Asia: An Extraordinary Buying Opportunity

We have rarely seen such a bearish mood in Hong Kong and China. Asia Pacific is nearing 5-year lows in terms of price earnings.  In particular, China is close to its lowest multiples in 5 years; but its economic prospects (despite the comments of Larry Kudlow) are still good.  We expect China’s GDP to grow 6% in the next year – and this means an additional US$840 billion of output on a US$14 trillion economy.

5 Year MSCI Asia Pacific Price/Earnings Ratio

5 Year Shanghai Composite EPS and P/E

The emerging markets are also at a very depressed and oversold level and have fallen 20% in 2018. Within the emerging markets, Asia now represents 75% with EMEA at 15% and LATAM at 10%.

Emerging Markets in 1988 vs 2017

When we consider that the Turkish lira and the Argentine peso have collapsed by -38% and -52% year-to-date, together with their respective stock markets, we can appreciate the contagion effect that this has on otherwise healthy economies in Asia.

Asian Currencies vs LATAM Currencies 1 Year Performance

Russia, too, has been suffering from US sanctions, and the Russian ruble and the Russian market have both reached new lows with negative effects on other Eastern European economies. Brazil has been dragged down by political uncertainty and the effects of the Venezuelan economic implosion have affected Colombia and its other immediate neighbors.

Asia stands out for political stability, financial strength, strong savings rates, and good growth prospects. India is growing at 8.2% on its last quarterly GDP numbers.  The inflation rate is low at 3.7%, and real interest rates are high.  The current account deficit, that India is currently experiencing, is half what it was 5 years ago, when it was 5%; and today, it is 2.4%, even with oil rising to US$80, and we expect US$100 by year end.

Mr. Modi is likely to get re-elected in May, 2019; the Reform Program will be maintained; corporate earnings are growing at 20%; and the Reserve Bank of India is probably one of the most conservative banks in the emerging world. The Foreign Portfolio Investors (FPI) owned by non-resident India have now been given some relief from the SEBI rule regarding KYC of beneficial owner of the fund.  There has also been a concerted attack on corruption and bankruptcies in the corporate sector as well as the banking industry in India, which recently affected banking and financial stocks.   September has been a torrid month for our Indian Ocean Fund, which fell 9%, together with the weakness of the Rupee.  The Indian Rupee at 73 is now down by 14%, against the US dollar since the beginning of 2018.  In our view, none of these extreme market corrections are justified by the economic fundamentals.

The real political risk today, it could be argued, is in Washington where President Trump, having threatened trade wars successively with Europe, Mexico, Canada, South Korea, among others, has settled new “deals” with all of them. This argues that he will logically find a new “deal” with China in due course, which would have a dramatic effect on the depressed share markets of Shanghai, Shenzhen, Hong Kong, and the region.  The midterm elections on November 6 actually highlight the political risk facing the USA, since the possibility of the Democrats gaining the majority in the House, if not the Senate, will create paralysis and stagnation in the legislature, and possible impeachment proceedings against the president.   This will surely lead to a fall in the US dollar and probably in the S&P 500.

The key for us is the relative performance of the US market and the US dollar compared with the rest of the world, in particular, with the emerging market index.

10 Year Ratio of S&P 500 / MSCI Emerging Market Index

In the past 30 years, we have never seen such an extreme outperformance of the US compared to the rest of the world. The key will be a change in the Dollar’s trajectory.  As the US debt surpasses US$21 trillion, and interest rates rise towards 3% (and, as J.P. Morgan suggested, to 5% over the next 2 years), net interest payments annually will reach US$1 trillion, exceeding total defense or social security spending.  At this point, it is hard to imagine there will not be some sort of crunch, or crisis, in the value of the US dollar, and the way foreigners perceive the risk in the Treasury bond market.

It is interesting to compare China, with US$3 trillion official reserves and US$7 trillion or more of private savings, and other Asian countries – Hong Kong, Japan, Korea, Taiwan, India – because there is clearly an imbalance in the world. The global savings glut, which has held down interest rates for the past several years, may now be reaching a moment of truth.  Instead of 50% of Chinese savings being channeled into US funds, we may see soon a reversal by which the huge private savings in China and India are channeled instead into their own capital markets.

China’s contribution to global growth has risen from 12% in 2000 to 30% in 2017. China is also becoming creditor nation with external assets of US$6.2 trillion and is increasing its direct investment into Southeast Asia, both because of cost pressures and trade tariffs.

China is not only an investor but the leading trading partner of nearly all Southeast Asian countries, notably Indonesia, Philippines, Vietnam, the most populous ASEAN nations. In our model portfolio, we are now targeting 40% China, 30% India, and 30% ASEAN.  Within Southeast Asia, we are overweighting Vietnam and Indonesia because of their large, young consumer populations.  For instance, we have selected the Home Depot of Indonesia, Ace Hardware, as one of our core positions.

The health of the world economy depends on the Emerging Markets, which account for 59% of global gross domestic product – up from 37% in 1980. This enormous shift of the world’s economic balance in the past 30 years is principally due to China’s rise as a manufacturing and economic power, especially in the last 20 years.  Now, many observers think that India is the next China, with its young population of nearly 1.5 billion, exceeding China’s, its growth rate surpassing China’s, and its open and democratic system of government proving, in the long-term, more resilient.  No investor in North America or Europe can afford to ignore the potential of China and India as investment destinations in the next decade.  Even if the oil price reaches US$100 a barrel, we expect that, as in 2007, the Asian markets can rise against this background of rising commodity prices.  Inflation may be coming back as wages rise and labour shortages grow. But for the next 12 months, we see a coming shift of capital away from the overvalued US market into the value opportunity of Asia.

 

 

 

Robert Lloyd George
5 October 2018
Hong Kong

The New Silk Road

Does China mean to conquer the world? Many western observers, seeing the scale and ambition of China’s infrastructure plans in 86 countries and over US$1 trillion of projects, have concluded that it is a sinister plan to dominate Eurasia and beyond.  This essay attempts to look at these projects objectively and draw some conclusions about their impact on the world, and on China itself.  The following table shows the countries with the largest commitment by Chinese banks and construction companies.

“One Belt One Road”

Source: Hong Kong Trade Development Council

What may be observed from this list is the heavy concentration on South Asia and Southeast Asia (Pakistan, Bangladesh, Malaysia, Philippines, Indonesia, Vietnam, Laos, and Cambodia, also Sri Lanka); but, in addition, for Chinese geopolitical reasons, there is a strong focus on Central Asia (Kazakhstan, Uzbekistan) and even some of the old Soviet-zone states like Belarus and Romania. Equally important to the Chinese is their very strong commitment to Africa, which President Xi Jinping, the architect of the “One Belt One Road,” emphasized last week in the Sino-African Beijing Summit.  The total Chinese investment in Africa will amount to US$60 billion this year alone, and nearer US$200 billion in total.

As we have observed in the past, the Chinese influence on the smaller economies is extraordinarily powerful. The example of Sri Lanka, which I visited last year, is a telling one, where the total investment promised will exceed US$10 billion (Sri Lanka’s GDP is US$60 billion).  Already, Sri Lanka owes US$8 billion to Chinese banks and has agreed to a cancellation of about US$1 billion in debt in exchange for China getting a 99-year lease on the 11-square-kilometer special economic zone around the port of Hambantota.  As in Djibouti and, perhaps in Pakistan, China is essentially gaining ownership of key strategic locations, especially ports, around the Indian Ocean, which serve its long-term purpose of protecting its sea lanes, especially the route of oil tankers coming from the Persian Gulf through the Malacca Straits and into the South China Sea.

