China Just Crossed a Landmark Threshold by Frank Holmes
Back in July 2013, the think tank Heritage Foundation predicted that China’s outbound investment “could very well exceed $80 billion [by the end of the year] and is on course to breach $100 billion by about 2016.”
With all due respect to the Heritage Foundation, China just beat the forecast by a couple of years, exceeding the $100 billion mark at the end of 2014. For the first time, in fact, China invested more capital outside its own borders than it did inside. As legendary Major League Baseball player and coach Yogi Berra once quipped: “It’s tough to make predictions, especially about the future.”
Be that as it may, it’s now estimated that within the next decade, China will have invested a staggering $1.25 trillion into the global market.
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It was once said that the sun never sets on the British Empire. Now the same might be said of China’s growing influence around the world.
“As China’s domestic infrastructure expansion matures and the yuan’s purchasing power rises, Chinese companies are seeking overseas opportunities so they’re not pigeonholed in any one marketplace,” says Xian Liang, portfolio manager of our China Region Fund (USCOX).
When you consider world economies using purchasing-power parity, China’s actually surpassed America’s in the second half last year.
One of the most headline-worthy developments is China’s $16.3-billion infrastructure initiative intended to revive trading routes along the centuries-old Silk Road. Thousands of miles of railways, roads and pipelines will link Beijing to major markets all over Asia, Africa and Europe.
Many are already likening the new Silk Road undertaking to the Marshall Plan, the large-scale U.S. program that aided Europe following World War II and helped secure the America’s role as the world’s leading superpower.
We all know that China is a big place with lots of people. As such, it requires unfathomable amounts of resources, for which it’s spending historic amounts of money. Between 2005 and June 2013, China spent $202 billion globally on energy and power, $100 billion on metals and $18 billion on agriculture.
Much of this capital is being channeled into Africa, home to about 60 percent of the world’s uncultivated arable land. If irrigated and optimized properly, Africa’s land has the potential to supply the same percentage of the world’s food needs. The continent is also home to 30 percent of the world’s minerals, with a large percentage of the deposits being platinum, diamonds and gold.
Since 2005, China’s spending in Africa has jumped 30 percent, and in 2009 it became the continent’s largest trading partner, surpassing the U.S. Every year it exchanges around $160 billion in goods with Africa, but with China’s middle class growing in number and demanding a higher quality of living, we expect that figure to surge.
Its largest trading partner among all African countries is South Africa, where I’ll be traveling to attend the 2015 Investing in African Mining Indaba and participate in a keynote panel on mining opportunities on the continent. Twenty years ago, we were the initial speakers at the creation of this event when there were only around 100 attendees. Last year, there were over 6,000, making it the biggest mining conference in Africa.
Some economists are suggesting that Africa is shaping up to be “China’s Second Continent,” the title of New York Times journalist Howard W. French’s 2014 book. Just as the Roman Empire reshaped and brought together disparate European cultures through its sophisticated network of roads, China’s presence in Africa promises to have a long-lasting effect on the continent’s financial wellbeing. Roads, mines, hospitals, schools and other important infrastructure are being financed and built at a rapid pace. Last November, for example, China Rail Construction Corp. signed a $12-billion high-speed rail construction deal with Nigeria.
Funneling Capital Around the World
Back in December, I discussed at length Premier Li Keqiang’s desire to turn China into the go-to country for the world’s high-speed rail construction. The country also shows signs of becoming a major creditor on the scale of the World Bank. According to Business Insider, it’s already overtaken other nations as a “primary source of credit for the developing world.”
The article continues: “When China invests in one country, it quickly becomes the biggest creditor, sometimes to the extent of altering the economic and diplomatic scenario.” Many developing countries now owe China many times more what they receive from the International Monetary Fund.
Yesterday, for instance, we learned that Chinese President Xi Jinping promised $250 billion in investment in Latin American countries over the next decade. China will be buying copper from Chile and Peru, oil from Venezuela and soybeans from Brazil and Argentina. Xi and Argentine President Cristina Fernandez de Kirchner also agreed on a deal that would see China cooperate with the Latin American country on two nuclear power plants.
It’s not just developing countries China has invested in. Since 2007, the U.S. has received around $72 billion. Among the American brands that Chinese companies have purchased are AMC Entertainment, Inc., IBM’s personal computer division and meat giant Smithfield Foods. WH Group, which owns the Shuanghui brand, acquired Smithfield in 2013 and is now introducing imported U.S. pork to the local Chinese market.
