With Rising Wages, Will China Remain a Manufacturing Hub?

Sunday, November 27th, 2011

With Rising Wages, Will China Remain a Manufacturing Hub?

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

Earlier this month, I spent a few days at the CLSA AsiaUSA Forum in San Francisco, which offered a geopolitical and economic intellectual feast for global investors. The research firm gathered a well-rounded cast of engaging speakers that included Republican Presidential candidate Herman Cain, Hall of Fame quarterback Steve Young, Pollster extraordinaire Frank Luntz and renowned physicist Dr. Michio Kaku. Here’s a photo I snapped during a Q&A session with former U.S. Vice President Dick Cheney.

Year-after-year I make it a point to attend this conference because of the comprehensive examination CLSA puts together on the factors affecting global markets. To gather its exclusive knowledge of Asia, the research firm posts its analysts in the U.S. and many Asian countries, including China, Indonesia and the Philippines.

CLSA often discusses the numerous opportunities for U.S. businesses in China because of the rise of the Asian middle class, an increasing urbanization rate, and additional disposable income. The latter has been partially spurred by recent increases in wages. In fact, many people in China saw their wages rise 20 to 30 percent last year.

However, while these wage increases have been positive to the Chinese consumer and the companies which sell the goods, they have prompted many people to ask me how rising wages affect China’s status as a low-cost manufacturing hub for the world. Does this reduce the profitability of companies that expect to continue to benefit from the country?

This is where CLSA’s more balanced view of China’s business landscape is not only helpful, but essential. It is not enough to look at rising wages to appreciate how attractive China is for businesses. To get a better understanding, let’s compare three factors—the World Bank’s Ease of Doing Business score, minimum wage and workforce size—across several Asian markets. The World Bank annually analyzes regulations that either enhance or constrain business activity among 183 economies. For a business that wants to expand into different markets, this report is helpful in determining the ease or difficulty in obtaining construction permits, electricity and credit, as well as hiring workers and trading across borders.

On the World Bank’s scale, the business environment is easier in Thailand and Malaysia than in China and Vietnam, and companies would find it even more difficult to expand their businesses into Indonesia, India and Cambodia. However, Indonesia, India and Cambodia have cheaper labor markets than China or Thailand. But of all of these countries, China offers the largest labor market. CLSA says China makes for an “appealing hub for manufacturing” when you evaluate its unique combination of strengths together.

In addition, China’s workforce is better educated and more highly skilled compared to other Southeast Asian countries, says CLSA. China was also named the “world’s most connected economy” by the United Nations Conference on Trade and Development’s Liner Shipping Connectivity Index, when it comes to how integrated global shipping networks are to enable worldwide trade. The country also has superior infrastructure and trade connectivity compared to many emerging markets, “even occasionally besting developed economies,” says CLSA.

In 2010, countries such as Hong Kong, Japan, South Korea and Germany depended on China for data processing, apparel, and iron and steel exports. China also happens to be America’s third-largest destination for exports behind Canada and Mexico. China’s largest import partners in 2010 were Japan, South Korea, the U.S., Germany and Australia, according to the CIA World Factbook.

For those companies not already doing business in China, there’s one dominant factor that shows they should start: the vast domestic market. Companies may be able to find a cheaper workforce in Bangladesh, India or Sri Lanka, but being located in China allows convenient access to what is rapidly becoming the world’s largest consumer market.

I’ve discussed how many U.S.-based consumer discretionary businesses have been riding the wave of China’s growth all the way to the bank. Starbucks, Coca-Cola and Kraft have expanded their operations in recent years, as they have been converting the traditional tea drinkers to consuming other beverages including coffee, juice and carbonated drinks. (Read it now: China’s Rising Imports of American Goods)

In “American Classic Finds New Life in China,”, I talked about how American car company General Motors (GM), along with Toyota, Audi and BMW, is also experiencing growth in Asia as Chinese consumers look to purchase their first automobile. According to the China Passenger Car Association, Shanghai-GM topped October’s list of the top ten largest automakers in China. In 2010, GM sold nearly 550,000 cars in China, and expects its global sales to expand by as much as 10 percent in 2012, says Bloomberg.

These are only a few examples of American companies benefiting from the rise of China. Have you positioned your portfolio to do the same?

