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    Gavekal Research

    The Great Pacific Gas Arbitrage

    Severe winter weather in the US has driven gas prices higher, forcing power firms to impose sizeable fuel bill hikes on consumers. But those who think that the low-cost US energy revolution is about to be dashed on the rocks of rising production costs are wrong. US shale gas still trades at a near 60% price discount to Asian liquefied natural gas (LNG) benchmarks, and the gap is unlikely to close quickly. As the US faces no meaningful constraint...

    0
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    Gavekal Research

    Hong Kong's Banks: Not Iceland, But Still Chilly

    In the gory aftermath of the global financial crisis, the International Monetary Fund investigated five countries with outsized financial systems. Iceland was in this group and got the harshest review, while Hong Kong, in contrast, was praised for its prudent financial regulation. Is it possible that in the few years since that report was penned, Hong Kong has morphed into the world’s next “Iceland”? This, at any rate, is the kind of talk we...

    0
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    Gavekal Dragonomics

    Wanted: More Creative Destruction

    If, as Joseph Schumpeter said, creative destruction is the “essential fact about capitalism,” then just how capitalist is China? Schumpeter coined the phrase creative destruction to refer to a process of corporate innovation that “incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” More recent economic research supports his insight that destruction is closely tied to...

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    Gavekal Research

    The US Current Account And Vanishing Global Liquidity

    The US dollar is the world’s reserve currency which in simple terms means that the United States is the only country which can settle a foreign deficit by issuing its own money. As such, any “improvement” in the US current account balance means that fewer dollars show up outside of the US, while the reverse holds true in the event of a deterioration.

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    Gavekal Dragonomics

    Riding The Rails To Reform

    Running railways in China has long been the prerogative of the state. But since mid-2013, officials from Premier Li Keqiang on down have been touting the opening of the rail sector to outside investors—a measure they say symbolizes a new environment favoring the private sector rather than state firms. On the face of it, this is an opportunity that private firms may not find very appealing: the Ministry of Railways could barely stay afloat...

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    Gavekal Research

    5C China: A Targeted Credit Tightening

    With rising worries about the effects of tighter credit, there has been much hand-wringing in Beijing about a slowdown in corporate investment. Some scholars are glum at the fact that annual growth in fixed-asset investment, China’s benchmark for capital expenditure, fell below 20% in 2013 for the first time in at least a decade. But perhaps the more interesting statistic is that growth in investment by non-state firms, at 23.1%, strongly...

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    Gavekal Dragonomics

    Who's Afraid Of Capital Outflows?

    With emerging markets around the world under pressure from worried investors, is China the next victim? While worries about China’s growth prospects arguably played a role in triggering investors’ re-assessment of emerging-market risks (see EM Carnage: Is It All China’s Fault?), there are also increasing concerns that China itself could be vulnerable to the loss of confidence. After all, Chinese companies have significantly stepped up their...

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    Gavekal Dragonomics

    Shadows, Subprime And Securitization

    Suddenly international investors are haunted by visions of a US-style credit bubble unfolding in China. This week saw an apparent RMB3bn bailout of a “wealth management product” (WMP) sold by China’s largest bank. Since these products are complex, opaque and constantly changing, parallels have inevitably been drawn with the collateralized debt obligations (CDO) that were used to slice and dice credit risk during the mid-2000s during the US...

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    Gavekal Research

    EM Carnage: Is It All China's Fault?

    With emerging markets in free-fall, it is worth considering how much of the damage results from China’s continuing monetary tightening and investment slowdown. After all, much of the last decade’s EM boom came from commodity exports to resource-hungry China. So now that China seems determined to crack down on credit growth and stem the tide of infrastructure spending, it seems logical that emerging markets should suffer. And if Chinese...

    1
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    Gavekal Research

    China's Growth And Debt Pressures

    The modest slowdown in GDP growth that China has just reported for 4Q13—to 7.7% YoY from 7.8%—is universally expected to be the first installment of a series of weaker growth numbers. Chinese authorities have been clamping down on new credit since May, and more recently pushing up short-term interest rates. These are welcome moves after the balance-sheet explosion of recent years, but ones that will inevitably have an effect on real economic...

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    Gavekal Research

    5C China: A Tale Of Two Targets

    With the momentum of China’s growth slowing again, some nagging questions about the leadership’s economic strategy can no longer be avoided. The big one is just how much of a growth slowdown they are prepared to accept from the current push for supply-side reform. While the previous administration talked a good line, its tolerance for such slowdowns in the event always turned out to be minimal.

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    Gavekal Research

    Asian Markets: A Ranking

    Investors in Asian markets have been frustrated by the poor returns over the past couple of years. To that frustration we can now add anxiety about the potential for a broad sell-off in emerging markets, including emerging Asia, if the China slowdown proves more severe than expected or if Turkey provokes panic by blowing up, as seems ever more likely.

