Chris Mayer: Sure. As soon as we landed, we visited a giant Carrefour, which is a big French retailer in Beijing. There, we got a chance to see the Chinese middle class in action. There store was kind of like a Wal-Mart. It was packed with people. There were 50-something checkout lines, four or five deep with customers, and this was on a Sunday afternoon. People were wearing jeans and sneakers. There were all the brands from all over the world on the shelves. There were 20 different kinds of toothpaste and just about everything you can imagine.

That sort of set the tone for the trip because we saw that sort of bustling consumer business scene everywhere we went. For example, there’s lots of KFCs there and you see them everywhere. In fact, KFC is the largest and fastest growing food chain in China now. They have almost 3,000 of them there. You see Pizza Huts all over the place, McDonald’s, of course and Starbucks. It was very interesting. I was in Beijing last in 2005 and even in just that 5-year time span, it’s changed a lot. It’s grown up quite a bit. It’s a fascinating thing to see. I think most Americans would be very surprised to walk the streets of Beijing.

In fact, one of the people I was traveling with, who is a very well read and well traveled guy, thought that he would find a city he could compare to Managua or Mumbai. Instead, he said, “This is a city that compares to New York or Chicago.” So I think that sort of captures some of what we saw when we were there.

Gary: You describe something that doesn’t sound at all like a communist economy to me, what with all that consumer choice. I was going to ask you differences between 2005 and now, what you would have expected and what you actually found this time. So I guess the Chinese really are wealthier. This is not like it was in America where a lot of our wealth in the past I’d say 50 years has been because of expanding credit.

They save. They are industrious. Some of their industry may be based on Western credit, but I would like to ask you about the growing wealth; if it’s actual wealth, real savings, and how dependent it is on our economy, which is one of, right now, deflating credit being available?

Chris: Well, certainly, like you say, the Chinese save a lot of money. That’s one of the things that really stands out when you look at some of the numbers. I think that the story of China up until now has been that it’s mainly been an export driven economy where they basically exist to service the US consumer. I think we’re at a kind of inflection point where the story starts to change and more and more, the economy of China, and not only China, but of Asia generally, are gonna be more focused on servicing a growing Asian middle class.

CLSA, which is known as Asian investing specialists, put out a report called The Future of Asia is Domestic. They had the number of Asians with disposable income of $3,000.00 annually – $3,000.00 or more, and this excludes Japan – will rise from 570 million to 945 million people by 2015, and more than two thirds of that increase is from China alone. Just think about that number. You’re talking about almost 400 million middle class consumers coming online here in a not very long time. We’re just talking about the next five years or so.

So they’re all gonna wanna enjoy the things that we sort of take for granted, and they’re just getting into that. China’s already become the largest cell phone market, for example. Within the next five years, it’ll be the largest market for luxury goods. China is the world’s largest market for automobiles. So, we start to see how this is gonna evolve, and the opportunities, I think, will be along those lines – will be finding ways to service the basic consumer needs that the Chinese want. That was really the message we got when we met with a lot of people in China.

When we met with some investors in China, everybody was worried about the bubble question. But as one hedge fund manager put it to me, “China is many mini-economies.” He’s not interested in investing in the big heavy steel or aluminum industries. He’s not interested in the property market, but he is interested in selling soap, or he is interested in selling alcoholic beverages to the Chinese. There’s interesting markets in fruit and agriculture that should do well. There will be little pockets that exist, and I think that’s where the opportunity is, and that’s where the transition is starting to take place.

Gary: That’s very interesting that the opportunity is in the core middle class enjoying just the basics, again, that we take for granted, not in servicing the West. That seems to be the important message here because people do ask that question. How much of this is a bubble, and how much should we be looking to China? But there are other things than those reliant on the Western bubble.

Chris: Yeah, I think some of it is a bubble. When you look at the property markets, especially in the big cities, I think that if it’s not a bubble, it’s awful bubbly. When you see apartment prices increasing 95 percent in Beijing year over year, that’s not natural. It’s been aided by credit, but also because the Chinese have less avenues to put their savings to work than Americans do.

And they tend to view property differently. This is one of the interesting dynamics I understand better after having been there. While we were there, we heard a lot of stories about how people are just buying brand new apartments and just sitting on them. They didn’t want to rent them. It’s almost like buying a new car and just leaving it on the lot.

They look at it as a store of wealth. So there’s apartments and there’s gold as a store of wealth. Of course, China is now the largest purchaser of gold in the world. They’ve recently passed India, so that is another interesting dynamic. If the China bubble pops, then the Chinese buying of gold could well pick-up. This started to happen when we were there. There were reports on the China’s CCTV where they showed how the sale of gold bars is up 70 percent year over year. So as the Chinese get a little nervous about their own property market, the other alternative is they buy gold.

