But before I get into the details, let me explain why I’ve been so reluctant to take a serious look at any Chinese stock, even those trading on major U.S. exchanges…

For almost a year, I’ve honored a self-imposed ban on the purchase of any Chinese stocks. I haven’t touched a single Chinese ADR since my ban — and I haven’t recommended a single one to my readers.

The saga began last year with a small Chinese travel stock called Universal Travel Group (NYSE:UTA). Back in September 2010, I recommended shares of the small-cap Chinese travel company to my readers, pinning hopes on a dirt-cheap valuation and breakneck growth in the Chinese travel industry. But the morning after I sent out the recommendation, a short seller published a report detailing why UTA was a fraud and why he was actively betting against shares. The stock opened for trading down 30%, and we quickly sent out an alert for readers to sit tight before buying while we investigated the claims.

After some digging, I felt the claims boiled down to a misunderstanding of the company’s business. Every argument for UTA being a fraud looked incorrect. Luckily, we were able to take advantage of the situation, re-issue the buy recommendation — and even ended up booking gains on the investment.

Even though we did well on the UTA investment, we were concerned about the power that unknown short sellers could have over Chinese ADRs. While there had been some rumblings about the abundance of fraud in China, UTA was one of the first major short attacks on a Chinese stock.

Then the floodgates opened. Fraud allegations appeared left and right. And short sellers eventually targeted another one of my recommendations, Advanced Battery Technologies (PINK:ABAT).

ABAT was a Chinese battery stock I recommended back in March 2010. It was up as much as 21% early last year — but that was before another short attack shoved shares more than 40% lower in a single trading day. I ended up closing the position for a loss — but was spared the 90% drop that eventually crushed the stock.

That’s when my ban went into effect. Even if Chinese fraud wasn’t truly widespread, the risks of a short attack were just too real to justify buying any of these ADRs — no matter how rosy the growth picture may have been at the time. Investors were eating up every fraud report that hit the web. There was no telling what stock would be the next target —or if the claims of fraud would even be legitimate…

But now, something has changed. I’ve found this new growth market in China that could have the potential to deliver early investors significant gains. It has the potential to be so powerful, in fact, that it could easily repel short attacks just like the ones I’ve experienced firsthand…

I’m talking about the Chinese pharmaceutical market. It’s growing faster than any other drug market on the planet right now, with some projections expecting it to balloon to $115 billion in the next three years.

Here’s the kicker: Because the Chinese government requires local testing of medicines — and because the cost for conducting the animal research to perform these tests is about half what it is in the U.S., domestic companies are beating down the doors of these Chinese drug research firms. They want to get their foot in the door so they can grab some of the profits of this red-hot growth market.

Because these Chinese-based firms are now buyout targets for major U.S. Pharmaceutical firms, we now have an extra margin of safety while exploring the sector for potential investments. If Big Pharma has sent its best people to China to investigate these businesses and their growth claims, I sincerely doubt a short-selling raid would hold up to the scrutiny.

That’s why the small-cap ADR WuXi PharmaTech Inc. (NYSE:WX) has caught my eye. Not only does WuXi grab 70% of its revenue from research for U.S. companies, it also was involved in a “near miss” $1.6 billion takeover attempt from U.S.-based Charles River Labs, according to Bloomberg. The only reason the deal went sour is because Charles River shareholders voted it down because they felt the premium was too high.

In my view, this was a huge mistake made by short-sighted Charles River shareholders…

A precedent was set by the offer — which represents a premium of more than 60% above WuXi’s market value right now. Analysts don’t see the company accepting anything less. Frankly, neither do I. WuXi is simply making too much money — and monopolizing too much U.S. business — to humor a lowball offer. According to data compiled by Bloomberg, WuXi’s profit margins are 5 times that of its U.S. counterparts. WuXi is eating their lunch, and they know it.

A buyout offer is not a matter of “if” but “when” at this point. Someone will come along with a massive offer for WuXi — or even one if its competitors in the research sector. An event like this should trigger a ton of activity in the sector. And anyone with the foresight to see the big buyout on the horizon stands to capitalize on the action.

Sincerely,

Greg Guenthner
for The Penny Sleuth

The Only Chinese Growth Story Worth Buying Right Now was originally featured in the Penny Sleuth.

It’s not just penny stocks, either. Earlier this week, the NYSE began the delisting process for Duoyuan Printing (NYSE: DYP), a company the SEC is investigating for fraud. Other reverse mergers have sparked investigations, as well as criticism from various financial blogs. Companies such as China Integrated Energy Inc. (NASDAQ: CBEH), China MediaExpress Holdings (NASDAQ: CCME) and Deer Consumer Products (NASDAQ: DEER) have all been in the spotlight this month due to fraud allegations, some relating to reverse mergers.

