World markets dance to China’s tune

The following is a weekly commentary by CEO and Chief investment officer Monty Guild and President Tony Danaher of Guild Investment Management Inc.

World markets are frightened that the fastest growing economy in the world will slow too rapidly. Thus, when China tried to slow real estate speculation with a series of actions over the last three weeks, many global investors panicked and sent stocks down in most of the world.

We find this interesting for the following reasons:

China is now recognized as the engine of world economic growth, with over $2.4 trillion U.S. dollars in surplus capital and a fast growth rate. People are looking more and more to China. The new saying is, “If China sneezes, the world catches a cold.” More and more countries are exporting to China, India, and non-Japanese Asia; and less to the U.S. and Europe.

Investors who do not know much about China’s economics are panicked that China’s economy will somehow implode because the government is trying to reign in speculation in real estate. This is patently wrong. China will grow rapidly in 2010.

There is a difference between the real estate speculation that is currently taking place in China with the speculation that occurred in the U.S. and Europe that eventually imploded.

In China, real estate speculation has been the result of large capital surpluses in the hands of Chinese investors. These investors have few options for investing their capital. Their options are:
A) They can buy stocks, although most of them already have stock portfolios.
B) They can purchase physical commodities like gold, but not futures on commodities.
C) They can buy residential real estate (apartments) to rent or to hold for appreciation.
D) They can hold bank deposits which pay a low interest rate.

Contrary to the developed markets of the North America, Europe, and Japan, China has virtually no bond market. In addition, sending money overseas for investment is close to
impossible for Chinese investors. Within the developed world, bonds and foreign

investments soak up a lot of capital, but this is not so in China. For these reasons, China has a large amount of surplus capital looking for a place to invest.

CHINA’S GDP WILL GROW BY AT LEAST 9% IN 2010, EVEN IF THE REAL ESTATE BUBBLE DEFLATES

Today, wealthy Chinese who invest in real estate put 50% down and pay higher interest rates than an owner occupied apartment purchaser would pay.

Compare this to the low down payment, or no down payment, real estate speculation that we saw 2-3 years ago in the developed world. In China, there is no speculation based on the feeling that they can quickly sell for a big mark-up; thereby it is OK to take on a lot of leverage.

The Chinese economy is booming because consumer and infrastructure spending are growing at double-digit rates. Accordingly, a decline in real estate activity as the government brings the real estate bubble under control will not cause the economy to grow by less than 9% in 2010.
Some investors have come to believe that lending to industrial and consumer companies will stop as China reigns in real estate lending. We disagree with this theory. There is no shortage of financing available for other types of businesses. Businesses can get financing to buy inventories and production machinery. Capital is available for Chinese companies to buy smaller competitors in China and abroad (the news media is full of stories of Chinese companies buying foreign suppliers).

In short, China is not going to implode if the Chinese government is successful at deflating the real estate bubble. The government believes that the currently too-rapid growth will moderate to a more acceptable 9-10% rate if the real estate bubble deflates.

SUMMARY

The current market declines in global markets will lead to a buying opportunity in Asian and selected Latin and Eastern European markets within 2 to 3 months. When the decline has run its course, we will also look closely at opportunities in Canada, Australia, Europe and the U.S.

In 2010, we expect to see China will grow by 10%, India by 8%, Brazil and non Japan Asia by 5%. Some other well-run countries will grow in excess of 5%. This means corporate profits in these nations will grow substantially, leading to higher prices for stocks.

For more weekly commentaries by Monty Guild and Tony Danaher, go to guildinvestment.com.