Like I said, parts of it are definitely bubbly, but I think that as an investor, I always take a more nuanced view of these things. I think the US economy’s in bad shape too, but it doesn’t prevent me from finding places in the US where I would invest, so I look at China in the same way.

Gary: Exactly. And you mentioned that annual income was going to be going up to about $3,000.00 or surpassing it for a growing percentage of Chinese. I guess that goes a lot further in China than it would here.

Chris: Yeah, that’s right. And it’s kind of one of those magic threshold numbers that once consumers have more than $3,000.00 in disposable income that you really start to see more consumer spending.

In China, we looked at a number of different shops just to get a sense for prices, and the prices of everyday things in China are very low. Things like food, you could live pretty well, eat good, fresh food pretty cheaply. There are lots of markets for knockoffs…and they are pretty open about it.

We visited one that was like four or five stories, and all they sold was knockoffs – I mean really good quality knockoffs. We stopped, and we looked at one stall where they were selling Apple iPhones. One of the people that we were with had one in his pocket, and he took it out. It was a real one, and we compared it to the knockoff, and it was a pretty damn good copy. You could buy anything from North Face jackets to Rolex watches. People were buying Rolex watches for $20.00 a pop. They looked really good. Apparently, they’re better at it than they used to be. I remember in 2005, I bought a knockoff Rolex watch, and it stopped working before I got home.

Some things are more expensive in China because they’re difficult to import, but a lot of the basic stuff, you can get pretty cheaply. Certainly, apartments in Beijing, for example, are not cheap. But in general, yeah, $3,000.00 goes a lot, lot further there.

Gary: Gotcha. Now, talking about things that they’re going to spend their money on, things that we take for granted: One of those things, from what I understand, is water – that as wealthy as China is getting, there are basic ecological issues to be tangled with. The Chinese think a lot more about having clean water than the typical person in the west does. Could you talk about that?

Chris: Yeah, that’s definitely true. Definitely true. China has an imbalance. They have a lot of people, and they just don’t have a lot of water, especially in the north where Beijing is. The North is mainly made up of fairly dry plains, and the water wells there, sometimes go half a mile deep. And I know just over the last 50 years, about half of the non-renewable water in northern China has gone. It’s a supply issue, No. 1, but No. 2, a lot of the water they have is not fit for human consumption. I think the number is something like 70 percent of China’s source water is unsafe.

That’s why China has the leading number of stomach and liver cancer deaths in the world, and most of that is attributable to polluted water. Polluted water also spreads infectious diseases. Hepatitis is a big problem. This is definitely an issue they think about and are much more aware of. There are a lot of different ways to play the water China story. We’ve owned one of them for a long time in our special situations portfolio. They build desalination plants turning seawater into freshwater.

Gary: I think that’s gonna be on a lot more people’s minds way down in the future, but definitely I could see China being pretty immediate right now. Speaking of basics, what about agriculture? They have some problems with water, obviously, with the growing population and a dwindling source, but what about what they can grow?

Chris: Yeah, , so the water problems extend to agriculture. Plus desertification and development impinge on their supply of arable land, which has been falling. The arable land per person has been falling. This is a good area to invest in because the Chinese government is really behind the agriculture industry. They want China to be able to produce more of its own food, so they’re doing things like subsidizing irrigation equipment and subsidizing fertilizer. They give these firms low interest rate loans to help them expand. And there’s a lot of ways to play agriculture.

Gary: So we’ve got basic needs like water, agriculture, and I have to ask about the currency because as soon as you got back from this trip, China unpegs their renminbi from the U.S. dollar. How will that affect everything?

Chris: It was interesting because right before I left, too, I wrote up in Capital & Crisis about how the currency was cheap and how they would eventually float it. Yeah, that was a question too that we put to everybody we met while we were there in China. We got all kinds of opinions, but I’d say most people feel like the currency is cheap, and there’s anecdotal evidence to support that. There’s the Big Mac index, which looks at what the price of a Big Mac is all around the world, and Chinese Big Macs are about 50 percent less than in the US. I don’t know if the renminbi is 50 percent undervalued, but it seems to be undervalued to some meaningful extent.

As investors though, it can be very important. I don’t think it’s one of those things that’s gonna have an immediate impact, but China saying that they’re gonna float their currency could mean that we’ll see some significant appreciation over time. The last time this happened, it did have a some strong effect on the commodity markets. From 2005 to 2008, the Chinese currency rose 21 percent against the dollar. It’s interesting to know as a side note to that, that China’s trade surplus actually tripled, so all these people that are hoping that a stronger renminbi will mean the US trade deficit with China goes away I think will be disappointed.

It did affect a lot of commodities though. For example, in ‘05, after they allowed the currency to appreciate, oil jumped 15 percent in the month after that news. That makes sense because when you think about China, they’re the largest incremental buyer of just about any commodity you’d care to name, so a stronger renminbi means that they have more purchasing power to buy iron ore and coal and oil and all the other things they need. That could be an extra little fire under commodity prices.

