By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Tens of millions of people were heading home for the Chinese New Year late last week, as they do every year. But this year, an estimated 77 million people were effectively stranded by a record-setting snowstorm that essentially cut the country in two.

It was every traveler’s worst nightmare, except that it was on a scale that we can’t even comprehend here in the United States.

Think about it: Millions camped out at railway stations, and at transportation facilities for trains, airplanes and buses that were never going to arrive – and that were never going to leave.

Some of the stranded travelers were there for days in the frigid weather, sleeping outside on the ground, huddled in groups, or simply milling about in the car parks. A lucky few found warmth in emergency shelters. But even those, built to house as many as 50,000 people each, were soon filled to capacity.

Widespread Fallout

The most recent news reports state that more than 100 million people were affected by the storm, the worst one that China has seen in more than 50 years. More than half a million homes were damaged or destroyed. Airports shut down, re-opened, and then had to shut down again when additional snow fell and airplanes iced up as they sat on runways.

On an icy stretch of highway in China’s Hunan province, more than 10,000 vehicles were backed up in a gaggle that reached back nearly 50 miles.

At least 60 people have been killed. The death toll is expected to grow, as reports on problems, damage and injuries continue to roll in. The government has put the cost of the winter storm – so far – at more than $7.5 billion. After initially mobilizing several hundred thousand troops to ensure power supplies and jump-start traffic flows, the government has since doubled the number of troops it has deployed to nearly 1.5 million.

Food and fuel costs are rocketing upward. The government was forced to ration coal. As grim as it sounds, China’s leaders say this mess will get worse before it gets better.

"The most difficult period is still not over yet," China Premier Wen Jiabao said during a weekend cabinet meeting. "The situation remains grim."

More Than Capitalist Bluster

This winter storm underscores a number of things. First, it demonstrates that China – despite its rampant growth and paradigm-shifting progress of the past several years – still has a long way to go in terms of internal infrastructure development. It also serves to warn the government and investors alike that social unrest could easily short-circuit the Great Growth Story of Mainland China.

But this also reminds us that every investor needs to have a China-investment strategy.

And here’s why.

The one thing China fears most is social unrest and the snowstorm is fanning the embers pretty hard by testing the patience of citizens and governors alike. It’s also exposing the latest schisms that exist between the newly affluent and the semi-literate migrant workers who manufacture most of the products that China peddles to the rest of the world.

In other words, in a bit of irony reminiscent of the U.S. economy of the 1800s, China is amassing its wealth on the backs of the very laborers that the wealthy elite despise, according to a report last week by The Associated Press.

Needless to say, that’s a simmering problem that the government will go to great lengths to keep from boiling over.

That fear is pushing the government in new directions that we think are "encouraging."

For instance, CNN last week aired footage of China’s premier standing in a Hunan Province railroad station, where he was using a handheld megaphone to offer an almost-unheard-of apology to waylaid travelers.

And the powers that be have allowed some pretty remarkable headlines to run, including: "Jiansu’s Coal Storage Can Sustain Electricity Generation for Four Days and a Half."

And the China Business News has carried an atypically direct commentary that alleged that the power shortage was caused by government monopolies controlling railways, power plants and the power grid.

In an effort to hasten a return to normal, China’s government has managed to persuade nearly half a million travelers to abandon their travel plans for this week’s holiday and accept refunds instead – even though, for many, this will be the only chance they’ll have all year to get home and see their families.

Investment Opportunities in the Wind

We are not so naïve as to suggest that Beijing is turning over a new leaf with regard to a sudden relaxation in media control, but the fact that they are allowing normally controversial headlines and stories to appear at a time when there is tremendous social stress could be setting the stage for more government spending as a means of appeasing the restless masses.

Assuming we’re right – and history suggests that we are – this future outlay could boost China’s gross domestic product (GDP) growth to an even brisker rate than the blistering 11.4% they reported for 2007. The fuel: The trillions of dollars that get unleashed as part of the high-visibility programs that are aimed at reducing social unrest even as they upgrade the company’s infrastructure and maximize economic production.

And they’ll need it. The damage estimate of $7.5 billion is certain to escalate. And the storm has spotlighted key infrastructure shortcomings that will now have to be addressed.