“Because of various food-related scandals in the last five to seven years, the average Chinese citizen tends to trust foreign food brands more than domestic brands,” Xian says.
This is just one of many examples of the Chinese preferring American brands to others. Buick, the best-selling automobile manufacturer in the Asian country, sold 1 million vehicles in 2013—810,000 of those in China.
China Ramping up Business Creation
Indeed, the U.S. continues to be the engine of the world in a time of Chinese and European deflationary risks. Having said that, I’m troubled by the fact that American business startups have been steadily declining over the past 30 years. For the first time in 2008, the “death rate” of businesses crossed above the “birth rate.”
Although Gallup says that “there has been no definitive answer as to why the rate of U.S. startups has declined so precipitously,” it seems likely that ever-expanding and restrictive government regulations play a huge role.
Now compare this to what’s happening in China:
Back in October, I pointed out that China has slashed hundreds of lines of red tape in an effort to jumpstart economic growth and encourage business startups. Even though its real GDP growth is slowing, the country has become much more efficient at fostering business activity.
Emerging Markets Webcast
Our next webcast, scheduled for February 18, will focus on the very topic of emerging markets. Portfolio manager of our Emerging Europe Fund (EUROX) John Derrick, Xian and I will discuss how China and the eurozone are confronting deflation through a series of monetary easing measures. As soon as you can sign up, you’ll be first to know!
- The major market indices finished higher this week. The Dow Jones Industrial Average rose 3.84 percent. The S&P 500 Stock Index rose 3.03 percent, while the Nasdaq Composite rose 2.35 percent. The Russell 2000 small capitalization index rose 3.44 percent this week.
- The Hang Seng Composite Index rose 0.14 percent; Taiwan rose 1.01 percent while the Korean KOSPI Index advanced 0.32 percent.
- The 10-year Treasury bond yield rose 31.5 basis points to 1.96 percent.
Domestic Equity Market
The S&P 500 Index rose 3.03 percent this week as markets rebounded from their selloff the prior week. Sector returns were positive for all but utilities, a defensive play and dominant outperformer over the past few months. Energy made a significant move to the upside as crude prices rebounded sharply this week.
- The telecommunication sector was the best performer this week. Frontier Communications Corp. was the best performer, rising 18.09 percent this week as the company agreed to buy some of Verizon’s wireline operations.
- The energy sector had a nice comeback this week as crude oil prices rebounded sharply off their lows. Denbury Resources was the best performer this week.
- Hospira was the best performer in the S&P 500 this week after Pfizer agreed to buy the company for $17 billion.
- The utilities sector was the worst performer this week as improving investor sentiment led defensive plays to underperform. Entergy Corp. was the worst performer within the utilities space as the company reported weaker-than-expected earnings.
- The health care sector, another defensive area, was a relative underperformer this week. Gilead Sciences was the worst-performing health care company despite a positive earnings report.
- Ralph Lauren Corp. was the worst-performing company in the S&P 500 this week. The company missed on revenue and earnings per share (EPS).
- Yields on U.S. Treasuries are retreating from their lows after positive jobs data was released this week. This reversal is positive for equities moving forward.
- A strong dollar continues to benefit domestic consumers, maintaining an advantage for certain U.S.-focused retailers and consumer products.
- The energy sector could very well be readying its comeback as global growth concerns begin to ease and supply conditions begin to tighten.
- According to a monthly University of Michigan survey, consumers expect gas prices to rise 20 cents this year. A significant expected rise in gasoline prices could offset some of the positive effects as consumers forgo spending in anticipation of higher costs down the road.
- The positive nonfarm payroll data released on Friday adds further ammunition to the Federal Reserve’s case to raise rates sometime in June. Such timing could very well be premature and cause a shock to the U.S. economy.
- Defensive plays should be monitored closely now that yields have turned the corner and investor sentiment is more positive.
The Economy and Bond Market
U.S. Treasury bonds reversed course this week, with yields heading back toward 2 percent. Bond markets sold off heavily on Friday after the Labor Department reported an impressive rise in nonfarm payrolls. The solid recovery in the labor market only continues to provide more justification for a June interest rate hike by the Federal Reserve. Nevertheless, the dollar continues to provide deflationary pressure while growth is still anemic in most of the developed world. Therefore, the Fed’s goal to remain “patient” should not be dismissed as there remain key areas of weakness in the domestic and global economy.
