“A gold mine is nothing more than a hole in the ground with a liar on top.” Mark Twain.
Investing in China
The Accuracy of Chinese Financial Reporting
In the news this week, was an infamous short-seller accusing a Chinese company listed on the TSX of fraudulently mis-stating their assets and financial results. Muddy Waters Research, the firm founded by short seller Carson Block published a report dated June 2, 2011 on Sino-Forest Corp. (TRE), essentially accusing them of deliberate and fraudulent actions.
The claims against the Chinese company were quite sensational and the stock of that company took a big hit. The company responded by denying the accusations and publishing documents. A financial newspaper this morning reported that the shares of that company had fallen by 78%.
Basic Tenets of Investing
A basic rule under which we operate is to forgo those opportunities that are the current rage and to invest in what we know.
While we agree that China is a marvelous economic miracle, it is also a place that has not enjoyed democracy as we have in the West.
It is a place where the wealthy buy second homes in Canada to protect their assets.
Do you think they know more than we know? A result of this constant flight to safety is the very high price of housing in Vancouver, compared to the rest of Canada’s real estate. The Chinese population of Vancouver, and of other parts of Canada, is high on a comparative basis. Canadian schools have many Chinese students.
All of this tells us that if wealthy native Chinese citizens seek safety in Canada, why would we think we know better what is safe and what is not.
Risk
The basic rule of all investing, is to measure risk. Under anyone’s list of risk factors is political safety and stability, a history of capitalism, the rule of real estate law and the law of property rights, and so on.
While great strides have been made in all of these directions in China, the basic economic and property traditions are different than those in the West. These differences do not disappear just because someone wants to list their company on a Canadian Stock exchange.
New York Hard Asset Show
Recently I repeated a thesis presented by a speaker at that show. It was very negative on China. We are not so negative, but we do have concerns and these were put forth in our blogs of May 2011. The reader might again skim those comments.
Will China’s Economy Overheat?
Here is an alternate view. We repeat some commentary by Frank Holmes CEO and Chief Investment Officer of U.S. Global Investors, who points out some imbalances in China.
China’s GDP growth continued at a blistering pace during the first quarter of 2011, rising 9.7 percent from the previous year, according to economic data released today from the People’s Bank of China. Once again this outpaced many forecasts—even that of the Chinese government—and reignited the discussion of China’s overheating economy………………..
Andy Rothman, from Credit Lyonnais Securities Asia (CLSA) points out that the first quarter growth figures “[aren’t] dangerously high given the GDP growth rate and strong income growth” in the country………………………
Fixed asset investment (FAI) also remains strong. China’s FAI grew 25 percent during the first quarter, a reversion to the long-term pace of FAI growth China saw for six-straight years prior to the government’s stimulus plan in 2009.
This pace is supported by a property sector that refuses to slow despite Beijing’s multiple efforts to tap the brakes. Property sales grew 15.8 percent on a year-over-year basis and commodity housing starts grew 19.5 percent in March……………………………………..
China’s biggest threat continues to be inflation. The country’s Consumer Price Index (CPI) rose 5.4 percent in March, the largest rise in nearly three years………………………………………
The Empty Cities and Shopping Malls in China. The Beautiful Roads to Nowhere
Other commentators point to these unique phenomena of the stunningly modern buildings in which no one lives, the gorgeous new office buildings in which no one works, and the beautiful new roads on which no one drives. Some say these are signs of great danger. Some say these are buildings for the future and are very positive.
Risk in the Unfamiliar
So what we have pointed out is that there are those that are fans of China, and those that feel it is fraught with danger.
Our issue is that with so many good investments in geographical areas that meet our criteria of rule of property law, history of democracy, absence of recent conflicts, and unfamiliar regulations, why should the unsophisticated investor stray elsewhere to places that don’t meet these criteria, when there are so many good investments in places that do meet these basic criteria.
Risk Used to Mean a Premium for the Investor
It has become a strange world. It used to be that greater risk brought a premium to the investor, With the speed at which money flows around the world, our brokerage houses now apply similar risk premiums, of very low magnitude, to everywhere.
Where you invest in a gold mine in Russia, Zimbabwe, Canada, China, Indonesia or Australia, the underlying property and the share price of the company are compared to every other similar property with very little mention of risk. As long as investors are willing to accept these new criteria, there will not be a substantial increase in return offered because of risk.
There is an old saying “Buyer Beware”. If you are willing to buy it, it becomes your problem. Risk only becomes apparent to you after you bought the investment.