The anti-China sentiment has put many investors on high alert. It’s gotten to the point where a single negative article or blog posting can spark panic selling. In fact, many of the stocks I’ve already mentioned have suffered near-catastrophic losses in just a short time frame. Some of the fallout has been attributed not to regulatory action, but to analysts, journalists and bloggers.

Complacency plays a large role, in my opinion. Investors will see a Chinese company listed on the Nasdaq or NYSE and automatically assume it to be completely legitimate. However, it is important to remember that complying with an exchange and producing timely SEC filings do not guarantee squeaky-clean management and business practices. You simply cannot rely on a major stock exchange to validate any company, whether it is domestic or foreign. This chore falls upon you and your research.

These recent American-listed Chinese company scandals are also revealing the thought process of many uninformed investors. As the market is now showing us, it has become painfully evident that those who have been speculating on Chinese microcaps have not bothered to digest all of the publicly available information into consideration before buying shares. Much of the research that has gone into “exposing” recent shady activity has not been provided by whistleblowers or in-depth investigations, but rather a thorough look at a company’s public documents by researchers with nothing more than an internet connection.

It is now clear that the climate of speculation regarding publicly listed Chinese companies has abruptly shifted. For now, the market has spoken. Investors want nothing to do with most American-listed Chinese companies. Until this critical point changes, these stocks will continue suffer.

Unless you intend to play them on the short side, I would avoid these Chinese companies at all costs. What began as a few isolated instances of fraud is now turning into an epidemic. Don’t get caught up in it, because I wouldn’t be surprised to see the current panic spread even further before it’s all said and done.

Sincerely,

Greg Guenthner
Penny Sleuth

Avoid These Chinese Microcaps was originally featured in the Penny Sleuth.

But more interesting were two tiny stocks that I want to tell you about today…

I have a favorable view of aircraft suppliers in general. And I think this is a good spot to drop some lines and fish for winners.

There are many reasons I think this way. Most of them have to do with growth trends that have been in place for a long time and show no sign of letup. Since 1977, for instance, revenue passenger miles have grown about 5% per year. RPM is an industry measure of air traffic. It is simply the number paying passengers times miles flown.

After dipping last year, RPM is on the march again. In fact, it seems to be making up for lost time, as this next chart shows. (Note that the drop in April was due to the volcano in Iceland, which scuttled air travel all over Europe.)

More passengers and more miles mean more planes. That’s the simplest reason to like aircraft parts suppliers. Secondarily, the industry retires hundreds of planes every year. And there is renewed demand for more fuel-efficient aircraft.

Put it all in a pot and you understand why the backlogs of Boeing and Airbus for new aircraft are very healthy. Over the next several years, these two will deliver more than 1,000 new planes per year. This next chart shows how these cycles have gone since Denny McLain won 31 games for the Detroit Tigers in ’68.

Looking out over the next 20 years, the industry will need more than 30,000 new planes. That’s about $3.6 trillion in new business for the aircraft industry. This next chart shows you how you get to 30,000 planes.

The main driver of all this, though, are the billions of new consumers from emerging markets. Listening to these companies made that very clear. All the big growth is coming from the emerging markets, in particular the Asia-Pacific region. This next chart is from Boeing’s presentation:

The top-growing markets with over 7% annual growth include the Asia-Pacific region as well as flights within China and Latin America and flights linking the Middle East to Asia-Pacific.

So that’s a big-picture view of why I like the industry. As to particular ideas, I’m looking over a couple that happen to be small-cap plays: Curtiss-Wright (NYSE: CW) and Hexcel (NYSE: HXL).

While Curtiss-Wright is a stock I’ve followed for some time, Hexcel is a new name to me. It’s also an intriguing story…

Let’s start with Curtiss-Wright. The company goes back 80 years when companies created by Glenn Curtiss and the Wright Brothers merged. Lots of people know the Wright Brothers’ story, but not so much Glen Curtiss. He was a brilliant inventor who brought many innovations to flying.

Curtiss-Wright makes many mission-critical systems for aircraft. It also makes pumps, valves and motors for submarines, aircraft carriers and more. Finally, the company has a good nuclear business in which it makes parts for reactors. In this, Curtiss-Wright is a kind of picks-and-shovels play on the nuclear renaissance.

The company has been growing rapidly of late. Sales have grown 20%-plus over the last five years. Curtiss-Wright is a reasonably priced industrial, at only 14 times trailing earnings and about 11 times next year’s guess.

Then, there’s Hexcel, which is a name I’ve not followed before and may be the best of the two. Hexcel makes advanced composites made of carbon fibers and glass that make an aircraft lighter, stronger and faster. The company also uses this know-how to make components for the wind power industry.