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    Gavekal Dragonomics

    China Goes Wicksellian

    Periods of structural reform in market economies are often the precursor to a phase of strong growth and equity market out-performance. The trouble is the in-between stage when the actual transformation takes place. During these phases the corporate winners of the fading era are often gasping for breath, while the emergent new players are establishing themselves through a process of Schumpeterian competition.

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    Gavekal Dragonomics

    Cleaning Up Coketown

    One year ago, as Beijing was smothered by an apocalyptic smog, a new word entered the English lexicon. At the height of its “airpocalypse,” readings of the most harmful types of pollutant in China’s capital hit 40 times the level recommended by the World Health Organization. With studies showing that noxious clouds are to blame for millions of premature deaths, the central government is finally taking action to clear the skies. It has ordered a...

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    Gavekal Research

    Three Ways Of Making Money

    Since the mid-1990s (when the data starts), the JP Morgan Asian fixed income index has delivered negative annual returns three separate times: in 1997 (during the Asian Crisis), in 2008 (when anything but the most riskless of risk assets collapsed) and in 2013. And the past year was also the first year on record in which Asian bonds fell, while Asian equities rose. The same dichotomy was even more visible on global markets for although the World...

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    Gavekal Dragonomics

    Fast Times In China's Financial Markets

    While most of the Western world was on holiday, the world of Chinese finance kept busy. The past three weeks brought the release of two comprehensive estimates of the nation’s debts (both claiming that the debt problem is far less scary than media reports suggest), another squeeze in money markets which saw short rates jump 100 bp, and a notice allowing local governments to roll over their massive short-term debt in 2014.

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    Gavekal Research

    5C China: Deleveraging vs Growth In 2014

    The big question in China for 2014 is how the tradeoff between deleveraging and growth plays out. Xi Jinping’s government has made clear its seriousness about getting China’s debt under control: the PBC has made deleveraging an explicit policy goal, short rates have risen by about 300bp to around 6% since April, and over the same span broad credit growth has decelerated by several percentage points although it remains well above the rate of...

    2
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    Gavekal Research

    5C Asia: Anyone For Recoupling?

    Last year saw Asia engage in a “re-coupling” but it was the wrong type: rather than an economic recoupling that captured something of the sunnier outlook for developed markets, Asia revealed its continued dependence on financial conditions in the big centers. Asian markets (excluding China and Japan) were hammered due to their reliance on foreign capital to lubricate trade and their financial systems.

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    Gavekal Research

    The Sun Hasn't Set On Asia

    People in markets, nervous folks, always need something to worry about. In 2012 the big anxiety was whether Europe would fall apart; in 2013 it was whether the Federal Reserve would start cutting back on its asset purchases. Now that Europe has crept from despair to stagnation and the Fed has anchored expectations that it will steadily reduce its asset buying while holding rates near zero, the anxiety-vane is likely to spin towards Asia.

    2
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    Gavekal Dragonomics

    Tearing Down Mountains, Building Up Castles

    For buildings to go up, some buildings must also come down. As anyone who has walked down a city street in China can attest, the construction boom of the past decade was also accompanied by the destruction of many older buildings. But getting a handle on the precise scale of this activity has always been difficult. Our estimates based on census surveys suggest the volume of housing demolished over 2005-10 was much larger than we and other...

    0
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    Gavekal Research

    Behind The Bitcoin Bubble - A China Bull Market?

    It is said that Voltaire, on his death bed, was visited by a priest who asked him to embrace God and reject Satan. Voltaire replied, “Now is not the time for me to make new enemies.” Speaking to gold bugs one often gets the same feeling: with the price of gold down roughly a third since the September 2011 high, now is not the time to abandon the faith. And look at the parabolic rise of bitcoins, we are told; clearly the market is yearning for an...

    2
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    Gavekal Research

    The Hangover From China's Urbanization Boom

    As China’s leaders in recent weeks have laid out an ambitious agenda for market-driven economic reforms, one element has been strangely lacking: urbanization. Premier Li Keqiang made this his signature issue during his years as deputy to the former premier, and has frequently talked up the potential for urbanization to drive China’s future growth. Yet a coherent urbanization policy has been nowhere to be found, as Li’s desire for a healthier,...

    1
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    Fathom China

    Profile: Tingyi: Scale Vs Margins

    Two family-controlled companies from Taiwan are battling for supremacy in China’s fast-growing convenience food industry. Although both specialize in instant noodles and soft drinks, they have strikingly different strategies. The larger, Tingyi (Cayman Islands) Holding, distributes across China and focuses on scale. The smaller, Uni-President China Holdings, prefers to pursue high margins by limiting its distribution and promoting innovative new...

