|
China’s Inscrutable Currency Strategy
By: Carl Delfeld
Purpose: Expose China Opportunities for Smart Investors
The move by China’s central bank to drop the yuan’s rigid peg to the dollar last
week on the day of my return after a three-week trip to Asia left a host of
questions unanswered. The basket of currencies that will allegedly determine the
value of the yuan going forward was not disclosed. What sort of band the
currency will be allowed to fluctuate within is not at all clear. The 2%
revaluation in the currency on Thursday followed by a slight strengthening on
Friday week may actually encourage further short-term speculation since most
economists believe the yuan is undervalued by roughly 10% to 20%. With $1
trillion of trade transactions each year and hot money capital inflows
equivalent to 5% of its GDP, the uncertainty concerning the Chinese currency is
high.
Not In the Mainland
In the near term, this uncertainty gives investors an opportunity to benefit not
just from the expected strengthening of the Chinese currency but the overall
rise of Asian currencies against the dollar. In early 2005, I advised clients
that the Euro’s rise against the dollar was over and that Asian currencies would
be the next area to appreciate versus the dollar. It may turn out that many of
your best China investment options don’t involve investing in mainland Chinese
companies at all.
Direct Currency Approach
The cleanest direct currency play on the expected rise in the yuan (also
referred to as the renminbi) is to open a renminbi currency account at Everbank.
A leading online bank ranked “Best of the Web” by Forbes, Everbank offers a
variety of world currency accounts as well as FDIC backed three and six month
CD’s which offer attractive rates.
Direct iShare Approach
Another direct equity China play is through the China iShare (FXI) that tracks
the FTSE/Xianhua China 25 index that is comprised of 25 of the largest and most
liquid China names. FTSE is a UK based index company and Xianhua is a China
based media company.
All of the 25 stocks included in the China iShare are listed on the Hong Kong
Stock Exchange. Some of them are incorporated in mainland China (H shares) and
some of them are incorporated in Hong Kong (red chips). The total market
capitalization of the index is $170 billion. The broadest Xinhua China index
includes 1,355 listed companies with a total market cap of $550 billion.
To put this in perspective, the average market capitalization for a company in
the S&P Global 100 Index is $70 billion. Again, that’s for one company. The
China iShare provides good exposure to three key sectors of China: energy (20%),
telcom (19%) and industrial (18%). This concentration can be viewed as a plus or
a minus depending on your perspective. For example, some smart investors are
placing a bigger bet on China’s consumer markets. The top five companies
represent 40% of the index. The annual operating expenses of the China iShare
are only 0.74% compared to 2% plus for other alternatives out there including
actively managed Asia and greater China region funds. Keep in mind that most of
these companies are still largely controlled and owned by the Chinese
government.
Indirect Approach
The best way to invest in China may be through more indirect vehicles that
benefit from Chinese growth and its currency moves. One example of an indirect
investment in China is through the Hong Kong iShare (EWH). It has sizable
allocations to Hong Kong real estate (33%), utilities (17%) and banking (16%).
Having just returned from a trip to Hong Kong, it seems clear to me that real
estate markets have a way to go before becoming too pricey. Supply is inflexible
and even if prices rise as expected 30% during the next 18 months, price levels
will still be about 50% below where they were in 1997. Being the last Asian
currency pegged to the dollar should encourage capital inflows. Furthermore, the
Hong Kong market has been much more successful than the Shanghai and Shenzhen
stock exchanges signaling that it will be China’s financial capital for the
foreseeable future.
Indirect Currency Play
China’s move last week will also increase pressures for a number of other
undervalued Asian currencies to appreciate. To compete with the China export
machine, many Asian countries have resisted letting their currencies rise but
now they have a bit of room to maneuver. The Malaysian ringgit was released from
its peg to the dollar last week and it rose 0.7% the first day. While currency
appreciation will somewhat dampen export growth it will also reduce the cost of
rising energy import costs and analysts expect the economy to grow 5.5% this
year. The easiest way to invest in Malaysia is through the Malaysia iShare (EWM)
which tracks a basket of leading companies listed on its exchange. Another
attraction - the annual fee for the Malaysia iShare is only 70 basis points.
The Play for the Informed
Malaysia is oftentimes overlooked by investors even though it has progressed
quietly but remarkably from a relatively poor producer of raw materials to a
bustling and broadly diversified middle income country.
Malaysia, positioned along the strategically important Straits of Malacca ,
should be on every investors radar screen for the following reasons:
- It has little external debt and healthy foreign exchange reserves. In area, it
is slightly larger than New Mexico.
- Malaysia has a balanced economy with strong industrial and service sector,
important natural resources and openness to foreign investment.
- It has a parliamentary system and divided powers between central government
and 16 states and federal territories.
- Malaysia is well situated to benefit from growth in the region with key export
and investment partners being Japan, China and the USA.
- Natural resources include tin, petroleum, natural gas, timber, copper, iron
ore, bauxite. Small but consistent exporter of oil and natural gas.
- It has a young and increasingly well-educated population with a median age of
24 and a literacy rate of 90%.
Malaysia’s per capita income is approaching $5,000. Solid middle-income country
with growing middle class.
- The Kuala Lumpur Stock Exchange, also known as Malaysia Bursa has over 800
companies listed.
Canada?
Another smart indirect China play would be to invest in the Canada iShare (EWC).
The Chinese are going on a buying spree investing in Canadian energy companies
and recently plunked down $2 billion to build a thousand mile pipeline from
Alberta tar sands to port on the west coast and onward to Beijing and Shanghai.
The Canada iShare tracks the MSCI Canada Index that has 40% exposure to Canada’s
energy and materials sector.
Starbucks?
And what about Starbucks (SBUX) as a China play? Starbucks has about 9,000
stores worldwide and in the first quarter of 2005 its sales were up 27% and
revenue exceeded $100 million. It entered the Chinese market in 1999 and has
about 300 stores that have performed beyond expectations. The company hopes to
expand to 30,000 stores and China is a key part of its expansion strategy. With
250 million Chinese approaching middle-class and millions of new affluent status
conscious youth, Starbucks expects that before long China will be its second
most important market. During my recent trip to China trip, I visited ten
Starbucks stores and all of them had brisk activity with a lot of young Chinese
enjoying not only coffee products but the higher margin specialty drinks. Think
the Chinese will always prefer tea? Japan shows that when income levels reach
certain tipping points, consumer preferences change from tea to coffee.
Starbucks always looks expensive but many great companies always are. Starbucks
investors have made 43 times their investment in its 1992 IPO and revenue was up
27% in July.
China represents an enormous opportunity for long-term investors but an indirect
approach may be the smartest strategy.
On August 20, 2005 find out what is the next great Asian Bull Market in the 21st
century – hint” It’s not China!
Find out more insights at http://www.chartwelladvisor.com
Copyright 2005 Carl Delfeld
About the Author:
Carl Delfeld is head of the global advisory firm Chartwell Partners and is
editor of the “Chartwell Advisor” and the “Asia Investor Intelligence”
newsletters. He served on the Executive Board of Directors of the Asian
Development Bank in Manila and is the author of The New Global Investor. For
more information go to http://www.ChartwellAdvisor.com
|
