, bad for oil prices and bad for stock prices. If we understand that China is not dumping dollars, then we see the potential for actual dollar strength. And as Jason Cimpl pointed out to his TradeMaster Daily Stock Alerts subscribers this morning, “A rising dollar will have consequences for U.S. stocks. Mainly, they will resolve lower. Commodity prices will be crushed, and this sector is a big part of the U.S. stock market. Risk aversion will also increase which means tech stocks and small caps will suffer.”

*****I’m not recommending that we sell everything and run for cover. I’m just pointing out how inter-related the fates of the U.S. and China remain, and give some more insight as to why I remain bullish on Chinese stocks.

*****I continue to believe that buying dips in Chinese stocks will produce gains. And we may be approaching a great buying opportunity. For instance, one of my favorites that we’ve discussed, China Natural Gas (Nasdaq:CHNG) has dropped from $15 to $12. A run to my price target of $18 will produce a 50% gain (you may recall that we started with this stock back in May when it was trading at $6.14, so we’re already well up on this stock). And that’s just one of Chinese stocks I have in the SmallCapInvestor PRO portfolio. I’ve got 4 more that could do even better than China Natural Gas. Click HERE for details.

Zai-jen,

Ian Wyatt

Editor

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