YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

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We came across a fascinating article this morning written by Andy Xie from the website Caijing.com.cn. The piece is titled Fear the Dark Side of China’s Lending Surge

In short Mr. Xie’s commentary highlights how the Chinese bank’s lax lending practices are giving rise to an increased amount of investment, not into private companies, but rather into asset speculation causing commodity prices to rise. What’s so surprising to us is that China is following a similar pattern to what we experienced here in the United States with easy lending practices, causing a housing boom and then subsequently a global financial liquidity crisis. China’s infatuation is not with real estate but rather seems to be with the commodity markets. Andy Xie comments “Banks usually have to be extremely cautious about such lending, as commodity prices fluctuate far more than property prices. But Chinese banks are relatively lenient. As an industrializing economy, China’s support for industrial activities such as raw material purchases for production is understandable. However, when commodities are bought on speculation, lenders face high risks without benefiting the economy. In some cases, this practice hurts banks and the economy at the same time.” It seems to us that there appears to be a gradual increase in the amount of “virtual business” around the world and not enough emphasis on real business. Xie points out that this type of business hurts China (and frankly the rest of the world) as the country focuses more on making money in asset markets as opposed to making money the old fashioned way by investing in small businesses and thus improving the current dismal global employment picture.

Xie cites that 10 years ago businessmen in Hong Kong became these quasi fund managers by speculating in the financial markets instead of their core products and services and as a result the city’s economy has been stagnant ever since. We recognize the importance of having exposure to commodities at times can be a useful alternative to fight inflation, however, with such huge speculation rampant all across the world markets one must be careful…very careful.

Andy Xie concludes his article with the following, “Putting money into speculative investments isn’t totally irrational. It’s better than expanding capacity which, without export customers, would surely lead to losses. Businesses currently lack incentive to invest. But many boom forecasters wrongly assume that recent asset appreciation, fueled by speculation, signaled an end to economic problems. That’s an illusion. The lending surge may have created more problems than it resolved.”

Global investors and speculators alike have looked to China’s recent record commodity imports as a sign of economic recovery and hence an indication of a global recovery, but when such imports are for speculative inventories only, a commodity bubble and bust could be the next crisis to torment world financial markets.

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Will Kruger | June 24, 2009 | Permalink

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