In the past, the spending has been targeted to critical areas such as power production, transportation and construction. This time around, we think it will also include market reforms that are designed to reduce the odds of the current crisis being repeated. And given that Beijing will play host to the 2008 Summer Olympics, which begin in early August [according to the official schedule, the opening ceremony is set for Friday, Aug. 8], we expect to see substantial capital outlays aimed at pollution-control initiatives.

This summer, for the first time, the world will get to see firsthand just how bad China’s pollution problems have become. China’s government will do all it can to minimize the problems it can fix now, and at least demonstrate that it has a plan to fix those that will remain [Editor's Note: For a brand new research report detailing the investment opportunities that Beijing's pollution-control initiatives are creating, please click here].

Investors seem to agree with our assessment that this flow of capital will be creating profit plays in Mainland China: Indeed, China’s main stock index soared a record 8.3% yesterday (Monday) "on speculation the government will act to boost equities and stimulate growth after the worst snowstorms in decades closed transport networks and shut factories," Bloomberg News reported yesterday. Chinese stocks had more than doubled last year before the impact of six interest rate increases and a clampdown on bank lending led to a retrenchment in share prices.

While the bullish response in share prices was nice to see, we still believe that current market conditions call for caution.

Global equity market problems have weighed heavily on Chinese stocks since last fall and we don’t expect those business problems to disappear anytime soon. So while we’re still huge believers in China’s long-term potential, we’re cautious about heavy direct investments in China shares in the near term [although there are some notable exceptions].

History suggests that until the current credit crisis blows over and the markets gain confidence, it is far better  [and far less risky] to place bets with companies that are doing business with China, even though they may not be based there. Indeed, by investing in companies that are poised to profit "because of China," but that aren’t necessarily "in" China, we benefit from China’s gains but enjoy the safety of more-heavily regulated markets – such as the United States and Europe.

Some of our favorite examples include Huaneng Power International Inc. (HNP), ABB Ltd. (ABB) and Diageo PLC (DEO).

The Beijing-based Huaneng Power provides electricity to virtually all of China’s East Coast, including some of the country’s fastest-growing areas. Although it’s based in China, and initially seems to contradict our "safety-first" China investing strategy, there’s a very good reason it made our list: Huaneng Power is working closely with the government, and has the inside track on key deals at many different levels.

You see in China, such contacts are a key element of who gets contracts and how business gets done. These "connections" – known in Chinese as guanxi [pronounced gwan-shee] – usually separate the winners from the losers. Hence Huaneng Power is a much less risky investment than it initially appears.

The Zurich-based ABB (ABB) is winning China contracts left and right, and is part of projects to provide everything from tie-in gear for electrical grids to construction of the power-transmission lines that actually deliver electricity to millions of people.

And don’t forget London-based premium liquor distributor Diageo. Thanks to the emergence of new economic middle and upper classes in China, the demand for luxury goods is escalating on a global basis. That’s one reason gold has spiked. In China, upscale liquor consumption is growing as fast as the Chinese economy, and the company’s double-digit sales growth there adds to overall earnings expectations.

Speculative investors who want to make this a round trip by taking advantage of any weather-related downturns over the next few months could also pick up the ProShares UltraShort FTSE Xinhua (FXP). This inverse fund actually appreciates with each drop in the iShares FTSE/Xinhua China 25 Index (FXI) exchange-traded fund (ETF), against which it is traded. The FXP fund has appreciated 53.85% since December, while the U.S. Standard & Poor’s 500 Index has dropped 12.28%. And that bellwether U.S. index appears set to drop even more.

Guess our tongue in cheek saying, "go global or go home" has some bite… even if it is to the downside.

News and Related Story Links:

• The Associated Press:
  Chinese workers suffer in snowstorms.

• The Associated Press:
  Train woes ease in snow-wary China

• AsiaOne.com:
  1 Million Troops for China’s Blizzard Relief

• Bloomberg News:
  China’s Stocks Rise by Most on Record; World’s Biggest Mover

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

A longtime investor in Japan who is familiar with how closely the companies there work with their government "minders" recently asked me if the same thing was true in China.

It’s absolutely true, but the level of direction – rather than cooperation – makes Japan positively appear laissez-faire by comparison.

Consider the 2003 book entitled "Practical Manual for Party Propaganda Work" published by Red Flag Publishing House. It’s a thinly veiled policy statement aimed at doing business with foreigners and serves as the de facto guide to how China’s Communist Party wants things done when it comes to presenting China in a most-favorable light.