- Nonfarm payrolls rose by 257,000 in January, the largest three-month jobs gain in 17 years. Improvements in the labor market continue to highlight the unique strength of the U.S. economy in the current global economic environment.
- The United States government budget deficit fell to 2.8 percent of GDP in 2014 and is projected to decline even further, according to the Congressional Budget Office.
- German factory orders rose 4.2 percent in the month of December, up from -2.4 percent in the prior month. This is yet another positive data point for the European economy.
- Most likely a consequence of a stronger dollar, the U.S. trade gap widened 17.1 percent to $46.1 billion in December. Cheaper foreign goods led to a rise in imports, which can be viewed as a sign of healthy consumer demand.
- Factory orders in the U.S. fell 3.4 percent last month compared to a 2.4 percent decrease in the prior month.
- The U.S. ISM Manufacturing Composite Index, similar to the purchasing manager’s index (PMI), ticked down in January to 53.5 from 55.5 in the prior month.
- The European Commission increased its growth forecast for the region while cutting its inflation outlook amid a decline in global energy prices. Gross domestic product is forecasted to rise 1.3 percent in 2015, up from a forecast of 1.1 percent in November.
- The divergence between the United States economy and the rest of the world is becoming more significant. On a relative basis, such a situation should prove accretive for U.S.-based assets.
- The continued depreciation of the euro should begin to have a positive impact on growth in the region by increasing export competitiveness.
- While inflation expectations over the next five years have bounced off their lows, a more long-term view of inflation is more dismal. The five-year five-year forward breakeven rate, an inflation proxy for the five-year period five years from now, continues to dwell around its recent lows. The weaker long-term inflation expectations are an important sign of investors’ persistent concern over global growth.
- The wave of monetary stimulus coming back over the global economy, while positive for economic growth, could have unintended consequences in the form of currency wars.
- With the rebound in crude this week, many investors are speculating a revival in global markets. If such a revival is taking place and risk-on mentality dominates, bonds would suffer.
For the week, spot gold closed at $1,233.92 down $49.85 per ounce, or 3.88 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost just 3.46 percent. The U.S. Trade-Weighted Dollar Index slid lower by just 0.17 percent for the week.
|Feb 2||US ISM Manufacturing||54.5||53.5||55.5|
|Feb 4||US ADP Employment Change||223K||213K||241K|
|Feb 5||US Initial Jobless Claims||290K||278K||265K|
|Feb 6||US Change in Nonfarm Payrolls||228K||257K||252K|
|Feb 12||German CPI YoY||-0.30%||—||-0.30%|
|Feb 12||U.S. Initial Jobless Claims||288K||—||278K|
- January saw the largest inflows in gold ETFs since the summer of 2012. Part of the allure has been the fact that interest rates in many countries around the world are now negative, a consequence of central banks’ easing policies. For example, the value of outstanding European government bonds that have a negative yield is now over €1.5 trillion.
- The dollar’s strength is beginning to hurt U.S. companies and is increasingly being met with skepticism in different corners of the market. Companies such as Pfizer, Microsoft, United Technologies, Procter & Gamble, Apple and Google all mentioned the strong dollar as a hurdle in the latest reporting season. Looking at the massive net speculative dollar long positions on the InterContinental Exchange, the bull view on the dollar is arguably the most crowded trade there is across the world. Renowned investor Paul Singer from Elliott Management recently stated that his firm disagrees with the seemingly universally held belief that the U.S. is unquestionably the safe haven for the foreseeable future.
- Bank of America Merrill Lynch calculates that for 2015, $2.3 trillion will be trimmed from global nominal GDP. This would be the sixth time since 1980 that this has happened. This is another wild card the Fed will have to consider. It would be as if the economies of Brazil and the U.K. would just disappear and there is no negative feedback to U.S. markets.
- Gold futures fell on Friday as the U.S. economy added more jobs in January than forecast, signaling economic growth that may reduce pressure on the Federal Reserve to maintain low interest rates. However, there are seeming inconsistencies in the jobs report as the Bureau of Labor Statistics counted only 1,900 jobs losses in energy firms, a fraction of industry reports.
