6 Reason for China Play

"For nearly three decades, China has been the fastest-growing country in the world. With a rate of savings and investment exceeding 35 percent among its 1.3 billion people, and foreign reserves that already top the planet, it is set to become the most important country in mankind's future." -- Jim Rogers, Legendary Investor

Many people speculate that China is communist in name but capitalist in practice, its more accurate to say that the country goes by a "whatever works" system। Deng Xiao Ping, the first Chinese leader to advocate privatization, famously said, "I don't care if it's a white cat or a black cat. It's a good cat so long as it catches mice."

The private sector in China has undergone a speedy evolution since President Jiang Zemin's 1997 call to increase "non-public ownership," while shutting down and selling the majority of China's state-owned enterprises. Private enterprises have proven to be most successful and now account for 70% of China's GDP -- 70% of profit in the second-largest economy in the world.

Since Beijing's confirmation as host city in 2001, China has seen record highs in venture capital investment. According to the China Venture Capital Report by Zero2IP, Venture Capitalist funds totaled $2.36 billion in the second quarter of 2007. Foreign funds accounted for nearly 90% of funds raised in China that same year.

20 or 30 years ago, small businesses were seen as either desperate ways to make money or for the greedy to hoard money at the expense of everyone else Now 50% of college graduates in China say they are seriously contemplating starting their own business, and small business is seen as a way of equalizing China's intense wealth disparity less than 1% of urban Chinese holds 70% of the country's wealth.

Whereas larger cities such as Beijing or Shanghai are relatively saturated with retail shopping malls, second-tier cities like Tianjin or Xi'an are experiencing high growth as wealth pours into the middle class.

The Chinese stock market has been a sliding for all of 2008 and even with the Olympics finally here it is still not spare, the mood hasn't brightened yet and a number of factors came together to hit China hard but the bottom could be just around the corner.

#1: The Silly Mania buying season is over
Chinese investors went through a mania phase last year. There were tales of lines half a mile long snaking out from the doors of the local stock brokers. In April 2007 alone, nearly 4.8 million new trading accounts were opened in China more than the prior two years combined. All these new buyers led to a silly season for Chinese stocks.

You could see it in the difference between Shanghai A-shares and Hong Kong H-shares. At one point, companies with dual listings in Shanghai and Hong Kong were getting as much as an 80% premium on the A-shares price. This was a reflection of Chinese capital controls because it's tough for mainland Chinese to get their money out of the country and naive buyers who wanted to play at any price.

Now that the frenzy has subsided, real values are starting to show up again. The hot money has burned itself out, providing opportunities for those who see longer-term value and aren't out to just flip a quick buck. You see this pattern play out over and over again when a new opportunity comes to a place.

Investors get excited and lose their heads, they push things way too far, and then the market comes crashing back to earth. That's when the patient and value investors get interested.

#2: Oil Is coming down of its Peak
Crude oil is more than 20% off its near-term highs as of 12 August 2008. It looks like oil could be heading for the $110 mark. One of Asia's greatest challenges has been keeping a lid on inflation pressures. It's not easy to grow like crazy without seeing the price of basic goods and services rise too quickly.

Oil closing in on $147 a barrel swamped Asia with inflation on a local level as the price of transport, food, and fuel went up and also to cut into export profits as shipping costs rose. Oil price cooling off make China and India to breathe easier. The fear that high-priced oil might kill the Asian miracle is lifting. That gives them more time to tap alternative energy solutions and build economic strength at home.

#3: The locals Chinese are optimistic
Thus far, news reports mostly focus on the bad things such as civil unrest, government crackdown, pollution and so on. That's the nature of the news mostly for the most part because good news isn't as exciting as bad news. But a recent survey from the Pew Research Center shows that most Chinese feel positive about where their country is headed.
According to the survey, 86% are "content with the country's direction." (That's up from just 25% six years ago.) Perhaps even more surprisingly, six in 10 Chinese reported being satisfied with their jobs. And 70% were in favor of China's shift toward a free-market economy. The biggest concern in the Pew Survey is rising prices. But that concern is addressed by the fact that oil is headed down these days and its not marching higher as it had been for most of the year.

#4: China growth is still there
China has had an amazing run, growing its economy at a near double-digit pace since the early 1980s. But the dragon isn't done yet as least not by a long shot. Global Insight, an economic consulting firm, forecasts that China will overtake the U.S. as the world's largest manufacturer in 2009.

This is as much because the U.S. base is shrinking, even as China's is growing but that still counts as an eye-opening statistics. Plus for the longest time, China was seen as the world's source for low-tech goods. Chinese factories were known more for sneakers, trinkets and cheap plastic toys than items of real value.

That's all changing now as China moves up the quality food chain. Now we are seeing savvy companies like China Medical Technologies (CMED:NASDAQ) produce some of the most sophisticated high-tech devices in the world. As China gets better at enforcing intellectual property laws, its high-tech skills will only increase and profit margins, too.

#5: Personal savings and domestic demand
Perhaps even more impressive than China's long-term growth rate is the personal savings rate. Americans spent more than a dollar for every dollar they earned in 2006. The U.S. savings rate actually went negative.

The Chinese, meanwhile, salt away 35 cents for every dollar they earn. Just imagine how much extra money you'd have on hand if you'd managed to save 35% of your income, year in and year out, ever since you started working. Then just think of all the things you could buy with that cash. Part of the reason the Chinese save so much is because there's no real social safety net. But that's changing, too.

As the Chinese economy evolves, things like insurance and health-care and retirement plans grow more affordable. At some point, China's big savers will feel a little bit more comfortable spending some of that cash they've saved up. And the newly minted middle class in China are already taking a hard look at things like cars, air conditioners, washing machines and so on. As local economies grow, the locals themselves feel more comfortable spending a portion of their ample savings.

That in turn leads to more domestic growth, which leads to a more positive outlook, which in turn increases spending. Chinese domestic demand is headed into a virtuous cycle that could run for decades.

#6: China huge foreign reserves
In balance sheet terms, China is massively rich. We've already seen what can happen when cities and counties go bankrupt. The residents of Orange County, California, got a nasty taste of that. Jefferson County in Alabama was on the brink this year, too. (As with Orange County in 1994, they took on some really dumb trades.)

So it's not good when some regional authority, be it local or national is running short on cash. China doesn't have that problem. If anything, they have the opposite problem. Economist Brad Setser estimates that China has somewhere between $2.3 trillion and $2.4 trillion in excess reserves.

That's a lot of dough which enough to make a 20% down payment on the entire U.S. econom and hundreds of billions more roll in every quarter. Point being, money can't always prevent bad things from happening. But it sure can fix a lot of things.

If China has to take extra steps to keep economic growth on track or keep the domestic demand side humming, it certainly won't be stymied by lack of funds. Because of that, and because of the depressed state of Chinese equities right now, some China plays look more favorable than they have in years.

One of the ironies of markets is that the biggest profits often come not when a good situation turns itself into a great situation but rather when a bad situation becomes good. This is because investors are so naturally predisposed toward optimism.

So when "good" becomes "great," some of the optimism premium was already built in, and the upside isn't always as strong (until the blow-off phase arrives). But when bad morphs into good, or even simply to "less bad," there is room for large (and safe) gains, as renewed excitement creeps in after an extended absence.

That's where it feels like to be with China while waiting for the bad to turn good, which it soon could. And aside from big picture trading opportunities, there are a number of smaller Chinese growth companies many of them traded on U.S. exchanges that look very appealing here and now.