Here’s a summary of the advice as assembled by noted China analyst David Cowling. Not only does it speak volumes about what China wants presented to the world; it also details what it wants achieved.

Consider these tips:

• Speak simply, [even] oversimplify if necessary. Deliver a message easiest for the foreigner to receive. This will vary according to what country or region they are from.
• Never use slogans. Propaganda with foreigners should be less direct than domestic propaganda. Present facts, let them draw their own conclusions.
• Arrange interviews for friendly foreign journalists.
• Through Xinhua [the state-run news service] if appropriate, arrange for articles by Chinese to be published by foreign media.
• When scheduling tour groups, strive to arrange a schedule that will give the best impression of China. When these people return to their countries, they can help form a positive impression of China in the minds of the people of the world.
• Attend to programs shown on the television systems of hotels frequented by foreigners so that a positive impression of China will be given.
• Arrange for tour guides and interpreters to subscribe to PRC foreign language publications.

This all sounds pretty innocuous until you realize the forward is by none other than Hu Jintao – as in China President Hu Jintao.

In Western terms, this would be like President George Bush issuing a national press directive regarding what can and can’t be reported – with guidelines for the content that actually makes it into print or out onto the air.

On the surface, it’s enough to make a free-press society foam at the mouth, but to longtime Asian observers like ourselves, it’s simply a roadmap – for global success.

[In an interesting side note, at a time when there's more of a need for global communication and understanding than ever before, every country in the world except one is either cutting back on - or ending outright - their government-sponsored international shortwave broadcasts. That includes Great Britain's vaunted BBC and the U.S.A's Voice of America.  The one exception is China, which is actually boosting its broadcasts of news, documentaries and propaganda to the rest of the world.]

All of this – from the directives to the boosted world band radio broadcasts – provides a clear and intimate look at how China intends to do things. In one sense, it’s a game plan focused on victory – measured as global economic success. In another, it’s a lot like a poker "tell" in that it reveals a great deal about China’s intentions and future courses of action.

And, as is always the case when it comes to investing, that inside insight can lead to significant profits at an acceptable level of risk if you search out companies positioned to profit "because of" China.

Consider this point: Many Chinese, including leading party members, want a more democratic society. Yet, they fear that modernization will spark social unrest.

Therefore, they place great emphasis as a nation on controlled growth, which to us suggests that infrastructure investments are a solid play. The reason: Having a solid infrastructure is one of the easiest ways to prevent the social strife that has destroyed so many civilizations throughout history.

The trick is that many companies inside China are in the wrong place at the wrong time. Despite their rush to get a stock listing and their seemingly unstoppable potential, they’re actually merely biding time before they are plowed under by more-modern, better-capitalized and better-managed overseas rivals.

Yet there are other firms – such as Huaneng Power International Inc. (HNP), China Southern Airlines Ltd. (ZNH), Vale, formerly Companhia Vale do Rio (RIO), and ABB Ltd. (ABB) that stand at the crossroads of potentially lucrative government contracts that will provide these firms with solid growth for years to come.

Furthermore, by virtue of their involvement with key elements of China’s infrastructure, these firms will either drive additional growth, or benefit directly from it, creating further investment gains from the raging growth created by an emerging middle class that’s 300 million strong – and growing.

And that brings us full circle.

In its attempt to control state media and set the standard for external communication, China’s government is telegraphing where it intends to take things.

Not surprisingly, that’s just where we want to be as investors.

And in the weeks and months to come, we’ll take you there.

News and Related Story Links:

• Money Morning Investment Analysis:
  China’s Economy Is 40% Smaller Than Thought – So What!

• Money Morning News:
  Chinese Insurance Companies Bulk up on Infrastructure Investments.

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Here’s a headline investors probably never expected to see: The United States and China have agreed to cooperate on the management of the two countries’ strategic oil reserves.

We don’t know whether to find this story – first reported by China’s state-run Xinhua News Service – amusing, or downright terrifying.

So for now we will think logically about the possible reasons why such an unlikely alliance would be formed, and ponder what we should do about it.

Let’s talk about the why first.

Ostensibly, this agreement is about curbing oil speculation in the international markets. By including China, the consortium of international members who report their oil-reserve plans through the International Energy Agency in Paris, not only get a look at China’s current inventory, but also at that country’s potential future energy needs.

Considering it’s the United States that’s shepherding China through the admissions process, we suspect this is what’s really driving the agreement.

