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Guinness Atkinson Asia Brief
October 2005
Edmund Harriss
Fund Manager Asia Focus Fund, China & Hong Kong Fund
Two Americans Abroad
The most recent trip to Asia by Secretary of the Treasury John Snow and Federal Reserve Chairman Alan Greenspan is remarkable in at least one respect. In an acknowledgement of new economic priorities the two men are going to spend only two days in Japan—and one week in China.
The outcome of the visit is going to be important in determining US trade policy in coming months. The Treasury must shortly submit its delayed report to Congress in the face of congressional demands that China be treated as a currency manipulator. This is coupled with threats of applying across-the-board tariffs of 27.5% on all goods imported from China, this being the amount by which it is believed the Yuan is undervalued.
The United States’ relations with China are by far the most complex of all its bilateral relationships. China’s growing military might (which, it must be said lag the US by a very long way) has to be balanced against its increasing economic importance.
One of the most important economic effects, though not so immediately obvious is the result of China’s export growth. The US trade deficit with Asia means that the region, including Japan is now buying US$35 billion a month and recycling these into Dollars; and China alone accounts for US$27 billion each month. This has the effect of keeping US interest rates well below what they would otherwise be, allowing American homeowners to extract equity from their houses and continue spending and keeping the economy growing at 3.5%-4%.
It is clear that since China’s first step to free up the Yuan exchange rate, very little has happened. The Yuan has moved less in 10 weeks than theoretically it can move in a day. This caution was bound to stoke up ill-feeling once again. In reality though, China will continue to have an unbeatable competitive advantage in the production of goods with a high labor component. Protectionist measures will not make American goods more attractive but instead may simply serve to dampen demand; the fear is that, unchecked, this may push the world into recession.
What China does need to focus on however, is the continual flagrant disregard shown for intellectual property rights (IPR) such as piracy of software films and other intellectual property. This issue puts Congressional and business leaders up in arms: it depresses exports of intellectual property, it undermines brands through the prevalence of substandard copies and it stifles innovation. In their dash for growth the government has found it convenient to overlook such breaches and occasionally, as a sop to foreigners, make some token and highly-publicized gesture.
Commerce Secretary Carlos Gutierez told the American Chamber of Commerce the US Administration’s view on IPR and wider trade very succinctly in June this year: “It's important that it be clear. We do not consider intellectual property rights to be a matter for negotiation. Intellectual property rights violations are a crime. And we don't believe we should be negotiating crimes with our trading partners. Everything else is up for negotiation.”
The hope for this visit therefore, is that the two men can propel China in the right direction at a pace that quells protectionist calls while at the same time sustaining the balance that continues the recycling of US Dollars into US Treasuries and keeps interest rates low.
Other China Talk
China is seeking to expand its railway network from 73,000 kilometers to 100,000 by 2020 requiring an annual investment of $12 billion. Foreign and private capital is being sought for a non-controlling interest in these projects. Investment banks Goldman Sachs and Morgan Stanley are both looking for ways to create a suitable investment framework.
Airplane manufacturers are looking to China as the big growth market. Boeing forecasts that China will take 2,600 planes over the next 20 years while Airbus (which focuses on larger aircraft) forecast 1,800 planes. This is based on expectations of 8.8% annual passenger growth and 10% cargo growth. These growth rates would imply that by 2025 annual passenger movements will have increased from the present 106 million to 631 million, equivalent to where the US is now.
China’s increasing demand for energy has led to talks with Russia’s Gazprom to build a natural gas pipeline from Russia to China. China used 39 billion cubic meters (bcm) of gas in 2004 and this pipeline will have a planned capacity of 30bcm. Gas only accounts for 3% of China’s energy and the aim is to raise this to 8-10% in 15 years.
In the same vein, Peabody Energy announced in September the opening of its China office in Beijing. Over 70% of China’s electricity is generated in coal-fired power stations and China’s coal producing industry is very fragmented with an appalling record in health and safety.
Industrial profits for the first 8 months of 2005 grew 20.7% compared to the same period in 2004, to $107 billion. State owned enterprises combined lost $9 million over the period.
Market Outlook
The modest performance of Chinese markets this year reflects a belief among investors that China’s economy is slowing or is about to slow. The belief is that government efforts to slow investment will cause a collapse in margins as has happened on every previous occasion.
However, the economic data coming out shows that aggregate economic growth is still over 9%; retail spending is still growing by more than 12%. Interestingly, it also appears that construction growth is accelerating again, which will support prices of basic materials such as steel and aluminum. This makes it likely that rather than slowing, China’s growth will be faster in 2005 and 2006 than markets currently expect.
The valuation of China shares is also looking attractive. Since their run up in 2003, China H shares have appreciated only 4.1% in spite of steadily increasing profits. As a result valuations are back at modest levels on 10.4 times 2005 Institutional Broker Estimate System (“I/B/E/S”) estimated consensus earnings.
The Guinness Atkinson Asia Focus Fund and China & Hong Kong Fund invest 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.
As of 9/30/05, neither the Asia Focus Fund nor the China & Hong Kong Fund held any shares of Boeing, Airbus, Gazprom or Peabody Energy. Each Fund's holdings may change at any time due to ongoing portfolio management and should not be considered a recommendation to buy or sell any security.
Opinions expressed are those of Edmund Harriss and are subject to change, are not guaranteed and should not be considered investment advice.
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.
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