The Next China Boom

The call was scratchy and barely audible. I was instructed to not mention any names. I should only use the prearranged code words when talking about political parties. You never know when the phones in China are tapped. I was just about to get a heads up that the People’s Bank of China was going to lower interest rates for the first time in four years.

Of course, we knew this was coming. Three relaxations of bank reserve requirements over the past six months telegraphed that the Middle Kingdom’s economy was slowing and that some serious monetary easing was on the way. But it appears that the things were now starting to get out of hand, possibly taking the GDP growth rate below the government’s 7% target.

Chinese companies were canceling contracts to buy imported commodities left and right, including for corn, sugar, copper, and iron ore, causing much distress among foreign counterparties. Now we learn that there are two dozen ships sitting off the Chinese coast fully loaded with coal, with no takers. The Chinese are walking away from contracted deliveries and refusing to pay, much as they did at the height of the 2008 financial crisis.

The really fascinating point that my friends in Beijing were trying to hammer home is that the current round of weakness is setting up the buying opportunity of the century. China is in the midst of changing government for the first time in a decade. The new president, Xi Jinping, is expected to take power in March, 2013, and will owe a broad range of constituents favors for his successful ascent. To solidify his position he will engineer a broad rise in the country’s standard of living that will benefit everyone in the country.

The first order of business will be to clean house and install loyal cadres across the upper tiers of the bureaucracy. Then he will launch a massive stimulus package designed to accelerate the growth of the domestic economy and wean the country off of its dependence on low waged export industries. The goal will be to move the Middle Kingdom’s economy inland, away from the coast where it is now concentrated.

That will enfranchise more of the 400 million of the rural population who have yet to participate in the modern economy and enjoy its benefits. The ultimate goal will be to raise Chinese per capita incomes from the current $3,000 to the $10,000-$20,000 range. A spin off advantage of this policy will be that it improves relations with the US, which until now has been drowning in Chinese exports in many politically sensitive industries. The economy will boom.

To finance this effort, the government will embark on a large scale privatization of state owned assets. Targeted is the government’s ownership of wide swaths of the banking, insurance, railroad, telecommunication, and energy industries. The effort will mirror the privatization policy that Margaret Thatcher imposed on the United Kingdom from the early 1980’s and the one the Japanese initiated a few years later. I participated in both, and the trading profits I took in were more than generous.

The funds that the Mandarins in Beijing will raise from this campaign will be used to pay off its enormous domestic debts. It will also be spent on repairing China’s badly tattered social safety net, with huge expenditures earmarked for health care and social security.

Stock markets will enjoy a major bull market for a decade, both in China (FXI), surrounding Asian emerging nations, like South Korea (EWY), Taiwan (EWT), Thailand (TF), Indonesia (IDX) and in Australia (EWA). Their currencies will rocket too, including The Australia (FXA), Singapore, Hong Kong, and Taiwanese dollars, as well as the Korean won.

The industry plays here won’t be the big infrastructure ones that worked so well in the last bull market, but instead will be focused on the country’s nascent consumer sector. I obviously need to do more work in this area, and when I get specific names, I will let you know.

Investments made near the current lows should see tenfold to twentyfold returns in coming years. This will also pave the way for full convertibility of the renminbi which could lead to the same sort of 300%-400% appreciation that we saw with the Japanese yen from the 1970’s to the 1990’s. That will create a double leveraged, hockey stick effect on the profits on Chinese investments.

What all of this does is to keep the Chinese economy growing at a 6%-8% rate for the indefinite future. While this is a slower rate than seen in years past, it will be off a much larger base, so the impact on the global economy will be substantial. China now boasts the world’s second largest economy, with GDP at $5.5 trillion, still well behind the US at $14.5 trillion.

Needless to say, basic commodities, like copper (CU), coal (KOL), iron ore (BHP), (RIO), all the food plays (CORN), (WEAT), (SOYB), (POT), (MOS), soar in this scenario. Gold (GLD), silver (SLV), platinum (PPLT), and palladium (PALL) also do extremely well. This could be the base case for taking the yellow metal up to my long term target of $2,300 an ounce, or even to the gold bug levels of $5,000 to $10,000.

So when does my friend expect the greatest bull market of all time to begin? After the new government comes in next March you should allow six months for it to get settled and get its ducks lined up. That takes us out to October, 2013. Until then the stock market will continue to bump along the bottom, as we have seen for the past year. Of course, if the markets get a whiff of what’s coming, they could react much sooner. You can take the China crash scenario and throw it in the trash.

I asked my contact if the demographic wall that I expect China to hit in five years will cool his expectations. This will happen with the population pyramid inverts as a result of its 32 year old one-child policy, and a large aging population supported by a smaller generation of young workers creates a large economic drag. He said that demographic effects won’t really impact the financial market for ten years, and could well be what brings the next bull market to an end.

 

 

 

 

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