Hexcel had been growing 10-15% per year before 2009. But earnings should grow 20%-plus this year. These composites are popular given the demands for more fuel-efficient aircraft. The new planes have 10 times the composites of older aircraft. And the wind power business is a growth area, too.

The story doesn’t seem to be much of a secret, though. Hexcel’s shares trade for 18 times next year’s earnings per share guess. But it’s one to watch, and perhaps we’ll pick it up on a dip.

That’s the scoop from Gabelli’s conference. I’ll keep an eye on how things unfold and pick up new opportunities on the cheap as the market gives us a chance. And yes, that goose is still laying golden eggs.

Sincerely,
Chris Mayer
Penny Sleuth

September 14, 2010

Two Aircraft Supply Stocks for 2010 was originally featured in the Penny Sleuth.

Incidentally, all three point to the same conclusion I’ve been hammering home with my Capital & Crisis readers: now’s the time for investing in China.

First, there is the new record in forex currency trading. The Bank for International Settlements dips its meters into the world of currencies every three years by way of a survey. Its latest effort shows currency trading tops $4 trillion a day. That’s a meaninglessly large number in a sea of such numbers, I know. (Who can really imagine what $4 trillion is?)

But for comparison, look at recent history. In 2007, it was $3.3 trillion. In 2004, it was “only” $1.9 trillion. We’ve more than doubled it in just six years.

That reflects the surging flows of money between countries. If you are an American company and do business in China, you create a need for foreign exchange as you swap profits from China back to dollars. Or if you choose to invest in China, your dollars convert to renminbi.

Every international transaction generates a need for currency trading. As The Wall Street Journal said of the recent BIS survey:

“The continued rise in trading reflects the increased globalization of investing. With the big developed economies of the U.S., Europe and Japan struggling, investors are turning toward other markets for returns and generating more foreign exchange trading in the process.”

That’s the key, in my view, and you can see it when you look at the numbers in more detail. Trading in dollars for Indian, Brazilian and Chinese currency jumped. But old mainstays like trading dollars for British pounds actually fell.

You can also see how important commodities have become in all of this. If you look, U.S. dollars converted to Australian dollars jumped 35% since 2007 — well ahead of the 20% gain in overall currency trading. And trading in the Canadian dollar was up even more, at 44%. Canada and Australia are resource rich and U.S. investors are putting more money there to take stakes in resource companies and projects.

If you look at stock mutual funds, those that invest overseas have taken in $42 billion this year. That’s in sharp contrast to outflow in U.S. stock funds.

The second piece of news that grabbed my eye this week was that meat prices have hit a 20-year high. Global meat prices are up 16% in the last year. Why?

Again, you have to think in terms of a global marketplace. There has been strong demand for a higher-protein diet from emerging markets as people get richer. In short, people are eating more meat. The Middle East is one of the largest importers for food, for example. Strong demand for lamb there helped push lamb prices to 37-year highs.

In Brazil, meat consumption will hit a record this year. That means less meat leaving Brazil, which could matter, since it is the second largest exporter, behind only the U.S. And if you look around the globe — Russia, Mexico, South Korea and Vietnam — they will all consume more meat this year.

China too has seen its meat consumption increase thanks to a burgeoning middle class that’s made meat a larger part of its diet. By most estimates, emerging market demand for meat will rise at least 65% to midcentury.

And finally, the last bit of news was the report on factory activity in the U.S. and China. It sent a jolt through markets on Wednesday. But again, look beneath the surface. What was the key driver of this favorable report?

As The Wall Street Journal put it: “The manufacturing sector’s recovery is closely tied to global growth, especially Asia.” Even just casual look at U.S. manufacturers for anecdotal evidence confirms it. The WSJ story included a note on Furniture Brands, which is tripling its capital spending this year. Most of it will go toward expansion — in Indonesia. Joy Global, a Milwaukee-based manufacturer, raised its profit outlook for the year.

The key reason? Growth in China.

Today’s world is very much a global one. It’s becoming more so by the day. As always, there will be winners and losers. As investors, this globally connected world creates a lot more uncertainty. But one thing is certain: You ignore the markets beyond your borders at your peril.

Sincerely,
Chris Mayer
Penny Sleuth

September 7, 2010

3 New Reasons to Invest in China was originally featured in the Penny Sleuth.

You may never have heard the name before, but Bolton was one of the U.K.’s investing wizards. For 28 years, he racked up returns of 19.5% annualized. Since he had a long and superb track record and managed money for Fidelity, people called him “the Peter Lynch of Britain.” Lynch is a name you probably know. He also ran a Fidelity fund, Magellan, for many years, to spectacular success. (After he called it quits, he also co-wrote a couple of books that are now investing classics, One Up on Wall Street and Beating the Street.)

