CHNG You Can Believe in

08/25/2009 1:28 pm EST

Focus: STOCKS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Ian Wyatt, chief investment strategist at SmallCapInvestor PRO, is sticking with his China plays, China Natural Gas among them.

China's hybrid capitalist system is difficult to trust. State-run banks make loans to state-run steel companies or car companies. The banks aren't as concerned with the return on those loans as they are with implementing government policy, which is focused on growth and jobs; profits are incidental.

That's led directly to the central issue that investors are grappling with today: have Chinese stimulus measures created an asset bubble? 

It's no secret that China has the world's largest foreign currency reserves, perhaps as much as $2 trillion. It's also no secret that China has vowed to plow as much as a 25% of that money into its economy to stimulate growth in the absence of global demand.

One way it's doing this is lowering lending standards to encourage lending. And so far, lending appears to have exceeded China's stated goals. $1.1 trillion in new loans have been made this year. That's double the amount for all of 2008. And the concern is that, for instance, money that has been invested in new construction is unlikely to generate a return. Some also believe borrowed money has ended up in China's stock markets, helping the Shanghai index to stellar returns this year.   

It's clear that China's government has stepped in to finance growth in the absence of global demand for China's exports. It's also clear that asset prices have risen on the hope that China's economic growth is sustainable. That necessarily means that global demand must return at some point to replace government spending. Given the current situation with unemployment and consumer spending here in the US, it would seem that any demand-driven growth in China could be years away.

I know, you're probably already asking about other emerging economies picking up the demand for Chinese goods and you'd be right, but only partially. Those economies are buying more Chinese goods, but they still lack the sheer scale of the US economy and many still have obstructive barriers to trade in an effort to protect local producers. So yes, they're picking up the pace, but no, they won't replace the US any time soon.

Still, in spite of the potential for a bubble, we are holding our Chinese stocks. The stocks that are in our portfolio carry attractive valuations and represent key sectors and industries. For instance, given China's needs to fuel factories and power plants, combined with environmental issues, China Natural Gas (Nasdaq: CHNG) should consistently benefit from China's growth, bubble or not. That said, severe swings in price should be expected. And in fact, that stock is off 22% in a week, dropping from $11.59 to $9.00 since August 10. Now, we could try and time entry and exit points, but [we are] not a trading service. And we don't want to miss the long-term potential for China Natural Gas.

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