China has a two-fold objective to gain goodwill and long-term economic advantages in a strong financial and trading relationship with many emerging countries in Central Asia, as well as Africa and even Eastern Europe, which over the long term, will give it a powerful geopolitical presence and, perhaps, export markets for Chinese products to these countries. The difficulty is that many of the loans which accompany the projects to build railways, ports, pipelines, even highways and, very often, airports and presidential mansions, are usually impossible to repay because of the weak economic conditions, for example, in African nations.  China, thus, obtains a strong position as a dominant creditor even though, as we have seen in Sri Lanka, in Malaysia, and in Pakistan recently, a change of government brings to power a new administration which tries to either renege on, or renegotiate, these overwhelming Chinese loans.

Prime Minister Mahathir of Malaysia, who came back to power recently at the age of 92, has attempted to stop the construction of an east coast highway and also a vast Chinese offshore city of nearly 1 million “colonists” in Johor. Although all these emerging countries desperately want foreign investment, it does not always benefit them greatly to see the arrival of large Chinese projects, financed by Chinese banks and built almost entirely by Chinese engineers and workers, and then coming under Chinese ownership once they are completed.

There are many unanswered questions about this key strategy of the current Chinese president. Will military muscle be required to back up the trading and financial presence of Chinese workers and companies?  The example of Djibouti is interesting in that, for the first time, China has built a military base on the continent of Africa with a clear plan to emulate American, French, or British policies in the past where a special forces group can enforce action locally to protect Chinese citizens or projects (the recent case in the Sudan of 2,000 Chinese workers being evacuated) has perhaps stimulated this action.

As investors, we have to try to assess what all this means. Will Chinese banks suffer from non-performing loans from these emerging countries?  Is the return on investment of the Chinese engineering companies, notably railways, going to be adequate?  What if the Chinese economy itself slows down and these small emerging markets are heavily dependent on Chinese investment and trade?  It is clearly in China’s interest to export its overcapacity of steel and other key materials, as well as large teams of Chinese workers.

The world has never seen anything quite like this before. Some observers compare it to the Marshall Plan, which the US directed towards the impoverished nations of Europe in 1948; but the scale and the purpose are quite different.  The only real parallel is that just as a market for US goods was created by stimulating the European post-war economies, so too China will gain markets by pumping capital into Africa, Central Asia, and so on.  But the key question remaining is, “How will China get repaid?”  When Imran Khan was recently elected Prime Minister of Pakistan, he found an outstanding debt to China of US$60 billion and requested funds from the IMF to help repay the loans; but President Trump has put his foot down and refused to fund IMF repayments to China.  Could a similar situation cause a financial crisis or even currency volatility in the emerging markets?

We are convinced that China’s long-term strategy is a peaceful one; and just as they have focused with single-minded energy an on rebuilding their own economy after Mao, so their rhetoric suggests that they have every good intention to rebuild the struggling economies of the third world. Certainly, one motive is also to obtain a supply of key commodities, such as oil, gas and minerals, as well as food, from Africa.  If this massive Chinese global building project continues, we would expect that demand for, and prices of, key commodities will remain firm in the next few years, even though the infrastructure demands within China itself are lessening.  For instance, the investment in railways in Southeast Asia, and in countries like Bangladesh, will only further enhance Chinese competence in railway building.

The last month has been a tough time for investors in Asia; but within the next 4 weeks, we expect to see light at the end of the tunnel. First of all, the US and China will reach a deal on trade; and this will lead to a strong 4th quarter rally in oversold Asian markets and currencies, especially China.  The Shanghai A Share Market is now on a forward PE of 10 times, and foreign institutions continue to put in capital (the MSCI just increased exposure of A Shares in its Emerging Markets Index from 2.5 to 5% of all A Shares, and an estimated US$17 billion has been invested from overseas).

India, too, is resilient, with the local market rising 11% in rupee terms this year, while the dollar’s strength has largely eliminated this return to international investors. We expect that strong fundamentals – trade, current account, pro-business policies, continuity after May 2019 elections, and average corporate earnings of 25% – will prevail over time; and that the Indian rupee’s temporary weakness, caused by the contagion of Turkey and Argentina, will prove short-lived.   Our outlook for 2019 remains for robust growth in Asia, including ASEAN.

Another important development is the growing shift of manufacturers from China towards Vietnam, Bangladesh, Cambodia, and Indonesia, especially for clothing and textiles; and for office and telecom equipment to Malaysia, Singapore, and Vietnam. Exports and economic growth will pick up strongly, especially in low-wage nations like Vietnam and Cambodia.  This results both from China’s higher factory (labour) costs and from Trump’s tariffs, but it is worth emphasizing that China still accounts for over a third of global clothing and telecom exports.


Robert Lloyd George
7 September 2018
Hong Kong

Hangzhou Renaissance

During the Sung Dynasty (1127-1279) the capital of China was in Hangzhou (about 100 miles south west of today’s Shanghai). The famous West Lake remains one of China’s famous beauty spots.  Looking at the extraordinary variety and exuberance of the Sung ceramics, one can imagine the vitality and high level of Chinese civilization compared, for instance, to Anglo Saxon England in 1040 AD, when the capital was moved from Winchester to London.

Today’s Hangzhou is the headquarter to Alibaba, the world’s largest e-commerce business, of Geely Automobile, a leading Chinese domestic auto company, of Hangzhou Hikvision, a leader in surveillance and artificial intelligence, and many other technology leaders. Due to the rapid development of many new industries, Hangzhou was recently upgraded to a ‘Tier 1’ city in July of last year. The local property market is one of the most vibrant and high priced residential markets outside central Shenzhen, Beijing and Shanghai, with 9.5 million residents.  It gives the visitor a clear impression of today’s China – wealthy, confident, and assured with a pleasant clean lifestyle: Bentley, Ferrari, and Maserati all have prominent dealer show rooms: high-end restaurants are packed out for lunch and dinner.  Traffic is heavy but not choking as in the 2 major cities.

In fact, Hangzhou is in many ways comparable to Seattle (Washington), which is one of the fastest-growing cities in North America today owing to the presence of Amazon, as well as Microsoft, Boeing, Expedia, and so on. Amazon has 40 buildings downtown and over 50,000 IT employees.  Like Hangzhou, the city is being energized by the rapid growth and wealth creation of one major online company.

Everyone we spoke to in China was confident that the ‘Trade War’ will be resolved: even so, China can easily survive Trump’s threats and tariffs. Consumption is now 78% of GDP.  Exports are 18% of GDP, and exports to the US is 4% of GDP.  China’s ambitions to be a technology leader can hardly be suppressed.  As we have written before, they will innovate, and lead, in many areas, including medicine, biotech, AI, robotics, and so on.  It is not a threat to the west any more than Japan in 1980s, although the US demonises any economic competitor: in fact, global economic activity is thriving as the Asian giants engage, compete and improve efficiency.