But I digress. The point is that Bolton is a heavyweight in the crowded field of investors — or was. He hung up his gloves in 2007. Nice timing, as it turned out. But now he is back in the ring, running a new fund called Fidelity China Special Situations Fund. (FCSS on the London exchange — check it out. Also, should you enjoy studying great investors, as I do: The best book about Bolton is Investing with Anthony Bolton by Jonathan Davis.)

So Bolton, Fidelity’s top-ranked manager, is taking his act to China.

I think this is noteworthy because Bolton sees something that I’ve also been writing a lot about lately: the rise of China’s consumers. “China is at a sweet spot in emerging markets,” he says, “where significant amounts of people can for the first time can afford cars, apartments and other goods… The driver of China’s growth is changing to domestic consumption.”

I agree. And I think such changes are happening much faster — and in a much bigger way — than the general market seems to believe. Andy Rothman, of the Asia specialist CLSA, predicts consumers will drive more than half of China’s economic growth this year. Investment in infrastructure will trail behind. Exports, Rothman believes, will contribute zero growth. The key point is that hundreds of millions of people will be joining China’s middle class over the next five years.

So Bolton’s loaded up on Chinese consumer stocks.

I also find some of China’s basic consumer stocks very appealing. The market consensus seems to be that China is going to blow up. There is a housing bubble there. And there are legitimate worries about its banking system and the losses lurking in dicey loan books. It seems most observers think this will spell disaster for China, as it did for the U.S. — with a market crash and a deep recession.

Market prices reflect these worries, however. The low prices compensate investors well for taking risks today. But that’s not all. Suspicions of fraud also hover around the edges of newly minted China shares, as I wrote about in last month’s letter. This cloud depresses stock prices, too. An investor can lower the fraud risk by being very picky and doing a little extra due diligence. A few rotten apples don’t spoil the whole bushel.

[Ed. Note: So, how can you play China’s rising consumer class? The PowerShares Golden Dragon Halter USX China ETF (NYSE: PGJ) could be a good start – the fund offers one of the biggest exposures to Chinese consumer discretionary stocks while maintaining one of the lowest exposures to financials.]

Sincerely,
Chris Mayer
Penny Sleuth

August 25, 2010

[Independence Note: Unlike scores of other penny stock resources, we’re 100% independent from the companies we talk about in the Sleuth – that means that we never accept compensation in exchange for profiling a company, and our editors never own a position in any stocks they talk about.]

Anthony Bolton Bets Big on China’s Consumers was originally featured in the Penny Sleuth.

Birinyi compiled all of the 2010 strategist forecasts and calculated the following averages: a yearend S&P 500 target of 1,222, $76 in S&P 500 earnings, and 3.1% GDP growth. The deviation from these averages was not wide. These numbers might be plausible if this were a typical rebound from an inventory-led recession. But this is not what we’re experiencing.

Just consider today’s weak nonfarm payroll report. Government number crunchers estimate that the economy lost 85,000 jobs in December. Of course, this figure is highly massaged by seasonal adjustments and the “birth/death model,” which assumed that new businesses created 59,000 new jobs in December. Without the birth/death adjustment, the headline would have been 144,000 jobs lost.

The civilian labor force participation rate fell to a new low — 64.6% — as more discouraged workers give up looking for jobs. If these workers were considered by the statisticians to be looking for jobs, the headline unemployment rate would jump several percentage points.

To gauge the accurate health of the labor market, check the tax withholding figures. These figures are still down significantly year-over-year.

Job creation needs to turn highly positive quickly to justify the valuation of the stock market. The employment picture is also vital to the health of the credit markets and the banking system. The popular obsession over how long the Federal Reserve is going to hold short-term rates at zero distracts many investors from the destructive influence that high unemployment will have on credit quality.

The Fed’s extremely loose policies have sparked investors to take on more credit risk in the secondary markets. This has pushed up the prices of junk bonds and junk stocks, lowering yields. But if the labor markets don’t rebound dramatically from here, we’ll see accelerating credit losses on everything from mortgages to credit cards. Those who piled into junky credits due to zero interest rate policy will flee out of them due to rising defaults.

We’re in uncharted waters when we combine stubborn labor market weakness with heavy private sector debt loads. Credit losses are likely to surprise the market on the upside in 2010. This is especially dangerous for a banking system that’s marking its own assets at “mark-to-myth” levels.