    1
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    Gavekal Research

    Energy Buyers Are In Charge

    After months of wrangling, Mexico has dramatically passed its long-awaited energy reform bill, amid fistfights and shouts of “treason” in Congress. Mexico’s oil sector opening—significantly more liberal than the initial proposal circulated in August—will be a boon to the country’s sagging growth rate and an opportunity for the oil majors who have been locked out of the country for decades. But it is also another sign of the times—with fuel...

    0
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    Gavekal Dragonomics

    Internet Firms Burst Into Banking

    For all the attention garnered by the new reform plans of China’s leaders, the biggest changes to the nation’s financial system have tended to come from the bottom up rather than the top down. One of prime examples is the rise of wealth management products (WMPs) since 2009, investment vehicles that act as an alternative to regulated bank deposits. These brought a new degree of competition and market pressure to the Chinese financial system, but...

    0
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    Gavekal Dragonomics

    The Targets Of China's Tightening

    Higher Chinese interest rates are back, and this time it looks like they are here to stay. The People’s Bank of China drew global attention in June when it sharply forced up short-term interbank interest rates. But the central bank mishandled the episode, causing unnecessary shocks to confidence in the financial system by failing to communicate its policy intentions, and had to allow rates to retreat. Though this led many observers to question...

    8
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    Gavekal Research

    Asia And Tapering Fear: Get Over It

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    Gavekal Dragonomics

    DragonWeek - The Follow-Through Begins

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    0
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    Gavekal Research

    Quarterly Strategy Chart Book - Look To Asia, Tapering Or Not

    In our previous Quarterly, we argued that investors should consider increasing their exposure to the emerging markets, and Asia in particular. The logic being that the taper tantrum sell-off in the summer was overly violent and that the valuation gap with the developed markets had grown too wide. Since then, our conviction on Asia has hardened. One reason for this is China, where a pretty decisive supply-side reform agenda has emerged in the...

    0
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    Gavekal Research

    A Thatcherite China

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    Gavekal Dragonomics

    China Economic Quarterly December 2013 - Internet Companies

    In the December issue of the China Economic Quarterly, we examine the state of the Chinese internet, with a focus on the Big Three internet companies: Alibaba, Tencent and Baidu. Despite continued government crackdowns on online discussion, China’s internet is booming: 600m people are online, including approximately 450m using mobile devices, and ecommerce may account for close to 10% of total retail sales in 2013. Nearly all this economic...

    0
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    Gavekal Research

    5C Resources: A Dark Outlook On Coal

    After two years of carnage in the coal sector, Asian thermal coal prices clawed back a bit of ground this autumn—rising US$5 to settle around $85 a ton. Prices are now down a mere –40% from their 2011 peak.

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Books

    In June 2011, mainland China-born banker Joe Zhang upped and left a successful career at UBS in Hong Kong to run a micro-credit firm in Guangzhou. Fourteen months later he returned to Hong Kong, frustrated at the obstacles that had prevented him from achieving his goal of turning Wansui Micro Credit into a lucrative money-making machine. Inside China’s Shadow Banking is an astonishing account of the messy business that is on-the-ground banking...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Wasteful Investment

    For the past few years, worries about China’s over-built, under-populated “ghost cities” were mainly the province of journalists and hedge funds. Now the central government is getting into the act, and while it has not yet hired Bill Murray and Dan Aykroyd to cleanse the nation of paranormal construction, it does seem increasingly serious about urban ghost-busting. A recent study by the National Development and Reform Commission, which found...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Urban Development

    For three decades China’s cities have grown by gobbling up fields and chopping down trees. But in a country that must feed one-fifth of humanity with just 8% of the world’s farmland, land is a scarce commodity. The government believes that it must maintain a minimum 120m hectares of cultivated land to ensure basic food self sufficiency. And since the current area is already very close to this so-called “red line,” cities must somehow grow...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Economic Reform

    Everyone agrees that China needs reform. It is facing rising inequality, worsening pollution, rampant corruption, and an increasingly restless society. Its debt-fueled economic model is plagued by inefficiency and waste. In November, China’s Communist leaders finally showed the world that they are serious about addressing these monumental challenges. The “Decision on Deepening Reform,” approved at the Third Plenum, is a broad and ambitious plan...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Baidu

    Baidu Inc has gone from strength to strength since its founding in 2000, but now China’s dominant search engine is facing its toughest competition since Google withdrew from China in 2010. Baidu’s execution in the internet search space has been top-notch, but it has never had to innovate to survive. Now the ground is shifting as the mobile internet grows more important to both consumers and investors. And upstart search engine Qihoo 360...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Tencent