In his fascinating book about Alibaba, Duncan Clark highlighted the strong nexus of small businesses which cluster in the province of Zhejiang in the city of Hangzhou. Alibaba has been able to leverage on this cluster of talent and products to the online e-commerce business which has really taken off in the 15 years since the outbreak of SARS in Hong Kong and China shut down a lot of physical shopping outlets.  Now the typical issue in America and Europe has become how far Amazon can be allowed to grow and destroy the old high street shopping outlets.  In China, it does not seems to be a big issue, but the question remains how far the ‘BATs’ (Baidu, Alibaba and Tencent) will be constrained by political authority just as the ‘FANGs’ (Facebook, Amazon, Netflix and Google) are now being constrained by new regulation, and some reaction in the case of Facebook, at their influence on the US electoral process (and Russian disinformation).

The Indian market has recovered in July, with the large cap index up 6% as the oil price corrected, and corporate results from Indian companies continue to be strong. In fact, in local currency, the Indian market has gained by nearly 8% since the end of last year, and is one of the best performing emerging markets.  The weakness of the Rupee has been the main drag on performance; but now that the Reserve Bank of India has hiked its policy rate by 25 basis points, we see the Rupee stabilizing.  Also we see major direct foreign investments in India by Samsung, Apple and, more recently, by J.P. Morgan.

The Indian market has also performed better in the last month, because it is not so badly affected by the trade tension between the US and China. In fact we have analysed the future situation of the assembly chains of technology and other products in Asia, and believe that South East Asia, India and its neighbours will benefit from a shift of manufacturing assembly work from China to India, Bangladesh, Vietnam, Thailand and perhaps Malaysia. Chinese capital is already moving into these areas.  We also notice that Samsung and Apple have both made major capital investments in Indian plants in the past several weeks.

Medium term, therefore, we believe that a balanced portfolio with China, India and ASEAN (Philippines, Malaysia, Singapore, Vietnam, Cambodia, Thailand and Indonesia) will be a very good portfolio to outperform in the next 10 years. It is interesting to observe that Pakistan has also elected its own home grown ‘Mr Modi’ in the shape of  Mr Imran Khan, the well-known cricketer and London socialite formerly married to Miss Jemima Goldsmith. He is likely to try and clean up corruption in Pakistan; and the Karachi market, and the Pakistan Rupee, have already rebounded by 4.7% in the first few days after the vote.  All of these countries in South Asia depend on China for capital investment and infrastructure improvement, so one of his first calls was on the Chinese Ambassador in Islamabad.

Our focus in our portfolios remain on the Asian consumer, now estimated to be 300 million in India and perhaps twice that figure in China (in ‘middle class’ consumers), and growing fast in Indonesia, the Philippines and other Asian countries; also on technology, e-commerce and other disruptive technologies and finally on the key sector in biotechnology and pharmaceuticals. The breakthroughs expected in oncology, by Chinese drug manufacturers, are extremely interesting and worth a diversified ‘punt’ on several promising new companies. The Hong Kong Stock Exchange has also relaxed its rules for new listings for biotech start-ups, and among the first names to list will be our favourite Chinese company, BeiGene.

Although we are now in the summer doldrums, we are looking forward to a strong and invigorating market bounce in the autumn, as the trade tariff war is resolved between Trump and NAFTA, and then Trump and China, as it has been between Trump and the EU. We are ready to buy into the A share market in China at a PE of 12 times, with earnings growth of over 20% in the pipeline, and local sentiment extremely depressed, even though the consumer spending and GDP numbers are coming in stronger than expected, at 6.7% for China, and over 4% for the US economy.  In conclusion, we do not believe that a trade war is imminent; and we are positive about prospects for China and the Oriental markets in the 4th quarter.

Robert Lloyd George
10 August 2018
Hong Kong

Summer Doldrums

The Asian markets are suffering from a strong US dollar and growing risk aversion (or a preference for cash). Nevertheless, the underlying fundamentals continue to be strong. The Indian market, for example, has seen a loss of nearly 7% year-to-date (large cap index moved up 1.7%, and mid cap index down 13.9%), mainly due to the weakness of the rupee, which has fallen 7% to 69 rupees per US dollar and matched lows of the past five years. Indian corporates however are estimated to report a 20% growth in earnings per share, and we continue to observe India’s “digital leap” supported by the growth of mobile phones, the Aadhaar identity card system, Jan Dhan, and the inclusion of over 300 million Indians into the financial system.

Source: Reserve Bank of India (RBI)

Together, these will transform India into the 3rd largest economy in the world, within 10 years, with a GDP of US$6 trillion, a market cap of US$6 trillion, and the 3rd largest banking system in the world with US$18 trillion of value (according to Morgan Stanley projections). Like China, the key will be the rapidly developing middle-class consumer sector, which is expected to quadruple from today’s US$500 billion to about US$2 trillion in market capitalisation; and per capita income growing from today’s US$1,500, to about US$4,000 by 2027, (or similar to China in 2010).

Our Indian advisor, Ashit Kothari, tells us that June has been a very difficult month for the small cap and midcap stocks, owing to changes in the domestic mutual funds and the general malaise of emerging markets in consequence of the trade war rhetoric between the USA and China, as well as the USA with the EU and Canada. Indian large cap stocks, however, have held up well; and pharmaceuticals are up 11%, and IT up 2%, both benefiting from the depreciation of the rupee.  The now established monthly pattern is for foreign portfolio investors to sell on average US$1 billion a month, while domestic institutions bought over US$2 billion.

Source: Ministry of Statistics and Programme Implementation (MOSPI)

This is a pattern we have observed throughout Asia with the growth of national and domestic wealth and savings becoming a much more important influence on the direction of stock markets than the volatile actions of foreign fund managers. We foresee that, in the 2nd half of the year, the US dollar strength will peter out, and that there will be a strong rally in these over-sold emerging markets.

Turning to China, we have also seen the Chinese Renminbi slip slightly against its trade-weighted average and about 3% against the US dollar in June. In response, the People’s Bank of China has cut the reserve requirement ratio for banks, freeing up over US$100 billion for new lending and investment.  This easing policy is distinctly different from the 2009 policy actions whereby the Chinese government greatly boosted fixed asset investment, or construction projects.  This year, fixed asset investment is growing at its slowest pace since 1995, as are retail sales.  Both of these factors have suffered from the tightening of credit in the system from the PBOC’s focus on deleveraging.  Corporate bond issuance has seen a sharp decline in the first five months of 2018 (down 37.5% compared to 2017 and 63% compared to 2016), while corporate bond defaults have increased at a faster rate than the previous two years.  Xi Jinping has directed that the “Growth At All Costs” policy, in place since Deng’s 1992 “To Get Rich Is Glorious” announcement, is now to be replaced by quality growth at a slower pace, with less lending.

 

In the past two years, Beijing has been able to achieve steady progress towards deleveraging, while growth remains above 6%. There is, however, still anxiety about a combination of bond defaults, a weaker RMB, and tighter liquidity, plus the trade tension with the US causing a financial panic.  The Shanghai and Shenzhen stock market has fallen sharply in June (down 7.4% and 7.8%, respectively).   Our funds continue to be 90% invested, with a strong focus on the high growth areas of Chinese biotech, tourism, and IT/internet, Indian financials and consumer, and some selected growth names, such as CyberAgent in Japan, an online gaming provider and Japan’s leading ad agency for mobile phone platforms.