Through several examples, it’s clear that the Treasury Department’s unofficial policy for dealing with underwater real estate loans is “extend and pretend.” This means that as long as underwater borrowers are making monthly payments, most bank examiners will look the other way and allow banks to mark loans at artificially high values. Bank regulators are also likely to look the other way if banks roll over maturing loans that are underwater on a mark-to-market appraisal basis.

But this isn’t cause for celebration. Instead, this mass denial of reality will only make the ultimate credit losses even larger. But this seems to be the policy, because it’s politically expedient and painless (for now).

Just like we saw in post-1990 Japan, “extend and pretend” will commit huge amounts of scarce capital in the banking system to defend bubble-era loans. Instead of extracting this capital out of bankrupt situations to be reinvested into new loans, we’re prolonging a misallocation of capital. By defending and maintaining old underwater loans at unreasonably high marks, most banks won’t have much room on their balance sheets for new lending. This one consequence of “extend and pretend”: continued tightness in lending for small businesses, which are the biggest job creators.

A Correction in China Looms

It’s likely that the growth we saw in emerging markets in 2009 will decelerate. China’s infrastructure-heavy stimulus package put Chinese people to work and boosted commodity imports from resource-rich countries like Brazil and Australia.

But this stimulus package is leading to excess capacity in real estate and many heavy industries like steel. It’s also gone hand-in-hand with mind-boggling growth in bank lending. Rapid growth in bank lending always leads to trouble.

So the People’s Bank of China (PBOC) is just now tiptoeing towards a tightening policy. The PBOC seems worried about the real estate bubble that’s now becoming more obvious in major Chinese cities. Earlier this week, the PBOC sold three-month bills at a higher (rather than lower) interest rate for the first time in 19 weeks. This is a clear signal to the heavily state-influenced banking sector that it should tighten its loose lending policies. Much of this lending went to finance large infrastructure projects deemed by (often corrupt) communist bureaucrats — not the free market — to be necessary.

This kind of activity can go on for much longer than logic would dictate, but eventually, misallocated resources become too obvious to ignore. Just as the U.S. housing bubble continued a few years beyond when it became obvious (say, in 2005), so can the excesses in the Chinese economy.

The potential catalysts for a correction in China are many, but the most likely would be continued escalation of trade protectionism. This protectionist trend could offer several attractive short ideas in 2010. For example, on Dec. 30, The U.S. International Trade Commission ruled that growth in imports of Chinese-made drill pipe and casing materially injured the U.S. steel industry. The commission imposed 10%-15% tariffs on imports of Chinese steel pipes, with the possibility of further tariffs in the coming months. The Chinese government is allegedly subsidizing its steel industry. This is probably true, but China will likely respond with its own protectionist measures anyway.

The interference of governments into free trade — in the form of both subsidies and tariffs — is not good for the future of globalization. Many of today’s big transnational corporations are built on the assumption of unending globalization. These big corporations are establishing closer ties to politicians around the globe, and many are seeking to game the system or pursue government subsidies rather than serve their customers.

Regards,
Dan Amoss

January 15, 2010

Why We’re Still Headed for a Correction at Home and in China was originally featured in the Penny Sleuth.

Rising living standards in emerging markets is a powerful investment trend. There are many reasons to expect this trend to continue. But central bankers and politicians all around the world, who think of ways to “improve” every possible situation with their enlightened meddling, are acting in a way that promotes future crises.

The most powerful, influential meddling right now is happening in the currency markets. By flooding the system with liquidity, and promises of much more liquidity, central banks have fueled the 2009 rally in “risk” assets.

The Federal Reserve’s zero interest rate policy has been the most important factor in financial markets for months. This policy is acting as an accelerant for money supply growth in many emerging economies. As Jim Grant says, the U.S. is the world’s reserve currency, so the Federal Reserve is the world’s central bank.

The U.S. dollar carry trade is prompting “hot money” to flow into countries like Australia — those with upward-trending currencies and short-term rates above zero. The Fed’s outlook for inflation focuses myopically on outdated, industrial-era statistics like the “output gap,” while its loose monetary policy fuels dangerous, unproductive bubbles.

The promises of limitless free money from central banks also embolden the big spenders in government, who are ramping up the GDP figures (but destroying real capital) at unprecedented rates. Without the belief that “quantitative easing” is available to finance deficits, big spenders in government might think twice about having to pay higher interest rates to borrow from the bond market.

The policies of central banks are also aggravating dangerous imbalances in the global economy. Countries that traditionally rely on exports are upset. With President Obama embarking on his first official visit to China next week, the issue of the dollar/renminbi peg is at the forefront of concern.

As the U.S. dollar index weakens, so does the exchange rate of the Chinese renminbi versus floating currencies like the euro and the Japanese yen. This translates into an effective price cut for American and Chinese exporters, without the typical hit to profit margins. European and Japanese exporters are suffering from what they consider to be an unfair playing field.

