Each year, the Gobi Desert devours 2,460 square miles of Chinese soil, an area roughly the size of Delaware. Violent sandstorms threaten to conquer Beijing. Dunes now tower just 43 miles from the ancient capital…firmly marching south, like Sherman through the soft Georgia pines, at a brisk 12-15 mile per year clip:

Why is Asia’s largest desert growing so quickly?

It is because of a process scientists call desertification. Basically, China’s rapid economic growth comes at a great price, as the fast-approaching desert threatens to blanket Beijing before the Summer Olympics in 2008.

The solution?

The “Green Wall.” Beijing officials set aside $8 billion to construct a natural wall of trees spanning more than 2,000 miles.

But they’re no match. Trees need water. And air pollution inhibits precipitation. Researchers from Israel’s Hebrew University of Jerusalem and the Chinese Academy of Meteorological Sciences found that on hazy days, precipitation from the top of Mount Hua in China’s northwestern Shaanxi province is cut by up to 50%.

Consequently, one quarter of China currently finds itself buried beneath sand.

China’s immediate need for water remains paramount.

Two out of every three major Chinese cities have less water than they need. Cities in northeast China have roughly five to seven years left before they completely run dry.

Beijing knows the stakes. It’s spent $60 billion diverting river water to address this problem. That commitment represents the largest civil engineering project since the Great Wall.

Regardless, it may be too late.

But those lucky enough to fill their pipes have another problem: 90% of China’s city aquifers are deemed polluted, and 700 million Chinese drink water contaminated with either animal or human waste. In most cases, their murky glasses contain both.

You see, water, in essence, is a commodity. When scarce, it’s the one commodity even more valuable than either oil or gold.

Westerners, however, take water for granted. We simply turn on the tap and it flows. But that’s certainly not the case the world over.

Arid landscapes, low rainfall and fast-depleting underground water tables make fresh water one of the most pressing issues facing countries like India and China today. Roughly 50% of the world’s population resides in this region of the world. They’re the economies experiencing the most dynamic growth.

Last year alone, these economies accounted for more than half of world GDP. They now churn out 43% of the world’s exports and hold 70% of the world’s foreign exchange reserves. Going forward, sustainable growth will require sustainable supplies of fresh water.

Solutions vary. Some have proposed towing icebergs. Despite being highly inefficient, we’re not assured the icebergs will even be there to tow.

Others argue for heavy investment in desalination. We see two potential problems here. First, desalination requires massive amounts of energy, as well as specialized, expensive infrastructure. Saltwater conversion also produces a byproduct of concentrated seawater, which some scientists claim attibutes to marine pollution.

We also like to point out that desalination takes place at sea level. For flat regions like the Middle East, where desalination plants account for a majority of total world capacity, that isn’t too much of a problem…

But what about countries with steep terrain? Pumping water to higher altitudes presents a significant challenge both economically and physically.

And finally, for the most part, countries use desalinated water for washing, filling swimming pools and watering golf courses…they rarely use it for drinking.

The solution: We firmly believe as does World Bank water resources manager John Hayward: “One way or another, water will be moved around the world as oil is now.”

There are companies very attuned to this trend. They’re in the midst of buying water rights in the same way wildcatters used to buy oil rights.

Which companies? I can’t reveal much more in this letter, but I will say this: I own one stock, and one stock only. As you might guess, it holds some of the world’s most precious water rights.

Until next time,
Christopher Hancock
November 16, 2007

P.S.: I’ll also say this: Chris Mayer has been deep in study over this very issue for years now. He has given his Capital & Crisis and Mayer’s Special Situations readers tons of opportunities to strike it big with it. Some of his water plays have helped readers double their money in no time flat. He has a few more in a very special report he titles “Blue Gold.”

Chinese Deserts and Water Stocks was originally featured in the Penny Sleuth.

The news sent the index of Hong Kong-listed shares in mainland companies up by 8.74%, their biggest one-day rise since May 2000. This should also go a long way in easing speculative pressure on the Shanghai A-share market.

This is probably the most important financial development in China since their entry into the World Trade Organization in 2001. So you all were a little surprised the announcement was delegated to page six in the Financial Times.

Once again, the cover story focused on the U.S. liquidity crunch. If you’re looking for liquidity, there’s arguably no better place to turn than China.

China had accumulated foreign exchange reserves in excess of $1.33 trillion at the end of June. Total national household savings in China are estimated to be roughly $2.2 trillion.

With regards to the “bigger picture,” releasing capital account control is the next step towards the eventual flotation of the RMB. This move should allow many on Capitol Hill to take a deep breath.

China took the first step towards currency liberalization in December 1996, when it made the renminbi convertible for current account transactions, removing both quantitative and regulatory restrictions on the use of foreign exchange for current account transactions. China’s WTO accession in 2001 has also been seen as a catalyst for capital account liberalization and currency convertibility.

For lack of a better description, the current account is the difference between a nation’s total exports of goods, services and transfers to its total imports of the same. Relaxing the current account has allowed Chinese manufacturers to feed American consumers. Thus far, this has been primary fuel feeding the Chinese economy.