The following chart is a useful one in the context of the trade conflict. China’s exports now stand at 18.5% of GDP, while their current account surplus only represents under 1% of GDP.  This compares to the height of the bull market before the GFC, when exports stood at 35% of GDP and the current account balance stood at 10.3%.  The overall risk in slowdown in the current account to overall GDP has shrunk over the years.

Source: Bloomberg

We are pleased to say that, despite the fall of MSCI Emerging Markets Index so far this year of about 6% and MSCI Asia Pacific Index of 3.4%, we are still recording a positive return for the year. We remain confident that we will deliver good results in the second half based on these strong fundamentals.  Our outlook remains fundamentally based on the assumption that trade tensions will be resolved, by China’s agreeing to buy an additional US$150 to US$200 billion of US food, energy, and other goods; an opening up of China’s industrial and financial sector; and a new commitment to respecting intellectual property.  This will provide President Trump with a “good news” announcement prior to the November mid-term elections, and will also significantly benefit the smaller trading nations of South East Asia and India, which have been trampled under by the two big elephants of international commerce, the United States (US$20 trillion GDP) and China (US$12 trillion GDP).

It is perhaps an auspicious moment for long-term investors in North America and Europe, to “dip a toe” into the Pacific markets, based on the long-term vision we have, that China and India, will be major economies and capital markets in the next 10 to 20 years and beyond.

 

 

Robert Lloyd George
9 July 2018
Hong Kong

Chinese Medicine

The heroic age of building in China which stretched from 1980 up to 2015 and even today, may be coming to an end. China today is a modern consumer economy similar to European countries (or Japan or Korea), with a large middle class, and consumption representing 60%+ of the economy compared to 40% a few years ago. Exports have fallen from 37% of GDP in 2006 to about 17% today, so the impact of potential trade tariffs is less than it was a decade ago.

Recently during a visit to Beijing, I learnt from many meetings with senior policy makers in Bank of China, State Administration of Foreign Exchange (SAFE) and China Investment Corporation (CIC), that the senior leadership is very confident that a compromise will be reached with President Trump in the next few weeks and that a trade war will be averted. This could indeed lead to a big rally in share prices both in New York and in Shanghai.

One fascinating area of research (and for us of long term investment) is the medical or healthcare field. Joseph Needham in his great work ‘Science and Civilisation in China’ established that almost every medical breakthrough occurred in China 500 years before Europe. Today, we have the uniquely positive set of circumstances whereby many Chinese PhDs from Stanford, Yale and Harvard are returning home and establishing new biotechnology businesses with world class standards, and scientists, involved. Among the companies we have already identified are Jiangsu Hengrui, CSPC and Wuxi Biologics, a major contractor with 240 drugs in the pipeline. Last week, we also visited BeiGene in the Life Science Park 20km north of central Beijing. It already has a capitalisation of US$11 billion with the promise that 3 important oncology products will be approved by the end of 2018. This is a Nasdaq listed company with important US shareholders, such as the Baker Brothers and Hillhouse Capital, other hedge funds, and even Merck. There is no doubt of its quality and of its potential, but to us it is a sign of the future trend in China. More and more biotech companies are coming to market, especially now in Hong Kong where the stock exchange has eased its listing rules to allow start-up biotech companies to list.

In the expectation that the trade talks will be settled, we are also optimistic about the technology sector in China. The news that Trump has relented on ZTE is important because it enables Chinese companies in the field of telecommunications and computer software to forge ahead even though China is still woefully short in its own national semiconductor manufacturing production.

Another key area of growth in China is domestic tourism. In the first quarter of 2018, 127 million domestic flights took place in China, a growth of about 11.5% from 2017. The expectation is that 550 million people will take flights in China this year, growing to 720 million by 2020. Including train travel, the figure rises to 1.3 billion. There are now 140 airports in China, accounting for most of the cities with over 1 million population. This is one reason we have focused on the hotel sector in our investment portfolio. By contrast, we have avoided the airlines where the advent of low-cost carriers will put pressure on profit margins.

The digital payment industry in China has also grown at an extraordinary pace since 2011, rising from US$15 billion that year to US$9 trillion today, or 80 times more than the USA, with the expectation that total mobile payments in China will reach US$47 trillion by 2020. Of course, this means that with the demise of cash, Chinese authorities, with the assistance of AI and big data technology, can track every payment and every e-mail that each citizen makes on a daily basis. Already 4 million Chinese individuals have been either denied travel permits or other benefits because of their low “civic score.”

I was also interested to discover that at very senior levels, there is a strong focus on Blockchain, and financial technology, in part because of the size of e-commerce and the on-line payment industry. There is a strong emphasis on security among the Beijing leadership; and even though there are very high transaction volumes, it is quite “transparent.” The leadership is also confident about the gradual resolution of the trade issue with GDP growth maintained at 6.5%, money supply at about 12%; and the debt ratio slowing down. Savings are still 45% of GDP, and most Chinese people like to own their own apartments, generally without large mortgages. (One major change could be a property tax, which has been widely discussed.) The government policy is, to open up to foreign ownership, most of the financial sector, including banks, insurance, and fund management; but there is no big rush on the part of foreign banks. The A Share market is generally undervalued, with banking shares under 1 times book, and many technology companies, growing at higher compound rates than their P/E multiples. The Hong Kong-Shanghai Connect has been a successful experience bringing in more capital into China. Now the authorities would like to see many of the big companies, such as Alibaba, which have New York listings, return to China, with the development of China depository receipts (CDRs instead of ADRs).

With the growth of this e-commerce market, I had expected to see physical retail spaces deserted or declining. In fact, some of the more up-market (up-scale) glitzy shopping centers in Beijing still maintain a high foot traffic, with not only international brand names, but also many new Chinese fashion brands restaurant chains. Dining out is now the most popular activity among young Chinese. Many of the millennial generation are less interested in accumulating material goods than having “experiences.”

It seems unlikely that Trump’s trade pressure on China will do much to break its rapid progress. In the 10 key sectors highlighted by the government in “Made in China 2025” – IT, robotics, aerospace, ocean engineering, railway equipment, electric vehicles, power equipment, advanced agricultural machinery, new metals and materials, and biotechnology – China is already making rapid progress; and much of the research is now taking place in laboratories in the major coastal cities, attracting some of the top Chinese scientists back from the US to work in good conditions with good salaries.

Robert Lloyd George
1 June 2018
Hong Kong

Disruptive Events and Technologies

The speed of change appears to accelerate both in technological disruptions and also in the diplomatic political area, as Donald Trump prepares to meet with Kim Jong-un. It is worth remembering that since the truce in 1953, North and South Korea and the United States have still been in a state of war, and no peace has ever been signed.  Hence, the existence of the Demilitarised zone, DMZ (about 1 mile wide) is a more complete barrier than the Berlin Wall ever was.

About 20 years ago, I had a visit in Seoul with the Minister for Reunification, who expressed to me the concerns that the South Koreans had, given that the 20 million population of North Korea was living at such a primitive economic level (and the country was suffering through a severe famine), the capital costs for South Korea to invest in, and upgrade, the infrastructure and living standards of North Korea would be 20 times that undertaken by West Germany for East Germany after 1990 (which cost US$1 trillion, and took nearly 20 years).