Debasing the value of a currency is an old-fashioned way for politicians and central banks to subsidize politically powerful exporters. Cheap currency policies are widely popular among the bureaucrats and central planners that populate the halls of academia and policymaking. But over long periods of time, the quality, efficiency, and productivity of an export sector will determine its success — not whether it’s located in a nation with a weak currency.

Like doping in sports, a weak currency gives exporters a price advantage against its competitors. But once too many countries get involved in this “mercantilist” type of policy, it transforms into an ugly race to the bottom. In the end, the average citizen is impoverished by diluted purchasing power.

Policies that actively weaken currencies are not good for the health of the middle class. Our “bail out bank shareholders and bondholders at any cost” policy is a hidden long-term threat to the health of the U.S. middle class. And the stimulus spending and inflation created by the Chinese Communist Party is a threat to the emerging Chinese middle class. This wasteful spending doesn’t appear to have a cost right now, but those costs will become obvious in time.

An August 2009 report from asset manager Pivot Capital Management has gained notoriety in the press lately. The report, China’s Investment Boom: The Great Leap Into the Unknown, captures the bear case for China.

Some of the themes outlined in his report will relate to Strategic Short Report’s future short ideas. In preview, Chinese central planners are blowing massive bubbles in asset-heavy industries like steel and cement. The ultimate returns on capital invested in these sectors will be nonexistent or negative. You can download the PDF version of Pivot Capital’s report at this link.

It remains to be seen whether positive global trends like advances in technology and education and the post-Soviet era trend toward freer markets and stronger property rights will overcome negative trends like the “white elephant” projects that will inevitably result from stimulus spending.

There certainly will be winners and losers in China’s capital spending bubble, and we’ll be targeting the losers.

Regards,
Dan Amoss

November 24, 2009

How to Profit from the Coming Currency Crisis was originally featured in the Penny Sleuth.

This industrial hub is not only home to millions of residents — it’s also teeming with high-tech surveillance equipment. As part of a project that began a couple of years before the Beijing Olympic Games, the government installed about 200,000
surveillance cameras throughout the city, according to journalist Naomi Klein.

Right now, the Chinese government is in the midst of a massive security overhaul. When the dust clears, the sprawling city of Shenzhen will contain more than 2 million closed-circuit television cameras. That’s double the number of cameras lining the streets and shops of London.

Make no mistake about it — Big Brother is watching the Chinese every moment of every day.

Klein detailed the rise of the high-tech Chinese security state in Shenzhen in her pre-Olympics exposé in a 2008 edition of Rolling Stone:

“China today, epitomized by Shenzhen’s transition from mud to megacity in 30 years, represents a new way to organize society,” Klein writes. “Sometimes called ‘market Stalinism,’ it is a potent hybrid of the most powerful political tools of authoritarian communism — central planning, merciless repression, constant surveillance — harnessed to advance the goals of global capitalism.”

The surveillance industry in China is booming. It will be a $43 billion industry by next year, growing 20% annually for the next two years, according to the Chinese Security and Protection Agency. This robust growth won’t happen by itself. China’s ruling political party and big business will be supplying the cash to expand surveillance and security measures in every city and town in the country.

Whatever bumps or growing pains the Chinese economy will face over the next several years, it is all but certain that the current expansion of the security state will continue unabated. And one small company is emerging as a security and surveillance industry leader — nabbing lucrative government contracts left and right, all while buying out smaller competitors to fuel its growing business…

China’s Best Surveillance Play

In the latest issue of Penny Stock Fortunes, we let our readers in on a Shenzhen-based company that develops both surveillance equipment and software for the government and commercial sectors. The company provides surveillance networks, traffic monitoring, pollution detectors, alarms and an array of security devices and software.

Thanks in part to the Communist Party’s strict security demands, this company also has a history of winning large government security and electronic infrastructure contracts. These deals are so large in size and scope that just one or two wins could significantly impact its top line – and they already have one in the pipeline right now.

Thanks to aggressive government surveillance legislation, this company will have plenty of opportunities to grow its business in the coming months and years. More on this specific play in a bit…

Mandatory Government Programs Are Set to Boost the Security Industry

Life in China is not like life in the United States. The party wants to have it both ways: maintaining control over the population while growing its capitalistic enterprises. This grand compromise will be no easy task. It will take plenty of technology, security — and money.

With that in mind, the Chinese government has passed specific safety and surveillance ordinances. These laws mandate street surveillance for 660 cities, courts and entertainment locations. The projects themselves will be worth an estimated $25 billion over the next five–10 years. Our company also expects to earn additional contracts thanks to the government’s infrastructure and social welfare stimulus package.