Gary: I see. So to pull it all together, what could a reader do right now to right now take advantage of any of this?

Chris: There’s a couple of different things. Before we talked about the renminbi, and EverBank actually is the only US bank that I know of that has a renminbi CD, so you can actually get some exposure to the Chinese currency if you’d like a pure play on that idea. I’d definitely look at EverBank’s product. Other than that, I would say that most people are probably already invested in China, whether they realize it or not. If you’re investing in commodities at all, you have some significant exposure to what happens in China. If you own oil or copper or even gold, what happens in China is gonna have some say on how those investments do.

I would say you that you have to stay aware of what’s going on in China because it could impact your portfolio. Specifically, for more speculative minded investments, there’s some interesting Chinese stocks. Most people think that Chinese stocks are very overvalued, but there’s actually two very different markets. There’s the China market for stocks, and then there’s the China stocks that are listed in the US. The US listed versions can be very cheap. A lot of them are trading at single digit multiples of earnings and have 20 percent growth rates. I think that’s a good place to go fishing too if you’re looking for some speculative plays directly on China.

Gary: And that’s what you are very good at: finding these speculative plays on stocks that are worth owning. I want to thank you for taking the time to answer my questions.

Chris: Great, thanks for having me Gary.

Whiskey & Gunpowder
June 30, 2010

How to Invest in China’s Future Today was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

This is important work, because the melting snow from the Sierra Nevada provides water for millions of Californians. The size of the snowpack at Gin Flat gives us clues to how much water will flow from the mountains. With the data gathered at Gin Flat, scientists can divine the future of California’s water supply.

The latest reading this year is that the snowpack is only 67 percent of normal. So California looks like it will have more water troubles this year. “I have not seen a more serious water situation in my career,” opined one official. “And I’ve been doing this 30 years.” Some scientists think that we’re overstating the water content at Gin Flat by 20 percent or more. If so, we have even less water than we think.

Across the globe, scientists look to the world’s mountains and watch carefully. The snow is melting earlier this year. That means water will flow less freely this summer, when people need it most. The areas most at risk of lack of fresh water include parts of the Middle East, southern Africa, the United States, South America and the Mediterranean.

In this piece, we return to a familiar theme: the unfolding water crisis. The spur that drives me to revisit it once again is the thoughtful annual report of a publicly traded water company that has purchased water rights in the western United States. In the shareholder letter, the company’s CEO wrote: “Arguably, the most critical issue facing the Western United States is the availability of water to support continued population growth.”

Water scarcity in the West is not new, the CEO admits. At least since the time of Mark Twain, people have been fighting over it. (“Whiskey is for drinking and water is for fighting over,” goes the old saying often attributed to Twain.) But what’s new this time is the sheer amount of water needed to support the fastest and largest population growth in the union. In Arizona and Nevada (and Colorado and Idaho), population grows at a pace double the national average. Yet water is scarcest in these places.

For all that’s demanded of it, water is too cheap. The CEO continues: “Market prices [for water] have started to appreciate dramatically in recognition of the actual economic cost of developing new supplies.” Despite constant threats of shortages, there is a reluctance to allow the price of water to rise. Lastly, the company’s CEO chides the public’s irrational view of water as something that ought to be a “free” public resource, not subject to market forces.”

“Paradoxically, this same public is willing to pay exceptionally high prices for bottled water,” he writes, “rather than drink inexpensive tap water, in part due to the often mistaken belief that bottled water is safer to drink.” This water scarcity issue does not only affect America’s dry Western half. It’s a global issue affecting many other parts of the globe. In a water-constrained world, conserving water becomes top priority. Treating existing water supplies when new supplies are not available becomes especially important.

On that idea, I’ve held Nalco Holding in my Mayer’s Special Situations letter since summer 2006. It’s up 46 percent for us, but I believe bigger gains lie ahead. Nalco is the world’s largest water-treatment company. Nalco is all about helping companies treat and conserve water in their manufacturing processes. A trio of insiders bought the stock in February and March for prices at $19-22 per share. It’s a steady business that generates plenty of cash flow and trades for 15 times next year’s estimate of earnings. Nalco is one of the few water stocks sitting a good 20 percent or more off its high.

As an investment idea, the water theme is not going away anytime soon. Many trends in energy and agriculture make the water situation only worse. Take a recent Tampa, Fla., development. Officials got a shock when the state’s first ethanol facility put in its request for water — 400,000 gallons per day! That instantly made it one of the top 10 consumers of water in Tampa, yet there are plans to double its capacity. All the while, Florida’s rivers and lakes are at or near record lows.

It’s madness, of course. But at least you can make it work for your portfolio by putting some money in the water resources arena. Maybe one day, people will quote the readings at Gin Flat — and its counterparts across the globe — as they do the Dow Jones industrial average.

Regards,
Chris Mayer
July 1, 2008

Investing in Water was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.