Yesterday, China’s benchmark Shanghai Composite Index dropped 5.2 percent after economic data revealed wholesale price inflation jumped to its highest level in 12 years in July.

However, Taipan Daily editor Justice Litle says China’s long-term outlook remains strong – and some China plays look more favorable than they have in years. Here are Justice’s six reasons why the China bears are wrong…

Reason to Buy China #1: The Silly Season Is Over

Chinese investors went through a mania phase last year. There were tales of lines half a mile long snaking out from the doors of the local stock brokers. In April 2007 alone, nearly 4.8 million new trading accounts were opened in China — more than the prior two years combined.

All these new buyers led to a silly season for Chinese stocks. You could see it in the difference between Shanghai A-shares and Hong Kong H-shares…

At one point, companies with dual listings in Shanghai and Hong Kong were getting as much as an 80% premium on the A-shares price. This was a reflection of Chinese capital controls — it’s still tough for mainland Chinese to get their money out — and naive buyers who wanted to play at any price.

Now that the frenzy has subsided, real values are starting to show up again. The hot money has burned itself out, providing opportunities for those who see longer-term value and aren’t out to just flip a quick buck.

You see this pattern play out over and over again when a new opportunity comes to a place. Investors get excited and lose their heads, they push things way too far, and then the market comes crashing back to earth. That’s when the patient players get interested.

Reason to Buy China #2: Oil Is Coming Down

As of this writing, crude oil is more than 20% off its near-term highs. It looks like oil could be heading for the $100 mark — a possibility we pondered in “What If the Price of Oil Implodes.”

One of Asia’s greatest challenges has been keeping a lid on inflation pressures. It’s not easy to grow like crazy without seeing the price of basic goods and services rise too quickly.

Oil closing in on $150 a barrel threatened to swamp Asia with inflation on a local level — as the price of transport, food, and fuel went up — and also to cut into export profits as shipping costs rose.

With oil backing off, China and India can breathe a little easier. The fear that high-priced oil might kill the Asian miracle is lifting. That gives them more time to tap alternative energy solutions and build economic strength at home.

Reason to Buy China #3: The Locals Are Optimistic

The news reports mostly focus on the bad things — civil unrest, government crackdown, pollution and so on. That’s the nature of the beast mostly… for the most part, good news isn’t as interesting as bad.

But a recent survey from the Pew Research Center shows that most Chinese feel positive about where their country is headed. According to the survey, 86% are “content with the country’s direction.” (That’s up from just 25% six years ago.)

Perhaps even more surprisingly, six in 10 Chinese reported being satisfied with their jobs. And 70% were in favor of China’s shift toward a free-market economy.

The biggest concern in the Pew Survey? Rising prices. But that concern is addressed by the fact that oil is headed down these days — not marching higher as it had been for most of the year.

Reason to Buy China #4: The Growth Is Still There

China has had an amazing run, growing its economy at a near double-digit pace since the early 1980s. But the dragon isn’t done yet — not by a long shot.

Global Insight, an economic consulting firm, forecasts that China will overtake the U.S. as the world’s largest manufacturer in 2009. This is as much because the U.S. base is shrinking, even as China’s is growing… but that still counts as an eye-opening stat.

Plus for the longest time, China was seen as the world’s source for low-tech goods. Chinese factories were known more for sneakers, trinkets and cheap plastic toys than items of real value…

That’s all changing now as China moves up the quality food chain. Now we are seeing savvy companies like China Medical Technologies (NASDAQ:CMED) produce some of the most sophisticated high-tech devices in the world. As China gets better at enforcing intellectual property laws, its high-tech skills will only increase… and profit margins, too.

Reason to Buy China #5: Personal Savings and Domestic Demand

Perhaps even more impressive than China’s long-term growth rate is the personal savings rate.

Americans spent more than a dollar for every dollar they earned in 2006. The U.S. savings rate actually went negative. The Chinese, meanwhile, salt away 35 cents for every dollar they earn.