Stocks That Will Continue to Shine

The Summer Olympic Games in Beijing was China’s coming-out party to the world. It gave the new industrial giant plenty of exposure — both positive and negative — no matter how hard the powers that be tried to control the message.

You see, China has everything to gain and a whole lot to lose. The country and those in power want to continue to see China grow and prosper into a top industrial nation. The risks of crime or uprisings would undermine these goals. That’s why security and surveillance remain important issues long after the final day of the Beijing Olympics…

With more than 15,000 companies out there servicing the Chinese security market, there’s no shortage of investment opportunities right now.

Sincerely,
Greg Guenthner

October 23, 2009

P.S.: For more details on this specific play, check out the Penny Stock Fortunes website…

Let China’s “Big Brother” Program Make You Rich was originally featured in the Penny Sleuth.

Unfortunately, today’s market isn’t presenting nearly as many of these opportunities as it used to. But we scoured the enormous — and growing — universe of penny stocks and found one with the potential of a blue chip.

Transition from “Developing” to “Developed”

“China” was the buzzword on Wall Street over the past few years. This recession is putting a damper on that, though. No one is jumping in on Chinese stocks quite the same as in 2006 and 2007. That fact alone has forced many of these stocks below their true value. But that alone is only a small fraction of the story.

You see, China is still a mega-growth story. It’s not going to churn out double-digit growth like it has been this year or next. But it’s still a major investment opportunity if you know where to look.

One of the most obvious places to find a solid investment is Chinese education. As any country transitions from “developing” to “developed,” its people inevitably transition from peasant to white-collar jobs. That means there will be a huge stream of students flooding colleges and trade schools.

There are plenty of easy ways to get in on this transition. New Oriental Education & Technology Group Inc. (NYSE: EDU) is probably the most obvious. While it has only a $2.4 billion market cap, it is still one of the largest publicly traded Chinese education plays on the market. The company has 47 schools, 257 learning centers and countless bookstores.

Another cheap, easy way to play China’s educational growth story is ChinaEdu Corp. (NASDAQ: CEDU). This small play (only $134 million market cap) runs 12 universities and is still expanding. This is another way for you to double or even triple your money. But as promised, we want more. The growth potential in this field is astronomical.

Dominating the Recession-Proof Testing Market

We found a backdoor play on this fast-growing market. This company is not a pure education play, which saves us from making a huge mistake in this recession. We’ll get to that in a minute.

Instead, it is the market leader in testing services. It runs computer-based testing operations for the government, corporate industries and, of course, academic institutions. The company’s testing platform consists of everything these customers need.

For instance, 11.4% of the company’s revenue comes from the Securities Association of China, which is the People’s Republic version of the SEC here in the U.S. The Securities Association pays this tiny Chinese play for its employees or potential employees to take regulation tests on the company’s systems. The number of tests and regulations has only gone up over the past several decades as the Far East superpower continues to open up to foreign investors.

In academia, the company is also a huge player. Nearly all students have to take tests like the SATs or ACTs here in the U.S. just to get into school. They also have to take placement tests to determine what level of schooling they are at. This is like when you take a Spanish test during freshman orientation to see at which level you should start.

All these tests add up, and the industry is continuing to blossom. So why are we looking at this backdoor play into education?

While this industry continues to grow at a fast pace during this recession, people are taking a few years off school to work. When that happens, schools don’t get paid. But this company does. You see, it doesn’t matter where these would-be students work: There’s a good chance they’ll have to take a test at some point. This bodes well for the company. It gets paid no matter what: if the person is in school or applying for work.

It’s as simple as that. So why do we think this is such a huge opportunity? Simple: The company is growing at record speed even though the rest of the economy is sinking. Once we hit a recovery, or at least when investors come back into the market, this one will be huge.

As you can see in the accompanying chart, the number of exams delivered took off last year as the rest of the global economy collapsed. Now is the time to buy, before anyone realizes it.

Sincerely,
Jim Nelson

July 7, 2009

Looking for Quadruple-Digit Gains in the Far East “Test” Market was originally featured in the Penny Sleuth.

One bit of news that grabbed me was that China officially passed Germany as the third largest economy in the world, behind the U.S. and Japan. (Although by another measure, it is No. 2, and has been for some time.) Most folks probably shrugged. It was inevitable, after all.

But it shows that China’s role in the global economy is bigger than ever. Even amid a global depression, China’s potential is mind-bogglingly vast. What follows are some thoughts on China’s potential…

China Will Be No. 1 When?