A current account deficit occurs when a country’s total imports of goods and services are greater than the country’s total exports. This situation makes a country a net debtor to the rest of the world.

See the U.S.

A current account surplus is just the opposite. Exports of goods, services and transfers are greater than imports.

See China.

The next natural step in liberalization is the capital account. Once again, for lack of a better description, the capital account is the net result of public and private international investments flowing into and out of a country.

Allowing mainland Chinese citizens to invest in the Hong Kong stock market signifies the most significant move to date by Beijing officials to liberalize the country’s capital account. This policy will allow the roughly $2.2 trillion conveniently stashed underneath one billion or so mattresses to find a better home with a better return.

But don’t go expecting the Chinese to float the RMB anytime soon. They are firm believers in gradualism. It’s taken more than 10 years to get from current account liberalization to this point. I would suspect it’s going to take many more before we reach full floatation.

But let’s forget the currency issue for a moment. The real winner here is undoubtedly the Hong Kong market, especially H-share companies that don’t have either a Shanghai or Shenzhen listing.

As Zhao Xiao, a professor of Beijing’s University of Science and Technology, said: “Remember, if all Chinese money can go to Hong Kong, then many global firms will favor listing in Hong Kong.”

According to our friends at CNBC, an official at Bank of China in Tianjin said the scheme was due to be up and running by September.

Less than two weeks and counting… The time is now.

Until Next Time,
Christopher Hancock
August 24, 2007

P.S.: I’ve been watching these Chinese-related trends very closely for years now, and it still amazes me that the mainstream media is still incredibly slow in covering it. But then again, it does give my readers a huge advantage over Wall Street.

In fact, staying with this theme, here’s a look at what I’ve been calling the “World’s Greatest Retirement Stock.” Wall Street hasn’t quite figured this one out yet, but when they do… Watch out!

Investing in China was originally featured in the Penny Sleuth.

M3 is the fullest measure of the U.S. money supply… and it is going up three to four times faster than the GDP itself.

The Fed’s irresistible desire to print more fiat dollars helps explain why the world is saturated with liquidity right now. And many of those dollars have conveniently found their way into the war chests of the world’s top ten sovereign wealth funds.

Morgan Stanley estimates these funds now control $2.5 trillion dollars.

Relatively speaking, SWF’s are already equivalent in size to roughly half the gross official reserves of all countries.

And if these government-backed hedge funds weren’t large enough, Morgan Stanley estimates their reserves will increase to $5 trillion by 2010 on their way to hitting $12 trillion by 2015.

China alone holds more somewhere between $1.2 trillion in foreign exchange reserves. These reserves are traditionally invested in liquid assets like U.S. Treasury bonds. Buying U.S. Treasuries enables China to peg the RMB to the greenback.

We knew China’s thirst for American Treasuries wouldn’t last forever. Nothing does…not even the world’s greatest empires.

So earlier this year, when China decided to set up its own sovereign-wealth fund, your editors became somewhat suspicous. This fund enables Beijing to shop for assets more exciting than stodgy, old government bonds. China can effectively take a chunk of that $1.2 trillion and search for things where it might make a better return…things like old-school British banks and white-shoed American PE funds.

What better way to own the world, right?

But when we read that China, for the second consecutive month, has been a net seller of U.S. securities, we stood up and took real notice.

China sold a net $6.6 billion of U.S. securities in May following net sales of $5.8 billion in April. The last time China sold U.S. securities for two consecutive months was during January/February of 2004.

We said that if this move proves to be more than a passing trend, this could put further pressure on the U.S. dollar.

Well, that may be the case.

In The Turning Point in China’s Economic Development, editors Ross Garnaut and Ligang Song point out:

“China has or is fast approaching reached the turning point in its economic development, at which ’surplus’ labour from agricultural employment in the countryside ceases to be available to drive the growth of the modern economy; so that labour becomes scarce and valuable; forcing large real wage increases and real exchange rate appreciation; which generate structural change towards more capital-intensive and technologically sophisticated industrial structure at the relative expense of labour-intensive manufacturing and agriculture; and changes fundamentally the character of China’s interaction with the international economy.”

I’ve always believed China’s path for floating the RMB would take place in three distinct stages. First, China would clean up the state banking system. Second, Beijing would gradually liberalize capital account convertibility. Finally, the Chinese RMB would be allowed to float alongside the dollar, euro, yen and pound.

We may be on the verge of reaching step number two. Meaning, China’s appetite for U.S. dollars may not be with us too much longer.

This may help explain the gradual shift taking place on Beijing’s shopping list.

But the real question is… If you had a $300 billion shopping budget and you knew the world’s demand for U.S. dollars was about to fall as M3 kept growing at a double-digit pace, what would you buy?

Until Next Time,
Christopher Hancock
August 3, 2007

P.S.: In my newsletter, Free Market Investor, I use this kind of analysis to bring my readers a ton of opportunities from around the world. In fact, right now I have a company that we are calling the “world’s greatest retirement stock”.

Investing in China was originally featured in the Penny Sleuth.