Tags: Asian Middle Class, Business Landscape, Cain Hall, Chief Investment Officer, China Indonesia, Chinese Consumer, Comprehensive Examination, Dick Cheney, Dr Michio Kaku, Frank Holmes, Frank Luntz, Herman Cain, Intellectual Feast, President Dick Cheney, Quarterback Steve, Renowned Physicist, Republican Presidential Candidate, U S Global Investors, Urbanization Rate, Vice President Dick Cheney
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Railway Revolution Builds China’s Consumer Culture

Sunday, May 29th, 2011

Railway Revolution Builds China’s Consumer Culture

By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors

Frequent readers of my weekly articles should be familiar with the story of China’s high speed rails. We’ve previously discussed how China is building the world’s largest network of high speed rails at an incredible speed.

Since opening the first high speed line between Beijing and Tianjin in 2008, the country has laid down more than 4,600 miles of new tracks. This is three times more than Japan, where the bullet train was invented, and this is just the start. Once completed near the end of this decade, the high speed rail system will connect more than 250 Chinese cities, span 18,641 miles and reach roughly 700 million people.

Currently, the high speed rail network connects about one-third of China’s cities. That figure is set to nearly double over the next two years. If current forecasts hold true, 100 percent of the China’s cities will be connected through high speed rails by 2019.

While linking megacities such as Beijing and Shanghai carries significance, connecting the urban East with rural areas of West and Central China is equally as important. This data from Morgan Stanley shows that the West and Central regions of China lag considerably in terms of GDP per capita, urbanization rate and property prices.

Many, including our investment team, believe that connecting these areas of the country could have a similar effect to what took place in the United States when Eisenhower’s interstate highway system linked cities such as Chicago and Philadelphia with their counterparts on the West Coast including Seattle and San Francisco.

The effect this massive buildout can have on commodities is evident: thousands of miles of new track, hundreds of new stations and dozens of new trains will certainly boost demand for steel. But there’s also a corollary effect that can expedite the transformation of China’s economy. More people traveling across the country means there will need to be more places for them to eat, sleep and shop.

Take hotel rooms for example. Currently, the U.S. has just fewer than 5 million hotel rooms spread across the country; China has about half that amount. However, Morgan Stanley forecasts that the two are set to switch places near 2025 as China pushes to offer more than 9 million hotel rooms by 2039. Familiar names such as Wyndham, Starwood and Hilton are planning major additions to their pipelines in China.

Morgan Stanley also says that the high speed rail expansion presents opportunities in areas such as consumer staples, car rentals and tourism. The latter is especially important because the average Chinese citizen is going to be able to explore culturally rich areas of the country that were previously too difficult or expensive to visit. A poll from CLSA’s China Reality Research last year showed that travel remained a top aspiration.

Rail passenger traffic has a strong correlation with instant noodle consumption (79 percent positive correlation) and soft drink volume (86 positive correlation), according to Morgan Stanley. This means that chains such as McDonald’s (1,300 stores in China) and KFC (4,000 stores in China), both of which are largely concentrated in the eastern third of the country, will likely follow the high speed tracks into Central and Western China.

These are all examples of how the dynamics of the Chinese consumer are forever changing. As investors, it’s important to understand these intermarket relationships and how a development in one area of an economy can dramatically affect another seemingly unrelated area of the economy. Being able to spot these trends and developments before they bubble up to the surface is how active money managers can create alpha for their shareholders.

Tags: Bullet Train, Central China, Central Regions, Chief Investment Officer, China Railway, Chinese Cities, Consumer Culture, Corollary, Frank Holmes, Frequent Readers, High Speed Rail, Interstate Highway System, Investment Team, Morgan Stanley, Regions Of China, Speed Line, Tianjin, Track Hundreds, U S Global Investors, Urbanization Rate
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Emerging Markets Cheat Sheet (January 31, 2011)

Saturday, January 29th, 2011

Emerging Markets Cheat Sheet (January 31, 2011)

Strengths

• Taiwan’s industrial production rose a stronger-than-expected 18.2 percent year- over-year in December and 4.3 percent month-over-month from November, driven by machineries, electronic parts and base metals. Consumer confidence rose to a 10-year high of 86.8 in January from 83.2 in December due to closer ties with China, a solid labor market recovery and asset price reflation.
• In a recent research trip to China, our analyst observed that all the airplane seats were sold. Most of the travelers in China were migrant workers and college students who couldn’t afford air travel 10 years ago. As incomes increase, the people in China are upgrading their consumption.
• Also in his China trip, our analyst witnessed seemingly countless construction projects breaking ground in Chongqing, a southwest municipality of 30 million people.