Just imagine how much extra money you’d have on hand if you’d managed to save 35% of your income, year in and year out, ever since you started working. Then just think of all the things you could buy with that cash.

Part of the reason the Chinese save so much is because there’s no real social safety net. But that’s changing, too: As the Chinese economy evolves, things like insurance and healthcare and retirement plans grow more affordable.

The upshot is, at some point, China’s big savers will feel a little bit more comfortable spending some of that cash they’ve saved up. And the newly minted middle class in China are already taking a hard look at things like cars, air conditioners, washing machines and so on.

As local economies grow, the locals themselves feel more comfortable spending a portion of their ample savings. That in turn leads to more domestic growth, which leads to a more positive outlook, which in turn increases spending. Chinese domestic demand is headed into a virtuous cycle that could run for decades.

Reason to Buy China #6: Huge Foreign Reserves

In balance sheet terms, China is rich… massively rich.

We’ve already seen what can happen when cities and counties go bankrupt. The residents of Orange County, California, got a nasty taste of that. Jefferson County in Alabama was on the brink this year, too. (As with Orange County in 1994, they took on some really dumb trades.)

So it’s not good when some regional authority — be it local or national — is running short on cash. China doesn’t have that problem. If anything, they have the opposite problem. Economist Brad Setser estimates that China has somewhere between $2.3 trillion and $2.4 trillion in excess reserves.

That’s a lot of dough… enough to make a 20% down payment on the entire U.S. economy! And hundreds of billions more roll in every quarter.

Point being, money can’t always prevent bad things from happening. But it sure can fix a lot of things. If China has to take extra steps to keep economic growth on track or keep the domestic demand side humming, it certainly won’t be stymied by lack of funds.

Source: Six Reasons to Buy China

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Consider China the mother of all direct and indirect subsidies. Especially when it comes to the staging of the Beijing Olympics—the greatest coming out party a totalitarian government has ever staged.

Not that the others didn’t try. Hosting Olympic Games tends to be a fiscal nightmare for the host. The Athens Olympics resulted in massive budget deficits for Greece. Australian taxpayers will be paying off Olympic debt from the 2004 Games for a decade to the tune of $32 million a year. Even the Salt Lake City Winter Olympics in 2002 left Utah with a $155 million deficit.

The true cost of the Beijing Olympics will dwarf everything previously seen. But thanks to China’s inscrutable web of direct and indirect subsidies, their full extent will be as difficult to determine as the true cost of Chinese labor.

Beijing just added another layer. It will be carried by China’s heavy industry and power plants. Dozens of heavily polluting factories in Beijing and Hebei Provinces—scheduled for closure over the next two years—will be permanently closed before June.

Temporary shutdowns of other industries will last from July 17 until September 20 and will affect the neighbouring municipality Tianjin and the provinces of Hebei, Inner Mongolia, Shanxi, and Shandong. These provinces represent an area larger than France, Germany and Italy combined.

This will have a major effect on the electronical manufacturing industry and those companies who have been outsourcing their production to China. The closures will also reduce the supply of components, good and services to the affected industries. Steel maker Beijing Shougang Co. estimates that output this year will fall by 16% from 2007.

The hardest hit industries include electricity, petrochemicals, as well as coal and cement producers.
Chinese officials are just as reluctant to release details about the full extent of the shutdowns as they’d be to announce that torturing puppies had been added as an Olympic exhibition sport.

Idling production facilities will hit major companies like Eastern Petrochemical Co., China’s largest manufacturer of polyvinyl acetate. Beijing Eastern is owned by China Petrochemical Corp., or Sinopec (SNP:NYSE). Sinopec’s first-quarter profits already came it 70% lower than last year’s.

If you need a reason to be cautious around Chinese stocks this year, look no further than the effect of the Olympic shut-down on third-quarter earnings.

Source:  China Closures Spell Q3 Trouble

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