Nevertheless, the implication is that Kim Jong-un wants to modernise his economy just as Deng Xiaoping did for China after 1989, retaining the complete control of the Communist party (and his family) while allowing economic liberalisation and the advent of market forces. The West wrongly assumed that the Communist Party in China would wither away or lose control, under the pressure of the new economic freedoms.  But nearly 30 years later, it has not happened and President Xi Jinping is in more complete control than anyone since Mao.  Perhaps Kim Jong-un can do it too, but it is a much less sure prospect with a family dynasty (the only parallel is Cuba, where the Castros have finally handed over power to a new president after 60 years).

Investors may be bewildered by the speed of change, and it is necessary to have the “seeing eye” or look two steps ahead to see who may be the winners and losers of this tectonic change in the North Asian geopolitical balance. Japan is apprehensive.  South Korea’s Chaebol may be ready to seize hold of the opportunity of a new market. In the longer run, there is no doubt that China’s hegemonic influence over the Korean peninsula will be strengthened, and the US influence diminished.  Within 10 years, Taiwan may be absorbed by China.

The threat of US protectionism has already caused repercussions all around Asia, and China has responded by opening up its banking, insurance, fund management, and even automobile sectors. The shares of China’s domestic automobile manufacturers have fallen sharply.  Given a more open market in consumer (for instance, medical products), American and Western brands will most probably prevail.  We have also seen sharp falls in Chinese drug stocks.  Asia’s business model was to protect its infant industries for as long as possible, and now the Americans are getting tougher.  There will be a shakeout in these more vulnerable sectors.

India is the least affected economy because of its lower ratio of Foreign Trade to GDP, and its large domestic consumer market, which is unaffected by US protectionism. We continue to see a rapid growth of corporate earnings in India (nearly 23% in the coming 12 months) and we are confident that Mr. Modi has an assured re-election in May 2019.  Nevertheless, our main concern today is the rise in oil prices, which is pushing up India’s current account deficit from less than 1% back up to about 2% of GDP (it was 5% a few years ago).  The Rupee has fallen by 4% this year, and foreign investors are again becoming skittish.  Nevertheless, the flow of domestic savings and capital continues to support the Indian share market; and we do not think that there is a severe risk for the Indian economy, since the sensitivity to energy prices has reduced in recent years.

Although the meeting between North and South Korea on 27th April has received the top international headlines, an equally consequential but less reported meeting was held between Chinese President Xi Jinping and India Prime Minister Narendra Modi in Wuhan. These two countries represent 40% of the world’s population and have been linked culturally since before the Han Dynasty (200BC) or the era of Emperor Ashoka (232BC), both in trading networks as well as the travels of pilgrims and exchange of knowledge and religions.  The dissemination of Buddhism from India to China had a transformative effect on Confucian and Taoist culture.  Mr Modi wanted to meet President Xi Jinping in order to alleviate Himalayan Frontier tensions near to Bhutan, where there was almost a military clash last year.  In addition, India feels surrounded by Chinese diplomatic engagement in Pakistan, Bangladesh, Sri Lanka, Myanmar and, even more recently, the Maldives.  Mr Modi is a man of vision, and wants to keep peace with his neighbours, particularly with the May 2019 election approaching. Although both countries have close diplomatic relationship with the US, their own peaceful relationship is more important in its long term beneficial consequences for Asia, and for investors in the region.

One historic development this week was when Mr Modi announced that all 600,000 Indian villages now have access to electricity. As with the inclusion of many poorer Indian citizens to the modern financial economy (with 300 million new bank accounts being opened in the past 3 years) this development of power has a deep social and economic significance.

In conclusion, we are facing a volatile summer in Asian share markets, owing to the shadow of protectionism looming over the region. We have reviewed all our positions, both in the broad Bamboo Asian portfolio as well as the Indian Ocean region and are satisfied that we own the best companies, with good earnings prospects both in the immediate 12 months and beyond, which are worth holding, despite the short term buffeting of trade winds.  In particular, we have taken a positive view of the China A Share market, which has corrected by a considerable degree in the last year, but we view this as an opportunity because of its opening up to foreign investors and because of the underlying momentum of growth and profitability, particularly in the technology and medical sectors in China.

This month, we have engaged a Singapore based advisor similar to VAL-Q in India which will enhance our coverage of the markets in Singapore, Malaysia, Thailand, Indonesia and the Philippines. In fact, we have had an underweight exposure in these markets in the past 12 months, which has not hurt our performance.  The coming Malaysian election has caused a lot of political uncertainty.  Thailand, while appearing more stable under military government, is experiencing slow economic growth, despite the steadiness of the Baht.  Singapore remains a fairly overpriced market with high real estate values, although these have corrected over the past 5 years.  The most interesting market in South East Asia, in our view, is Vietnam which has risen about 40% in the past 12 months and retains the attraction of being a younger, faster growing, economy in a ‘catch up phase’ of manufacturing expansion.

Robert Lloyd George
4 May 2018
Hong Kong

Asian Realities Behind the Trade War Headlines

Mr. Market, as Warren Buffet calls him, is getting nervous as interest rates slowly rise, and the Trump administration threatens tariffs on steel and aluminum, and a number of other products imported from China. Although the US/China deficit amounts to US$375 billion, at least 1/3 of that, are products such as the Apple iPhone, created by US multi-nationals, and assembled in China, for re-export (31% of Asia’s sales to the US are technology products).

The complex network of suppliers throughout Asia, means that any US/China trade tensions are quickly felt throughout the region. However, our assessment, and that of other informed observers (such as Goldman Sachs) is that the economic impact on China is likely to be modest, less than half a percent of GDP.  Only 10% of sales are to the US, and the direct revenue exposure to the US for China equities is only 1%.  We have reviewed all our China positions, which are mainly in the domestic consumer, healthcare, education, and tourism sectors, and do not see any impact on our average 25% earnings growth forecast for 2018-2019.

The likely outcome is a negotiation, leading to a “managed-trade agreement,” between the two major economic giants, to reduce the deficit over the next few years. We expect some volatility over the summer months, followed by a strong recovery in Asian, and specifically Chinese, equities in the fall.  Our China New Era Fund launches April 17th, and we will carefully conserve capital to achieve the best possible purchase price, as we did in India, slowly accumulating long-term positions in companies.

Healthcare in China is one of our favourite sectors. By 2050, 33% of the Chinese population will be at, or near, retirement age, meaning 500 million people.  11% of the population suffer from diabetes.  The government will spend about 7% of GDP on healthcare, or US$1 trillion by 2020.  Medical insurance is expanding rapidly, and there are already 500,000 medical tourists travelling overseas for operations today.  Our favourite 3 healthcare shares are Jiangsu Hengrui, CSPC, and Wuxi. Jiangsu Hengrui specialises in cancer and anesthetic drugs and is growing at a CAGR of 20-25%. With a similar growth rate, CSPC has a strong position in generic and innovative drugs as well as the largest global market share in vitamin C and caffeine.  The most interesting company is Wuxi Biologics, which is the largest contract development and manufacturing organization (CDMO) in China with 63.5% market share, and is growing at about 70% in net profit annually.  Within its pipeline Wuxi has 161 projects in development, 8 in Stage 3, and one of which has just passed the US FDA. 

