What's Driving Our Investments?

Robert Hsu, March 27, 2008

It's hard to believe that we're approaching the end of 2007—and the second anniversary of China Strategy. In the past year, we've added many new members to the growing ranks of investors who want in on the historic wealth-building opportunity that is China's economic emergence. Welcome, and get ready for another profitable year!

The year 2007 will likely go down in the history books as a year in which developing countries led by China reached critical mass and started to hold their own as major economic powers. For the first time in history, over 3 billion people around the world now have the right to pursue better lives and there will be no turning back.

We're lucky to live in a time when unprecedented global wealth is being created by a historic convergence of technological development and ideological progress. Those of us willing to participate in this immense global wealth creation can reap huge rewards. Although we've made huge gains in our stocks, this is just the tip of the iceberg.

In this month's visit, we'll talk about the dominant themes that drove our stocks higher this year that will continue to pick up momentum in 2008. I also have six major predictions for the coming year that I'd like to share with you. I expect all of these trends and predictions to be beneficial for our China Strategy portfolio.

In addition, I'll share what my China Investing Tour Group learned last month from their visit to the Shanghai headquarters of E-House (NYSE: EJ). And as always, I'll tell you which of our China Strategy stocks are the best buys for new money this month. Plus, we'll discuss why it pays to be patient and build our wealth over time instead of trading in and out of stocks quickly.

So let's get started!

Since we're in the final days of 2007, I'd like for us to take a look back at what we've seen this year and what we can expect in 2008. Although we periodically look backwards and forwards throughout the year, I like to save my broad predictions for January's letter because it's a good way to say goodbye to the old year and ring in the new one.

But before we get to that, let's look at the big picture—the year as a whole. I'm proud to report that 2007 turned out to be another terrific year for us here at China Strategy. The number of our subscribers more than doubled, making us by far the best-selling China-focused investment advisory service in America. I'm both honored and pleased that there are even more of us who will build wealth from the China Miracle. And our wealth-building this year has been significant—of the stocks we currently hold or have sold in our China Strategy portfolio this year, 10 have more than doubled and four more are up over 50%.

In addition to purchasing profitable stocks, we were helped by the fact that China's economy grew by approximately 11% this year—that's a serious tailwind. We also capitalized on a combination of currency and asset appreciations. We decreased our exposure to currencies that were depreciating (the U.S. dollar) and increased our holdings in companies with assets in appreciating currencies (the Chinese yuan). We'll continue to capitalize on these forces in the coming year.

Now let's take a look at some of the major trends that we profited from this year that will continue to drive our investments in 2008:

The A-Share and H-Share Bull Markets

Following a stellar year in 2006, both Hong Kong and Mainland Chinese stocks had another great year in 2007. As of mid-December, the Shanghai Stock Exchange A-Share Index is up a cool 90% year-to-date, continuing its climb from a 123% gain in 2006. The Hang Seng 30 Index, Hong Kong's equivalent of the Dow Jones Industrial Average, was up 46% in the same period. In 2006, the Hang Seng Index also did very well, up 34% for the year.

Bull markets of this magnitude create fortunes. The number of retail stock investors in Mainland China more than doubled to over 60 million in 2007. Doubters who cried "bubble" in late February when the Shanghai stock market pulled back 15% in a routine correction missed out on a 120% run-up in the following six months. Too many observers, especially those outside of Mainland China, couldn't tell the difference between a boom and a bubble, and it cost them dearly. To be clear, there is definitely a boom going on in China.

Mainland Chinese Money Investing in Foreign Markets

One of the main investment themes we've covered in China Strategy in 2007 is the flow of Mainland Chinese funds into the Hong Kong stock market. As the Chinese central bank accumulated the world's largest foreign reserves, the country's money supply increased and billions of dollars sought higher returns.

To help alleviate some of the pressure building in China's red-hot market, government officials announced they would allow Chinese banks and brokerage houses to set up instruments that could invest in Hong Kong shares. The new initiative was called the Qualified Institutional Investors Program—or QDII for short.

Chinese institutional investors responded positively to the QDII. They understood that Chinese companies were still the best bets for high-growth investing. But they also knew that Chinese companies listed in Hong Kong trade at a huge discount to shares in Shanghai. As a result, sophisticated Mainland Chinese institutional investors started selling Chinese shares in Shanghai and buying shares in Hong Kong. Fortunately for us, the ADRs that we own in our China Strategy portfolio are backed by Hong Kong-listed shares. So as Chinese institutional investors purchased QDII mutual funds containing Hong Kong shares, our American-traded shares surged higher. This was the main catalyst behind the huge run-up in our stocks between mid- August and October.

After the run-up, Beijing decided to let banks and brokerages create special mutual funds under the QDII program that would allow individuals to invest more broadly in foreign markets. As of right now, Chinese individuals can invest up to $50,000 outside of China per person each year. However, given the huge demand for alternative investment options in China, QDII funds are certainly a welcome investment avenue. As long as the Chinese continue to get richer, the demand for overseas investing will increase, which is good news for the ADRs in our portfolio.

Commodity Prices Increase Sharply

Back in January 2007, I predicted that commodities would be a hot market this year. I said that in order for China to sustain its economic growth, it would have to import large amounts of energy and industrial metals from the rest of the world to support the ongoing buildout for the Olympics and the creation of basic infrastructure. I pointed to commodities like iron ore, oil, copper, aluminum and nickel.

This is exactly what we saw unfold in 2007 and we profited from it—we sold three commodity positions this year and made an average gain of more than 100%.

I fully expect that we'll continue to see this trend play out in 2008. Oil prices shot up 50% this year. Prices of corn and soybean also rose sharply. As long as emerging market economies continue to grow rapidly, the long-term trend of rising commodity prices will continue in the foreseeable future and we'll continue to find ways to profit.

Not yet a member of China Strategy? Register today to learn more about my predictions for 2008 and what trends to look out for.