    China’s biggest listed internet company, Tencent Holdings, stands nearly alone in figuring out how to earn money by offering free technology. Common online business models like advertising and ecommerce contribute little to Tencent’s revenue, though they comprise nearly all revenue both at Tencent’s competitors in China and at global giants like Google, Facebook and Amazon. By contrast, Tencent earns billions of dollars selling virtual goods,...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Alibaba

    Alibaba is ecommerce in China. About 80% of China’s consumer ecommerce transactions pass through its Taobao and Tmall units, accounting for an astonishing 5% of the country’s entire retail sales volume. Chinese spent Rmb1.4 trn at online markets and malls in 2012, 10 times more than in 2007. This growth will continue: we expect the industry to quadruple in size during the next several years, reaching Rmb9trn in annual sales in 2020, or around 18...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Chinese Internet

    Cognitive dissonance is helpful in trying to understand the Chinese internet. China’s virtual town square remains crowded and rambunctious— even as members of the Public Security Bureau mingle in the throng and grab those who step too far outof line.

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Capital Markets

    For adecade, Chao has followed mainland Chinese equities with a wary eye. Back at the end of 2003, China’s GDP stood at Rmb13.6 trn and the Shanghai Composite Index was a whisker below 1,500. Ten years on, China’s GDP is set to surge past Rmb55 trn, yet the index is languishing around the 2,200 mark. The economy is four times bigger than it was a decade ago (and nearly six times bigger in US dollar terms), but stock prices have risen by less...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Property

    Forecasting future construction volumes is a tricky business, as any calculation must be based on a number of different moving parts. One of those parts is the volume of demolition: the more shoddy old flats that are torn down, the greater the volume of construction needed to replace them. Over the past decade, demolitions proved a significant driver of construction demand, as millions of home owners demanded newer and better apartments. But...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Retail

    China’s retail landscape is changing at incredible speed and traditional channels are struggling to fend off the onslaught from online shopping. As growing hordes of Chinese consumers prefer to shop at home rather than on the high street, jumping on the e-sales bandwagon is now a matter of survival. We are clearly going through a period of retail Darwinism in China, and not every retail species will survive. Retailers that remain wedded to a...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Metals Man

    In September, a unit of China’s sovereign wealth fund acquired a 12.5% stake in Russian potash miner OAO Uralkali, the world’s second-largest producer of the potassium-rich ore. The US$2 bn deal has not provoked as much interest as it should: after years of failed attempts to lock in affordable supplies of potash, China will finally be able to influence the price it pays for this vital, but expensive, fertilizer additive. The investment also has...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Income Inequality

    Most of the news about China’s economy over the past few years has not been very good: growth has been on a steady downward slide, debt has piled up, and housing prices have continued to climb. Yet there is at least one exception: while other things have been getting worse, China’s income inequality has been quietly getting better. Most observers have either not recognized this trend or actively denied it (the OECD’s China desk is an honorable...

    0
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    Gavekal Dragonomics

    CEQ Q4 2013 - Economic Survey

    After a notably weak start to 2013, China’s economic growth staged a genuine if modest comeback in the third quarter of the year. Headline GDP growth picked up to 7.8% year on year, as the industrial sector benefited from the combination of stronger housing construction, improving exports to the US and Europe, and the end of inventory destocking. Even consumer spending, which had slowed sharply from mid-2012, started to turn around. And...

    0
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    Gavekal Dragonomics

    Property After The Plenum

    For ordinary Chinese, high housing prices remain one of their biggest concerns, and for economic analysts, the risk of a construction slowdown one of their biggest worries. For our part, we have argued that China’s housing market is moving into structural oversupply, after a decade of structural undersupply, and that significant adjustments are necessary. So it is surprising that the 60-point reform plan from the Communist Party’s Third Plenum,...

    0
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    Gavekal Research

    Xi's China Flexes Its Muscles

    Having celebrated Chinese leader Xi Jinping’s bold economic reform agenda, we must now take stock of a less appealing element of the new regime: a more determined and muscular effort to throw China’s weight around Asia. Beijing’s declaration on Saturday of a new “air defense identification zone” (ADIZ) covering a huge swathe of the East China Sea and including the disputed Senkaku Islands, came as an unwelcome surprise to Japan and the United...

    0
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    Gavekal Dragonomics

    DragonWeek - Interpreting Rates And Reform

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    0
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    Gavekal Dragonomics

    An Exit Strategy For China's SOEs?

    One of the many surprises in the ambitious reform agenda just announced by China’s Communist Party leadership (see Xi Jinping Changes The Rules Of The Game) was how much it had to say about the vexed subject of state-owned enterprise (SOE) reform. The conventional wisdom in Beijing had been that the plan would focus on technical policy changes on which there was already agreement—such as financial system reform—while putting off difficult...

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