- While inflows into gold ETFs have surged in January, silver ETF flows have remained muted. The metal’s volatility has shaken investors so much that even the 10 percent rally last month failed to boost purchases of silver ETFs.
- Gold appears to be losing momentum after the best month in three years as investors pulled back on deposits into gold-backed ETFs.
- Gold rose in response to China’s reserve ratio cut this week. Central banks from Europe to Asia are taking action to counter slower growth and deflation. Furthermore, gold imports by India are expected to surge this year as the government has eased curbs on overseas purchases. In addition the Bank of Montreal has launched a new product backed by physical bullion stored in Canada that takes aim at the ETF market. The bank said the program will issue $500 million worth of shares to start buying gold.
- Centerra Gold and Premier Gold announced they will form a joint partnership to advance the Trans-Canada Property. This shared risk approach may be indicative of a new model to better manage development of mining properties as well as better decision making.
- A report by Bank of Montreal Private Bank shows that between 2004 and 2014, a simple portfolio divided equally between large-cap equities, U.S. Treasuries and gold delivered the same returns as an all-stock portfolio, but with just about half the risk. While investors often focus on returns during bull markets and then turn around and focus on risks only after markets have fallen, this study shows gold helps diversify extremes.
- Hardrock miners have been handed the short end of the stick in Obama’s proposed budget as provisions seek to subject miners to a royalty of not less than 5 percent of gross proceeds, increases for annual claim maintenance fees, and a new mineral leasing process.
- China’s official purchasing managers’ index (PMI) fell to 49.8 in January, a low last seen in September 2012 and below the crucial 50-level. The contraction affirms the growing unease about China’s GDP slowdown.
- UBS said that the early 2015 safe-haven gold trade has run its course and thus, gold probably won’t gain much more for the remainder of the year.
Energy and Natural Resources Market
- The Dow Jones North American Junior Oil & Gas Index gained 7 percent this week as crude oil prices climbed above $50 per barrel following last Friday’s large drop in the Baker Hughes rig count. Whiting Petroleum Corp. gained 26 percent this week.
- Oil and gas equipment stocks performed well this week with the S&P Supercomposite Oil & Gas Drilling Index gaining 10 percent.
- Base metals and related equities rebounded this week following China’s stimulative cut in bank reserve requirements and a better-than-expected jobs report in the U.S. Glencore Ltd. gained nearly 7 percent this week.
- The S&P 500 Utilities Index declined for a second consecutive week and fell 4 percent over the prior fivedays, as Treasury yields spiked in response to the favorable jobs report.
- Gold and related equities also suffurerd loses this week on renewed fears that the Federal Reserve might raise interest rates later this year. The Philadelphia Stock Exchange Gold and Silver Index declined 3 percent in the period.
- Iron ore prices and the Baltic Dry Freight Index remain under pressure in spite of a histrorically strong seasonal period. The benchmark freight rate has now fallen below the prior lows set during the financial crisis of 2008.
- Suncor will accelerate the development of Fort Hills oil sands project in Alberta even with oil prices low. The company has allocated $1.3 billion in capital expenditure to the project in 2015 and is expected to start oil production in 2017. Teck Resources has a 20-percent stake in the Fort Hills mining project.
- Rio Tinto is planning to restart the development of its $20-billion Simandou iron ore project, with a capacity of 100 million tonnes per year in West Africa, which was stalled amid the Ebola outbreak. The company expects the feasibility study of the project to complete the year.
- Sumitomo Metal, Japan’s largest nickel producer, foresees a global nickel deficit of 12,000 tons in 2015, compared to a 36,000-ton surplus in 2014.
- The recent oil price rally may be premature given that oil market fundamentals are not expected to improve until the second half of the year. According to industry analysts, inventories are expected to increase well into the second quarter of 2015.
- Industry concensus expects copper to remain oversupplied as China’s growth slows. Given recent property data, the surplus could worsen rapidly in the first half of 2015. As of the week ending January 18, weekly property sales in China continue to decline 6 percent year-over-year, sustaining the weak environment for copper.
- Greek stocks rose significantly this week after the newly-elected government retreated from its policy of seeking to write down a portion of the country’s debt. The banking sector struggled in the latter half of the week, however, after it was announced the European Central Bank (ECB) would no longer qualify Greek debt as collateral. The Athens Stock Exchange General Index rose 11.28 percent this week.