If China’s economy continues to grow at its current rate, it will pass the U.S. as the world’s largest economy in 18 years. Of course, it won’t grow at its current rate for 18 years — not continuously, anyway. It will grow somewhat slower in spots and sometimes faster. What growth rate comes out in the end is anybody’s guess, but the 18-year guess will probably be off.

Then again, the guess also assumes the U.S. stays where it is. And that is also unlikely. The U.S. economy shrank last year and looks to shrink again in 2009. Meanwhile, China is one of the few big economies still growing, though at a slower pace. The result is that China will actually make up ground faster in 2009. As Ting Lu, a Merrill Lynch economist based in Hong Kong, notes: “In 2007, the gap between the growth rates of China and other big countries was huge. Actually, in 2009, the gap between will be even bigger.”

As the Great Depression II continues to lay siege to the world’s economies, China remains a coiled spring of growth. Even though China is now the world’s second- or third-largest economy, it still is a relatively poor country. And its resources are barely tapped.

The vast potential of China is hard to grapple with. Already, China has built the world’s largest building (Beijing’s airport terminal) and its longest transoceanic bridge. It has the world’s fastest train and the biggest dam. As John Pomfret, former bureau chief for The Washington Post in Beijing, observes: “It is a nation of builders, of grand schemes, of gigantism.” He calls China’s engineers “some of the world’s biggest risk-takers.”

The Key in Unlocking Resource Treasures

The Qinghai-Tibet railway was another engineering feat. Chinese engineers, already considered the best railway builders in the world, built a railway on the complex and shifting permafrost linking Llasa with Golmud in China’s western hinterlands. The railway stretches hundreds of miles across a treacherous plateau.

Author Abrahm Lustgarten in China’s Great Train describes the area as one of “intermittently frozen marshes, lakes and soggy permafrost that heave and shift more actively than almost any other geologic environment on Earth.” In places, the quicksand is deep enough to swallow a tank. It is also higher than any other railway on Earth — at its peak, more than 16,600 feet above sea level. The cars of the train are pressurized as in an airplane, with oxygen pumped in.

After this stretch of the Qinghai-Tibet railway opened in 2006, the riches of Tibet started to come to light. The Ministry of Land and Resources disclosed huge resource finds — big veins of copper, zinc, lead, iron, gold, silver and other minerals.

“The new reserves make Tibet one of the richest regions in China’s territory,” Lustgarten writes, “and could shift the country’s reliance on imports of copper and iron altogether.” Tibet could hold 40 million pounds of copper — one-third of China’s total. There is more than a billion tons of high-grade iron ore.

More than just minerals, there is also an abundance of oil. Sinopec estimates some 65 billion barrels of oil will become accessible in Tibet. “A find, that if proven,” Lustgarten writes, “would make the region one of the next great petroleum envies in the world.”

What makes these projects economic now is the Qinghai-Tibet railway. Many Canadian and Australian companies already have joint ventures in place to mine the plateau.

Booming Lhasa… And China’s Electricity Use Grows Again

The economy boomed in Llasa, too, thanks to the railway. The number of restaurants and bars in Llasa increased over 20% within a year of the railroad’s completion. More than a million tourists took the train west to Llasa. Where it was once hard to find a hotel room in Llasa, over 660 hotels sprouted up after the railway. One, the Brahmaputra Grand, is a luxurious hotel with crystal chandeliers the size of Volkswagens and 50-foot tall plastic palm trees. A night here set you back $1,100.

Tibet industry up to that time was mostly in trading yak tails, fur and salt. And now, it looks as if Tibet will play the role of China’s great western frontier, much like America west of the Mississippi in the 19th century.

There will be and is an ugly side to all of this that I’ve not talked about — the suppression of ethnic Tibetans and the weakening of a very old culture. China, though, continues to build and build. As Lustgarten notes: “The western outposts are linked by an expanding transportation infrastructure — roads, power transmission lines, pipelines and railways — built at a rate that makes Dwight Eisenhower look lazy.”

But as with the rest of world, the pace has cooled. The fingers of depression wander all over the globe. No one can say how long it will take to work out of this mess.

However, some hopeful signs emerged recently. The China Electricity Council reports that electricity consumption rose nearly 7% in December, year over year. (More on that below.) If no one has doctored up those numbers, that would be the first such increase since July. And there is some anecdotal evidence that housing prices in China are on the rise again.

Nonetheless, over the long term, China has lots of room and resources to grow. We got a glimpse of the implications of that growth in the last several years — the huge pull on resources such as oil, for instance. At the moment, economic depression has set in most everywhere. But longer term, it seems foolish to bet against the great dragon in the East.

Sincerely,

Chris Mayer

January 29, 2009

A Coiled Spring of Growth was originally featured in the Penny Sleuth.