China’s growth is unprecedented. But as a Communist nation, its workings are all too often closed off to the rest of the world. Having international disclosure of China’s oil reserves and future stockpiling plans will theoretically provide advanced notice to other nations of higher oil prices in the event one or more nations makes a run on the markets.

Knowing how secretive Chinese traders can be – and the potential competitive advantages they are giving up in the interest of international cooperation – we’re more than a bit stunned over the prospects of a China that would be willing to disclose this information.

As for how we might use this agreement to create bigger profits in the years ahead, that’s a crucial point to consider.

Our sources suggest that China is slated to spend between $300 billion and $500 billion in the next five years on energy conservation and environmental protection equipment. And that’s in addition to the $1 trillion or more that nation already has apportioned to energy production and other petroleum-related matters. Therefore, any storage and demand figures can conceivably be utilized to develop better investment intelligence on where it plans to spend its money and in what order.

Indeed, now that the OPEC crowd has finally conceded that the global supply outlook for petroleum is nowhere near as serene as they’ve tried to have us believe for years, this kind of market intelligence becomes all the more valuable to investors.

And given that $300 billion to $500 billion represents nearly 30% of the total global market for such conservation and protection equipment, this could be a powerful indicator when it comes to future profits. With regard to energy production, that’s more of a wildcard. But since oil remains priced in U.S. dollars, the potential demand figures carry a highly correlated relationship to the strength – or weakness – of the greenback.

Moreover, given that much of this equipment – as well as China’s reserves – come from the United States, China’s participation in the IEA consortium could serve as important political antacid when it comes to reducing China’s trade surplus, which has been a major point of controversy in Washington.

News and Related Story Links:

• Chinagate.com:
  China, U.S. to Cooperate on Use of Strategic Oil Reserves

• Money Morning Commentary:
  Investors Will Clean Up From Beijing’s Toxic Mess for Years to Come

• Money Morning News:
  Oil Hits $100 a Barrel on Global Political Tension and Supply Concerns

By Keith Fitz-Gerald
Investment Director

In a report that is sure to send shivers down the backs of investors who have been blindly pumping money into China-related investments, the World Bank recently stated that China’s economy is 40% smaller than previously thought.

The report also suggests that China will not become the world’s biggest economy in 2012 – as everyone has been expecting – and said the nation is far poorer than most analysts think.

In our opinion, all this report means is that there’s a lot more upside for savvy investors.

Clearly, there are major implications – particularly as the data affects aid and monetary agreements – so we don’t want to dismiss it. But the fact is, reports like this are hardly unusual when it comes to emerging economies.

With their rush to riches, that’s something investors too often forget. That’s also why, over time, so many investors fare so poorly: They’re so busy trying to get to the party, that they fail to notice that they’re the last ones still there and drinking from the nearly empty punch bowl when the lights go out.

It’s understandable. They’ve become so inebriated from the easy profits that they fail to see the big "Stop" signs that are in plain view.

We all know how that story ends. Those investors incur major portfolio damage by failing to factor in the periodic corrections like the one the Chinese stock markets are experiencing right now.

Unfortunately, too many investors make a major error in assuming that they can only make money in a market if there’s a raging bull market in stocks. As we know, that’s just not so. As long as an investor "follows the money" – a central component of the Money Morning/Money Map Report global investing strategy – and pays attention to the powerful trends that are always at play, profit opportunities can always be found.

The World Bank report is worth noting for several reasons. But here’s a key point: Even after all the estimates for China are revised downward, its $5.33 trillion net worth is second only to the United States, which has a $12 trillion net worth. That means that, for all its supposed shortcomings, it is wealthier than such countries as Japan, Germany, France and the United Kingdom.

And even with the downward revisions, China still accounts for 10% of the world’s gross domestic product (GDP), making it the second-largest economy in the world – again, bigger than such stalwarts as Japan and Germany.

When measured in terms of purchasing power parity, China accounts for nearly 10% of global output, yet its per-capita gross domestic product is a mere 9.8% of that of the U.S. economy.

In other words, the world’s biggest "undeveloped" nation is rapidly chasing the world’s "most developed" – and actually is ahead of many of the world’s most sophisticated markets.

Imagine the potential when China really gets going!

So do the revisions tell the whole story?

Not by a long shot.

