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Guinness Atkinson Asia Brief

January 2005
Edmund Harriss
Fund Manager Asia Focus Fund, China & Hong Kong Fund

Prospects for Asia

The overall prospect for Asia is one of steady growth and low inflation. The bias for Asian currencies is for them to appreciate, as they have been doing in recent months. The banking sector across Asia is significantly under-leveraged and thus we are at the early stages of a renewed credit cycle. With current accounts in surplus, foreign exchange reserves at record highs in a number of cases and low levels of foreign and corporate debt Asia is looking very stable. The region is expected to produce economic growth of 6% in 2005.

Growth drivers for Asia

Asian growth is still largely determined by external demand and exports and growth in domestic investment and consumer spending across the region has been slow in coming. Within the region China, rather than Japan, is the main economic growth driver and thus all countries are affected to a greater or lesser extent by changes in China’s growth profile. China accounts for between 9-15% of smaller Asian countries’ total trade and accounts for 21% of Korean and 24% of Taiwanese trade. At present China’s export growth is well ahead of what many were expecting and the consumer is therefore not being hurt by the ongoing efforts to slow excessive domestic investment.

Will there be a revaluation of China’s currency?

This year we could well see a revaluation of China’s currency. The market is expecting a modest move of around 3%. However, we believe that a more substantial move of 5-8% is possible. China does want to move away from a pegged currency because doing so will allow greater flexibility in coping with external volatility as its economy is liberalized as envisaged by the terms of its membership of the World Trade Organization. The issue of competitiveness due to a cheaper currency is in reality a side issue. Average labour costs in China were US$0.66 in 2003 compared to US$21.33 in the USA and a currency adjustment is not going to change the picture materially. However, China is more sensitive than many might realize to the effect of its own competitiveness on the rest of the world. Doing nothing is no longer an option since a rise in protectionism in its export markets would do more harm than any marginal erosion in its pricing advantage.

Technology

A word on technology. The technology sector has been dragged down by a slowdown in global IT spending that is expected to continue at least into the middle of 2005. Growth in Personal Computer (PC) sales is lackluster and there is a lack of drivers to boost the replacement cycle. Components such as memory chips and TFT LCD display panels are dogged by increased capacity; even the independent semiconductor foundries are beginning to suffer from structural changes in the industry. A slowing in the pace of technological gains in production methods means that competitors are catching up and the combination of increased capacity and a potentially slower rebound from the cyclical low will shift the balance of power further toward the customer. Nevertheless there are bright spots. Firstly, consumer electronics will still see strong demand growth. Secondly, demand for notebook PCs is still a growth area and it appears that the market among suppliers is consolidating. Thirdly, technology stocks are trading at or close to trough valuations and are ready to perk up at the first signs of good news which is likely to come in the middle of the year.

A period of stability

The message we would like to leave is that Asia is at a point where it has regained its balance following the Asian crisis. The banking systems are working and are able and willing to lend. The macro-economic data show a region with trade surpluses, broad fiscal balances and low inflation. The global cycle has peaked and exports are slowing but growth is still expected to be 6% in 2005. Moving into 2006 the global cycle is expected to pick up and Asia with its lack of excesses and substantial reserves of liquidity and savings still looks a good bet. The region is still at the very early stages of the credit and investment cycle. And Asian equities are not expensive on 11.13 times estimated 2005 earnings.

The Guinness Atkinson Asia Focus Fund and China & Hong Kong Fund invests in foreign securities which involves greater volatility, political, economic and currency risks and differences in accounting methods. The Funds are non-diversified meaning they concentrate their assets in fewer holdings than diversified funds. Therefore, these Funds are more exposed to individual stock volatility than diversified funds.

This information is authorized for use when preceded or accompanied by a prospectus for the Guinness Atkinson Funds. The prospectus contains more complete information, including investment objectives, risks, fees and expenses related to an ongoing investment in the Funds. Please read the prospectus carefully before investing. Mutual fund investing involves risk and loss of principal is possible.

Distributed by Quasar Distributors, LLC (01/05).

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