Weaknesses

• According to a quarterly Nielsen survey, 79 percent of Asian consumers cut spending to save on household expenses in the fourth quarter of 2010, compared with 65 percent of North Americans and 62 percent of Europeans. Higher prices for food and fuel may have contributed to the rise of frugality.
• India’s central bank raised its benchmark interest rate for a seventh time since March 2010 by 25 basis points to 5.5 percent and raised its inflation forecast to 7 percent from 5.5 percent by March 31, citing a widespread increase in food prices. India has been the worst-performing Asian market so far this year.
• Thailand’s industrial production dropped 2.5 percent year-over-year in December, the first decline in 14 months and worse than the market expectation of a 0.7 percent gain, reflecting weaker exports for the same month due to a higher base in 2009.

Opportunities

• At the UBS Greater China Conference, an NRDC official said China’s planned urbanization rate for the next five years is to rise from the current 40 percent to 60 percent. That means China expects 600 million more people to live in cities. Experts estimate that demand for base materials, such as cements and steel, will increase at an average annual growth rate of 7 percent until 70 percent of the population moves into cities. Urbanization will also bring about demands for urban transportation, plumbing, interior design and other consumption of urban lifestyles.
• The China Ministry of Railway estimated recently that railway passenger turnover will increase 13 percent a year until 2015. High speed trains have changed lifestyles in China. They shorten distance and make the population much more mobile. China now has 8,300 kilometers (about 4,960 miles) of high speed rail, and plans to build another 4,700 kilometers (2,814 miles) by 2013.

Threats

• Although Shanghai and Chongqing’s property tax programs have been widely expected in China, their implementation, announced only one day after the central government released eight harsher policy guidelines to combat property speculation, was much sooner than investors had anticipated. A higher frequency of anti-speculation policy measures and tighter coordination between central and local governments may increase the risk of over-intervention and lead to an imminent decline of property transactions and even a price correction like what happened in 2008. Pending a property market shakeout, investors may stay away from higher-end property developers with lower asset turnovers and higher leverage.

Tags: Airplane Seats, Asian Consumers, Asian Market, Asset Price, Base Metals, Benchmark Interest Rate, Breaking Ground, China, China Conference, China Trip, Consumer Confidence, Emerging Markets, Expe, Food And Fuel, Greater China, Household Expenses, India, Nielsen Survey, Reflation, Research Trip, S Industrial, Trip To China, Urbanization Rate
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Emerging Markets Highlights (week ending 02/07/10)

Sunday, February 7th, 2010

Emerging Markets
Strengths

• Hong Kong’s retail sales rose 16 percent year-over-year in December, the fastest pace in 20 months and ahead of market expectations. The growth was thanks to improving employment and a 14 percent year-over-year increase in tourist arrivals from mainland China.
• South Korea’s exports jumped 47.1 percent in January from a year earlier, the highest growth rate in more than 20 years, as the continued global recovery drove external demand for autos, appliances and electronics.
• Chile’s economic activity expanded by a higher than estimated 3.9 percent year-over-year in December, the country’s highest growth in 15 months, due to a rebound in services and retail sales.

Weaknesses

• China’s official Purchasing Managers’ Index moderated to 55.8 in January from 56.6 in December, partly due to seasonal factors.
• Fitch described Hungary’s fiscal prospect as uncertain ten weeks ahead of the country’s general elections and remained undecided whether to increase its credit rating outlook.
• Emerging market equity funds saw a $1.6 billion outflow in the week ended February 3, the biggest liquidity exodus in 24 weeks. The outflow came amid rising concerns on the sovereign debt situation in such European countries as Greece, Portugal and Spain.

Opportunities

• While China’s city population has been consistently growing in the last decade, over 40 percent of the counties in central China still have an urbanization rate of merely 20-30 percent. According to CEBM, consumer spending can be boosted by more than 45 percent when the urbanization rate rises by 10 percentage points to the 30-40 percent range. Expanded urbanization, especially in inland China, remains one of the policy solutions for stimulating domestic demand and bodes well for consumer plays in the long term.

Threats

• The current rally in the U.S. dollar may continue to be a headwind for investors in Asia given the longstanding negative correlation between the U.S. dollar and Asian equities.

Tags: Central China, China, City Population, Debt Situation, Emerging Market, Emerging Markets, Equity Funds, General Elections, Global Recovery, Headwind, Last Decade, Mainland China, Market Equity, Market Expectations, Negative Correlation, Outflow, Policy Solutions, Purchasing Managers Index, Seasonal Factors, Sovereign Debt, Term Threats, Tourist Arrivals, Urbanization Rate
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