- Russian equities as well as the ruble rebounded this week as Brent crude oil prices rallied. The MICEX Index was up 6.54 percent, the ruble 4.84 percent.
- Highly oil-leveraged markets rebounded this week alongside the jump in crude oil prices. The Qatar Exchange Index was up 5.22 percent, the Indice General de la Bolsa de Valores de Colombia Index 4.17 percent.
- Chinese equities declined for the third straight week despite the announcement of more easing from the government in the form of required reserve ratio cuts. The Shanghai Stock Exchange Composite Index fell 4.19 percent this week.
- Turkish stocks retreated this week after its central bank refused to cut interest rates further amid a slump in prices this past month. Furthermore, Turkey’s bank regulator seized one of the country’s financial institutions, Bank Asya. The Borsa Istanbul 100 Index fell 4.45 percent this week.
- Indian stocks fell for the second straight week on the back of weak earnings reports. The S&P BSE SENSEX Index fell 1.60 percent this week.
- China’s bank reserve ratio cut on Wednesday came less than three months after the interest rate cut in November, a strong signal that policymakers are committed to reflating the economy amid deteriorating growth indicators, accelerating capital outflow and mounting deflationary pressure. Historically, declining reserve ratios tend to correlate with positive performance from interest rate-sensitive sectors such as financials and property. Short-term investor skepticism could create buying opportunities.
- Sentiment among manufacturers in Poland is growing strongly despite concerns of regional deflationary pressures. The HSBC Poland Manufacturing Purchasing Manager’s Index rose to 55.2 from 52.8 the prior month.
- Crude prices jumped off their bottoms this week. If the uptrend remains intact, highly oil-leveraged counties, significant underperformers of late, will rally.
- Hong Kong’s retail sales growth in December declined 3.9 percent year-over-year, well below moderate market expectations of a 4.4-percent gain. The city is scrambling for repeat visitors, as mainland Chinese tourists had been arriving in fewer numbers even before the Occupy Central demonstrations hit late last year, with less spending per person. Chinese outbound tourists traveling farther away from the country may continue to weigh on Hong Kong’s retail sector.
- Russian inflation skyrocketed last month, underscoring the true challenge facing its central bank. Overnight rates remain unacceptably high in Russia, yet inflation continues to pick up speed. The central bank is being pressured by officials and business leaders to ease rates further. However, after the release of January’s inflation data, they may be unable to do so.
- The crisis in Ukraine took another turn this week as the government devalued its currency 33 percent on Thursday. The policy move was aimed at attracting funds from the International Monetary Fund (IMF), which is discussing an extension to its 2014 bailout package. With the geopolitical crisis between Ukraine and Russia worsening, more trouble for Ukraine is to be expected.
Leaders and Laggards
The tables show the weekly, monthly and quarterly performance statistics of major equity and commodity market benchmarks of our family of funds.
|10-Yr Treasury Bond||1.96||+0.32||+19.18%|
|S&P Basic Materials||313.21||+13.99||+4.68%|
|Korean KOSPI Index||1,955.52||+6.26||+0.32%|
|Hang Seng Composite Index||3,349.56||+4.82||+0.14%|
|Natural Gas Futures||2.57||-0.12||-4.53%|
|S&P/TSX Canadian Gold Index||182.34||-11.77||-6.06%|
|S&P/TSX Canadian Gold Index||182.34||+20.16||+12.43%|
|S&P Basic Materials||313.21||+14.69||+4.92%|
|Korean KOSPI Index||1,955.52||+39.93||+2.08%|
|10-Yr Treasury Bond||1.96||-0.01||-0.61%|
|Natural Gas Futures||2.57||-0.30||-10.52%|
|Hang Seng Composite Index||3,349.56||-332.01||-14.83%|
|S&P/TSX Canadian Gold Index||182.34||+37.48||+25.87%|
|Hang Seng Composite Index||3,349.56||+117.97||+3.65%|
|S&P Basic Materials||313.21||+7.43||+2.43%|
|Korean KOSPI Index||1,955.52||+15.65||+0.81%|
|10-Yr Treasury Bond||1.96||-0.34||-14.84%|
|Natural Gas Futures||2.57||-1.84||-41.77%|
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.