 We have selected 20 A-Shares, after 2 years of intensive research and close collaboration, with our associates at the Bank of China Asset Management (Hong Kong), out of well over 3,000 listed A-Shares, both in Shanghai and Shenzhen. The A-Share market will become more open to international investors this year, and will also become part of the MSCI Global Index by May, but a passive or index approach to this market, which is 70% state-owned enterprises, with doubtful accounting and transparency, is not a strategy that we advise.  Careful stock selection among smaller and midsize companies in less well-known sectors may reward investors over the next 5 years.

Just as the FANGS in America have now begun to lose momentum, with the investigations into Facebook, and the prospect of anti-trust or monopoly measures, so, too, the dominant position of Tencent, Alibaba, and Baidu in China may, at least, slow down, but they will not be under the same regulatory pressure as their US counterparts. We also see further growth in the financial sector in China, especially in life insurance, and have selected Ping An and Fanhua as leaders in that field. Our core selection of Chinese equities, in our Bamboo Fund, has delivered almost 30% per annum in total return over the past two and a half years, and we are confident there is more to come in the China New Era portfolio this year.

In India, although the market has slowed in the short term, we remain very confident that, looking forward, Prime Minister Modi will be easily re-elected in May 2019, and that his reform program will continue.  India’s wealth and savings (32% of GDP) are beginning to become more visible since demonetisation; and there is almost US$2 billion per month of domestic Indian capital being channeled into Indian shares and mutual funds every month. This is a significant shift from the traditional preference for gold, property, and cash.  We have also reviewed the generic drug sector in India last month, which has continued to grow rapidly, mainly in sales to the US market; and with the focus on cost containment of healthcare in the USA, these Indian companies are well-placed to benefit.

This week, we have reviewed our 9 India private sector banks, and financial shares, and concluded that they have higher earnings growth, lower non-performing loan ratios, and better management than the public sector banks (which they have outperformed by 70% in the past 12 months). With mortgage lending in India at only 10% of GDP, we see great possibilities as India progresses towards the 40% level typical of other emerging markets.

Last week, we also made a visit to Vietnam where the economy continues to grow at 6.7%.  There are now 22,000 millionaires in Vietnam, and domestic consumer spending is growing rapidly with housing, autos, tourism, and construction all benefiting.  Although the Vietnam share market rose 48% last year and 18% in the year-to-date, we are maintaining our long-term commitment to a small portfolio of outstanding companies as part of the Indian Ocean Fund, which is now 50% in Indian midcaps.  This portion of the fund continues to perform and we continue to screen, and revisit every company in our portfolio, on a regular basis.

Although the US and international background remains uncertain – especially the geopolitical factors, which Washington’s unpredictable policies, and cabinet changes have exacerbated – we believe that the trend towards Free Trade and peaceful resolution of international tensions has not stopped, but will, in fact, be maintained, despite all the current concerns. The prospect that President Trump and Kim Jong-un will meet in May must be welcomed as a step towards (in Winston Churchill’s words) “jaw-jaw rather than war-war.” Much more important to the markets is the rise in Libor rates towards 2.5% and the prospect that the US government’s interest payments will rise to an unsustainable level by 2020.

We, therefore, conclude that, within two years, there may be a more serious US dollar crisis, for which we need to start preparing. Asia will likely emerge from this crisis stronger because of its current large financial reserves and political stability and demographically favourable factors; but we have to look through the next market downturn and see the opportunities that are arising in the East, especially in fields such as healthcare.

Robert Lloyd George
3 April 2018
Hong Kong

The Rise of India and China

“You must never forget that the unification of Germany is more important than the development of the European Union, that the fall of the Soviet Union is more important than the unification of Germany, and that the rise of India and China is more important than the fall of the Soviet Union.”     Henry Kissinger

Our fundamental approach to investing is a long-term strategy based on the most significant changes in the global economy. Although “technology may be the next macro”, we still believe looking forward to 2030, that India and China will constitute the biggest opportunity to invest in growing populations and rising incomes in Asia, (and we cannot find any parallels in Europe, North America, or the other nations of the emerging world).  That is why Lloyd George Management is this month completing its range of three funds with the launch of “China New Era Fund” for international investors.  Our objective is to invest in technology, consumer, and medical companies in China, many of which are smaller capitalisation shares listed as A Shares in Shenzhen as well as Shanghai.

The headline news at the end of February is that China is going to abolish term limits for the presidency which effectively means that Xi Jinping can continue to be the President for life. This news has been greeted in different ways by the Chinese and Hong Kong press (who essentially support the national effort to clean up corruption and strengthen the country which has been President Xi’s hallmark policy), and the foreign press which is criticizing the emergence of a Putin-like dictatorship. From an investment angle we do not see any significant impact, although it is interesting that the market’s first reaction in Hong Kong and China was to strengthen.  At the same time there have been further crackdowns on the most aggressive private Chinese companies making foreign purchases such as Anbang, which bought the Waldorf Astoria in New York, and whose chairman has now been arrested, and HNA, whose shares have been suspended.  On the other hand, we see the example of Geely, whose chairman is closely related to the President, and who has personally just spent US$9 billion buying a 10% stake in Daimler.  The company already owns Volvo and this has caused some reaction in Europe where Volvo and Mercedes are keen rivals.

There is no doubt that China’s ambitions, both military, strategic, and economic, encompass nearly all regions of the world, particularly those in the ‘One-Belt-One-Road’ strategy of Central, South and South East Asia, and even as far as Africa and the Piraeus in Greece. But the imperative perhaps today, is in the field of technology. China is forging ahead in Artificial Intelligence, as well as in solar power, electric vehicles and other key strategic areas, in which, under Trump’s administration, the USA is beginning to retreat from leadership. If we therefore take a neutral view on political developments, we can see that there will be great opportunities in the area of technology in China.

Another key area is biotechnology, or the field of Biosimilars, in which Amgen and Biogen have lead in the US. There are a number of Chinese companies in this field and the one which our China analyst team has selected is Wuxi Biologics.  We selected this company because we are convinced that with rapid investment in R&D for biologics, Wuxi is the number one contract development, and manufacturing, organization in China, with a 48% market share.  Wuxi has 92 projects in preclinical development, and has had a 100% customer retention rate since 2010.  The US FDA has recently completed its inspection of Wuxi’s facility for the commercial manufacturing of Ibalizumab for launch in the US.  This is the latest stage molecule in Wuxi’s pipeline.  If this molecule approved, it will be the first-China-manufactured biologic to be marketed in the US.

We also made an interesting visit last month to New Delhi, during which we were reassured that there would be continuity in BJP policies of opening up and anti-corruption, even after Prime Minister Modi. Although we have made a significant investment in private banks and financial groups such as Gruh Finance, HDFC Bank, HDFC Standard Life, ICICI, Oracle Financial and Yes Bank, we have recently decided to exit our investment in the mortgage lending company, Repco Home Finance.  This company operates in the state of Tamil Nadu, where there have been contradictory and surprising policy changes from the state authorities regarding building permits, cement production and mortgage lending, which will in our view restrict the potential growth of Repco.  We are always conscious of local conditions and regulations as they affect the value of our investments.

Although we have been cautious on the Indian real estate market generally, because of the lack of transparency, one exception is the long established Bombay group, Godrej Properties, which has a large land bank and is managed to the highest standards of corporate governance. We have also added a remarkable retail group named Vmart, whose CEO and senior management we met in Delhi last month. We are very impressed by their commitment to financial discipline. In the Indian Ocean Fund, we have reduced our exposure in both Bangladesh and Sri Lanka, and trimmed Vietnam, because of our desire to increase the focus on Indian mid-caps.

