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China Manipulates Investors

Fudged Numbers

By Adam English
Wednesday, December 5th, 2012

You've probably heard the big news out of China earlier this week...

For the first time in a year, Chinese factory output grew in November.

At the same time, U.S. manufacturing fell to its lowest level in more than three years.

China has a lot going for them compared to the rest of the world: Trade deficits are hovering around all-time highs of about $29 billion per month between China and the U.S and GDP growth is far greater than any other developing country, at 7.4%...

Even its stimulus plans have been well received. A $157 billion infrastructure investment and efforts to cool a housing rally with new supply won rave reviews from Merrill Lynch.

Of the BRIC nations, only China is doing reasonably well, leaving investors with a single country for emerging market plays.

As Reuters pointed out, "That has left investors once again hoping China will take up the slack, and evidence has been accumulating since late September that the Chinese economy is regaining its vigor after seven straight quarters of slowing growth.”

Indeed, confidence in the Chinese economy is at a three-year high, and investors have pumped nearly $4 billion into Chinese equity funds in the past two months alone. So, is it time to hop back into Chinese companies and ride the recovery?

Certainly, there are some good plays hiding out there. Wealth Daily's Christian DeHaemer just uncovered a great Chinese play yesterday.

But investors need take a closer look at what is going on before they pull out the stops and start buying across the board...

Fudging the Numbers

Let's take a look at the rebound in factory output and GDP.

The official data contains alarming signs that the Chinese economy has failed to shed its heavy reliance on state-led investment.

The National Bureau of Statistics said in a note accompanying the report that growth accelerated for large firms for the third month in a row. At the same time, medium and small companies saw a retrenchment, with smaller firms having the worst time of them all. This ties into the massive Keynesian infrastructure projects being expedited by the Chinese government.

"The improving numbers are mostly because of government investment," explained Dong Xian'an, economist with Peking First Advisory.

While China certainly has pockets deep enough to cover massive stimulus efforts, they cannot fully mask their role in propping up GDP figures. The $157 billion in rail, road, and water projects is the equivalent of 2.1% of economic activity in China in 2011 — and that amount covers ONLY the infrastructure projects in this particular package, not the rest of China's spending spree...

Xian'an went on to say, "From the second quarter the government has unleashed a lot of projects, and that has started to be felt in the economy, but it's not a very healthy recovery yet."

And while large state-supported businesses are doing well, medium and small firms lacking clout within political circles are continuing to suffer...

Debt

Investors should also fear the absurd loans Chinese banks are giving to companies in sectors the Chinese government supports.

Take a look at Yingli Green Energy Corp as an example: The third-largest solar panel manufacturer in the world has tripled outstanding short-term borrowing to about $1.3 billion since 2009.

Analysis of 40 of China's most indebted companies shows operating profit dropped 15% in 2011 as debt piles grew by the same percentage on average. Overall corporate debt levels will increase to 122% of GDP by the end of the year, as compared to 108% at end of 2011. That's 32% higher than the 90% ratio the Organization for Economic Cooperation and Development considers "tolerable."

Chinese bank officials claim risks are under control — yet loans are being made at or below market rates as Chinese banks are holding too much bad debt.

China's central bank says the country's lenders have a non-performing loan (NPL) ratio of just 0.9%, which cannot possibly be true. Goldman Sachs estimates the NPL ratio is more than six times the official rate; many investors fear levels exceed 10%.

“If you run a bank's operations in a certain province and the governor tells you to roll over a loan, you are going to do it even if it doesn't make commercial sense," said Arthur Kwong, head of Asia Pacific equities at BNP Paribas Investment Partners.

So far, this method has worked — but China's banks can't shoulder this heavy a burden for long.

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Brazen Fraud

And the manipulation doesn't end there...

Outright fraud is being perpetuated by China and its state-sponsored companies to keep investors buying Chinese stocks.

The Securities and Exchange Commission recently charged the Chinese arms of five top accounting firms with securities violations over their refusal to produce audit papers for U.S.-listed Chinese companies.

A number of Chinese companies used “reverse mergers” to ensure they could make share purchases by U.S.-based investors as easy as possible. The SEC has removed many of these companies from exchanges, but negotiations between the SEC and Chinese officials have been languishing all year as the Chinese stall for their unscrupulous comrades.

Caveat Emptor as Investors Rush into China

We're looking at GDP figures inflated by government funding, shrinking small and mid-sized firms, unsustainable short-term loans that maintain excessive debt, and outright systemic fraud...

The unifying aspect of these concerns is the influence of and manipulation by the Chinese government.

Our goal is to keep investors from chasing Chinese growth and dumping their savings into questionable Chinese stocks.

A majority of the investors pushing back into China are undoubtedly tired of the U.S. economy and the political debacle that is suppressing it right now...

And while I certainly can't blame them, I still advise them to proceed with caution. Red flags are being shrouded by manipulation and fraud.

Analysis from an experienced trader is crucial to finding a solid pick.

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Adam English
for Wealth Daily


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