World Bank officials, like other government apparatchiks everywhere, have to take all kinds of "official" information into consideration when cranking their numbers. In fact, as part of this effort, they consider the prices of more than 1,000 goods and services in 146 countries – as measured in the local currencies – as they calculate the relative purchasing power parity between countries.

In doing so, they obviously place a huge emphasis on so-called "local information" – such as local prices and government-generated data.

That’s good, since it helps determine global purchasing power more accurately.

And yet, this process is just as flawed – and is as full of holes – as earlier studies.

For example, China is primarily a cash economy, which means that trillions of yuan are circulated outside the "official" financial system. And that means the economy is growing at a clip that’s much faster than the 12% rate that China’s government is reporting – perhaps as much as 3% to 5% faster, making the annual growth rate 15% to 17%.

Compare that to the tepid 2% growth rate of the U.S. economy.

With regard to how this affects our investment capital, there are several important implications to consider. Chief among them: If China is, indeed, smaller than is commonly believed, the United States is much less likely to levy punitive trade actions that stymie China’s economic development.

Once this report is fully digested, it could well mean that U.S. investments in China will accelerate, causing China’s economy to increase its speed, too.

And that’s important because it suggests the rules of the game have changed once again, especially when we strategize about how to best pursue profits from China.

At the present time, it’s better to profit "from" China than to invest "in" China.

That’s a Money Morning mantra, and it makes a lot of sense, when you consider it carefully.

Profit From China Without the Dangers of Direct Investments

Direct investments "in" China have become increasingly dicey, as many investors have discovered of late. It turns out that many of the most exciting companies trading on China’s stock exchanges have actually profited because of their investments in other exchange-traded companies – somewhat of a "keiretsu-like" arrangement, and one that we’ve discussed quite frequently.

To the uninformed, this can transform certain China stocks into an unforeseen gamble. If one of these companies stumbles, or collapses, then the companies that invested in it all the way up the line will probably stumble, too.

No wonder some Chinese euphemistically refer to domestic investing as "stir-frying" shares.

On the other hand, international companies doing business in the greater Chinese region are positioned to profit "from" China’s substantial growth. These firms tend to be stable and to produce longer-term profits, while dodging the "Wild West" kind of risk that some of their domestic counterparts seem actually to be courting.

These "global titans" provide another benefit to investors shrewd enough to understand this strategy: These firms have the added advantage of being traded in accordance with Western rules and with Western regulatory transparency – which adds a substantial amount of certainty to an equation that badly needs it at the moment.

Speaking of which, there’s a substantial group of people who believe that China’s going to collapse. We believe it won’t, and for one very good reason.

By giving tens of millions of its citizens a taste of the "good life" of Western consumers, China has opened its version of Pandora’s box.

Money Morning Executive Editor Bill Patalon calls it the "Baywatch Effect." And he’s only partly joking.

At this point, China can’t halt consumerism and shut down growth anymore than America could completely shelve democracy – even if China’s economy is 40% smaller than we all thought before.

And that brings us around to how we play this news as investors.

Assuming you buy into our current "safety-first" strategy of "profiting from China instead of investing in China," one terrific avenue to travel is the one that leads to global titan service-providers. One solid play: the Zurich-based ABB Ltd. (ABB), which recently won $440 million worth of contracts to build a 2,000 kilometer electrical link that will ultimately provide power for 31 million people when it is completed in 2011.

Then there’s Nam Tai Electronics Inc. (NTE), which makes electronic parts and sells them to China-based original-equipment manufacturers, or OEMs, for short. This company is poised to grow from the growing use of its products in China-made goods that are then sold to the rest of the world. With those relationships in place – and relationships, known as guanxi, are crucial in world of China-based business – the company logically will be able to transition to supplying parts for goods sold to the customers that are part of China’s growing middle class.

The bottom line on China is that the World Bank report is important…just not for the reasons that many people will think when they first hear about it.

We see the data differently and regard it as a strong base from which to build in the years ahead.

News and Related Story Links:

• The Voice of America/VOANews.com:
  World Bank Finds China’s Economy 40 Percent Smaller Than Thought.

• The World Bank:
  2005 International Comparison Program Preliminary Global Report Compares Size of Economies.

• Money Morning Investment Analysis:
  The Baywatch Effect: Can China’s Growth Help Gold Prices Triple?  

• TradingMarkets.com:
  ABB Wins USD 440 Power Line Order in China.