In the Bamboo Fund, our focus continues to be mainly on China and Hong Kong, which are almost 45% of the Fund. Our Chinese shares have returned over 30% per annum over the last 3 years since we launched, and this gives us the confidence in our selection of 36 key names, half of them A shares, which we will include in our China New Era Fund beginning in early April.  This will be a combination of healthcare, technology, consumer, financials and some exposure to the booming travel business in China such as Travelsky and Shenzhen Airport.  Our belief is that the A-Share market will benefit from the stable Renminbi, tighter controls of Chinese capital flowing overseas and a cooling property market.  This means that the A-Share market at 14x PE, or about half of the S&P 500, presents a compelling alternative for the very large amount of Chinese private savings.

In Hong Kong we also see some recovery in the traditional defensive high yield stocks such as HSBC, Hang Seng Bank, China Light and Power and the large property groups such as SHK Properties, which now appear to benefit from the loosening up of the government policy on property development in the New Territories. There are plans to build about 500,000 new apartments over the next decade to counter the present elevated prices for the younger generation, and balance the supply and demand.

Hong Kong also appears to benefit from the steady and growing inflow of Mainland capital through the Shanghai-Hong Kong connect, which favours some of these undervalued Hong Kong blue chips.

In a meeting with HSBC senior management this week, we learned that 77% of profit is now coming from Asia, mainly Hong Kong and Southern China. In addition to this “back to their roots” pivot to Asia, HSBC is benefitting from rising interest rates, growing trade finance, and the end to a decade of heavy compliance and fines.

We expect this year will be a more volatile year than 2017, but as stock pickers, this gives us an opportunity to outperform the growing competition from passive and index products.

 

 

Robert Lloyd George
2 March 2018
Hong Kong

 

Clean Energy in Asia

The future of the world’s climate may depend largely on decisions currently being taken by Asian governments and consumers. The rise in world temperatures since 1980 correlates closely with the rapid industrialization of China (which, like India, depends for 70% of its electricity on coal-based power). In the past 3 years, Beijing has made a massive investment in solar and wind power, in natural gas, and more recently in Electric vehicles. Gasoline driven cars and trucks will be banned in China by 2030. All this is prompted by the serious health consequences of pollution in China’s capital and its environs. Today 55% of world solar output and 30% of wind, is generated in China. The Chinese automobile industry will probably lead in electric vehicle production by 2020, Geely alone making 1.5 million electric cars and trucks: But VW, GM and Ford have also been stimulated by China’s direction, to announce US$5 to US$10 billion capital investments each in EV production. Where China leads, it is probable that the rest of Asia will follow. India is 20 years behind in industrial development, infrastructure, and alternative energy, but will rapidly catch up. The Modi government has made the largest single solar energy investment in the world (58 gigawatts with a target of nearly 50% from renewables); like Africa, it has the benefit of near year-round sunny weather.

China has committed to spend US$360 billion on clean energy projects, about 2.5% of GDP, and to create 13 million renewable jobs by 2020. This will include hydro, nuclear, wind and solar, as well as electric vehicles, and natural gas as an alternative to coal. China has a problem of heavy pollution as it emits twice as many greenhouse gases as the United States. While the official standard for PM 2.5, or noxious particles in the air, is 10 micrograms (the World Health Organization), in China the average is 58; in the EU, it is 15; and in the United States, it is 8 micrograms.

Although China has improved from the very high levels of 2012, there are still only 25% of Chinese cities which have passed air quality standards; and it is estimated that 1.1 million Chinese citizens have died from heavy PM 2.5 exposure (or 40% of global pollution deaths in 2015). Nearly 40% of these noxious PM 2.5 are from coal, and the government is now trying to cap the coal-fired power plants, and increase natural gas from 6.2% to 10% of energy production by 2020 – converting residences in the northeast of China around Beijing from coal to gas.

Wind capacity will be increased to 210 gigawatts by 2020, and solar energy capacity to 250 gigawatts. China dominates the global solar industry, producing 50% of polysilicon, 87% of wafer, 70% solar cells, and 75% of solar modules. China’s own domestic demand is about 50% of total global installations in 2017, followed by USA and India.

President Trump’s recent decision to impose a 30% tariff on solar imports from China will have a big impact on the market. (India also has a 70% import duty on Chinese solar cells and modules.) Hydro capacity will grow to 380 gigawatts, but China is going to reach a limit to the number of dams it can create except in the southern provinces, for instance, on the Mekong River which has a big impact on Laos, Thailand, Cambodia, and Vietnam.

Finally, on electric vehicles, China has seen rapid growth already of 130% compound annual increase for the past 5 years, followed by Norway, Japan, and USA. China’s demand accounts for about half of global demand and supplies more than 60% of the world’s EV battery capacity. In 2016, electric vehicles accounted for 2% of all automobiles in China, rising to 4% in 2020, and a possible 25% in 2025. The main manufacturers are BYD (30% market share), Geely (15%), BAIC and Zotye. We believe that the best investment prospects are for Geely, which has demonstrated their management capabilities in their successful absorption of Volvo and their ambitious plans to be 30% of the electric vehicle market in the next 5 years. China is also investing heavily into the key commodities for the new batteries, acquiring lithium mines in Chile and cobalt mines in the Congo.

India is the second fastest growing renewable energy market, globally, after China, already about 18% of total energy capacity. It has attracted $6 Bn. of foreign investment in this sector. Prime Minister Modi has proposed building new model cities powered only by solar energy.

On my recent three-week trip around Asia, which comprised China, Hong Kong, Thailand, Cambodia, Australia, and India, I observed that the impact of China’s investment and tourism continues to be a dominant factor in all the Southeast Asian countries, especially the smaller nations. India has tried to counterbalance China, inviting all the 8 (or 10) leaders of the ASEAN countries to their National Republic Day on January 26. India, under Mr. Modi, is a confident expanding economy which has made great strides to improve transparency and clean up the abuses of the past.

In Australia, I observed that the impact of Chinese overseas investment has now rapidly reduced since Xi Jinping’s government tightened up controls on capital outflows. From 2016, when Chinese buyers accounted for 40% of new property sales, particularly in Sydney, this has now fallen to 1% by the end of 2017. Some major commercial developments have been cancelled, such as Wanda’s Sydney office building. The Chinese government announced a year ago, that capital controls were to curb “irrational” overseas investments in real estate, hotels, cinema, media, sports clubs, and other noncore businesses. They are, however, still intent on acquiring strategic industries in technology, finance, energy, and food. 43% of China’s overseas investment goes to the USA, followed by Hong Kong (18%) and Australia (15%).

Even London has felt the impact of Chinese investors, both mainland and Hong Kong, in city commercial property, as well as residential units. London presents a spectacle of multiple cranes and large building construction projects, which, however, have generally been decided on, and commenced, prior to the June 2016 Brexit vote. Now there is some sense that the British capital is running “on empty” as the decisions of major investment banks to relocate thousands of their key traders and executives to Frankfurt, Paris and Dublin are increasingly important in their impact on London property and retail activity. Kensington and Chelsea properties are already down 20%-30%.

We are in a new era approaching 2020 where liquid securities, such as Bitcoin and easily realizable equities and currencies (but not government bonds, now in a bear market as it passes 2.7% on the 10-year Treasury), are more desirable than real assets such as property. The key factor will be what happens in the currency markets. We continue to believe that the weakness in the US dollar may be a temporary phenomenon, but a generalized crisis of confidence in central banks and leading currencies by 2020, could result in a reversion to gold as a safe haven.

We have just done a study of the Chinese gold market. Although the USA continues to hold the largest official reserves of 8,000 tons (out of the total world holdings of 171,000 tons), it is also interesting to note that the largest private gold hoard in the world is in India, with over 20,000 metric tons, followed by China, now estimated at 19,500. The actual reported gold reserves are under 2,000 tons in the People’s Bank of China, but we estimate that the real gold reserves could exceed 4,000 tons as the Chinese are continuously buying all their domestic gold production, which is nearly 500 tons a year, the largest in the world, ahead of Australia, and also importing 1,300 tons through Hong Kong, in the last reported year of 2016.

Since the Shanghai Gold Exchange began operating two years ago, this importation and dealing has rapidly expanded. In addition, as China’s middle class expands and becomes more confident and wealthy and travels more widely, there is a growing demand for gold jewelry.  The two listed gold mines, Zhaojin and Zijin, are, in our view, less interesting than the most competitive Australian gold mines, which we have invested in.

Finally, I would like to mention to our readers that the Chinese New Year falls on 16 February when the Year of the Earth Dog begins. In the past, this has been a good year for investors, most recently in 1970, with some increased volatility.  We are launching our China New Era Fund by the end of March since we believe that the next five years will see a rapid expansion of the A Share market in Shanghai and Shenzhen as it becomes open to international investors and is included in the MSCI Emerging Market Index.  We have seen our Indian Ocean Fund rise 30% since launch in December 2016, and Bamboo Asia also growing by 36% over the same period up to 31 January 2018.

Additional Note

This is a healthy correction. The markets are pointing to economic strength, rising wages, and (mild) inflation after a long period of slow growth and deflation since 2008.  Corporate earnings will continue to be robust after the US corporate tax cut.  Asia will be one of the principal beneficiaries, both in exports and domestic consumption (especially in China and India).  Free trade has not, after all, been curtailed.  The Trans-Pacific Partnership is still alive.

After a 40% rise in 15 months, we have a 10% decline; and, in the long run, we see this as a buying opportunity. We are reviewing all our core conviction positions to see if cash flow, earnings, debt ratios, PEs, and yields still justify repurchase today.  In most instances, we still see strong profit growth and reasonable valuations on a “Price/Earnings to Growth” basis.

Robert Lloyd George
8 February 2018
Hong Kong

Will Inflation Return?

With almost full employment, and with commodity prices rising, it is possible that 2018 (despite money supply slowing down) may see the first glimmer of a trend of rising prices. Many investors consider that the July 2016 low of 1.34% yield on 10 year US Treasuries marked the peak of the bond bull market, which has been going since 1981 (and Paul Volcker’s crackdown on 15% inflation).

The surprising aspect of today’s world is that despite the quadrupling of central bank’s balance sheets since 2009 (and the quadrupling of global money supply), there is no apparent rise in CPI official inflation.  But everyday experience tells us otherwise.  (And we recall Disraeli’s words, “There are three kinds of lies:  lies, damned lies, and statistics.”)

Certainly in Asia, inflation remains historically low, although to take the example of Japan, which has been in deflation since 1990, there is now definitely a positive trend towards higher prices. (Japan’s central bank target is 2% CPI.)  And in both China and India, we expect that the interest rate cycle and the inflation trend has bottomed out and will slowly trend upwards (as the Federal Reserve, under its new chairman, Jerome Powell, also expects).

In our investment strategy, therefore, we are looking for the most laggard performing sectors of 2017 to surprise on the upside, notably mining and energy. We have recently added Vedanta to our Indian Ocean Fund portfolio:  it is controlled by Anil Agarwal and has an excellent diversified portfolio of minerals, including copper, zinc, and aluminum as well as energy assets.  We are reevaluating Reliance Industries as India’s largest oil refiner.

In East Asia, we see the rise of natural gas as being the key trend towards curbing pollution. While some Australian and international energy companies will benefit, there may also be local beneficiaries:  Hong Kong China Gas, Sinopec Kantons and China Gas Holdings.

We have confidentially received a recent report, made by a think tank in China, about China’s coming energy crunch, which suggests that domestic oil production in China will peak in 2018 and that China is now scrambling, as a national security priority, to secure overseas energy assets. Part of this strategy is to secure the South China Sea through militarizing the coral reefs and laying claim to the undersea oil and gas basin that may be in that off-shore region.  Also, China is rapidly investing in natural gas, both through LNG facilities and building ships, mainly to transport liquid natural gas from Australia and Papua New Guinea.  Other suppliers may be Qatari, Middle Eastern, Russian, and Kazakhstan gas producers.  Hence the strategic thinking behind the “One Belt One Road” vision of Xi Jinping.  It is very much in China’s long-term interests to have secure energy supply and military control over the supply routes, whether at sea or over land (on the Silk Road).

Although we are bullish on Indian GDP in 2018 and the first February national budget, which should be pro-business, we are also concerned about the gradual rise of inflation in India (Wholesale Price Index 3.9% and Consumer Price Index 4.9%). However, despite the rise in oil prices and the strange calm in the gold market, we see the Indian Rupee strengthening against the US dollar.  It is now 64, which is the strongest level for over 2 years.

Regarding India, we have continually focused on the ‘inclusion’ of many poorer Indian citizens into the modern economy and financial system, epitomised by the opening of 300 million new bank accounts in the past 3 or 4 years, and the ownership of iPhones.   This is symbolic of a larger change in the world which has seen such an extraordinary and positive progress in the past generation.  Every day the number people living in extreme poverty (under US$2 a day) goes down by 200,000.  Every day 325,000 more people (according to Oxford University) gain access to electricity and to clean drinking water).  As recently as 1960, a majority of the human population were illiterate and living in extreme poverty.  Now these figures are less than 10% and some observers believe that the end of poverty is in sight by 2030.  Recently, polio has been almost completely eradicated, along with a number of other debilitating diseases, in developing countries.  India is a poster child for all these improvements and education, and electricity go hand in hand with the general economic improvement

The key to 2018 investment trends may be the direction of the US dollar, which continues to be weak against the Euro and Asian currencies. However, now that the Tax Reform has been passed, capital may very well flow back into the USA, with corporation tax reduced from 35% to 21%, (many nations will now have to compete.)

We remain confident that despite the possible rise in interest rates to 2.5% in the US, the bull market remains intact, especially in Asia where growth in trade and corporate profits remain strong, and currencies are still well-supported against the US dollar. We are contrarian investors and look for underpriced opportunities in places where other investors fear to tread or where there is a perceived risk, such as the Korean Peninsula (South Korean technology shares are looking very attractive).  Our 5-year forecast continues to be that India will be the standout investment opportunity because of its economic and political transformation, which is now being translated into higher economic growth and stronger corporate performance, as well as a strengthening Rupee, under the leadership of Narendra Modi.


Robert Lloyd George
9 January 2018
Hong Kong