Issue: June/August 2008
Trilinear Investment Managers

Buoyancy of the South African share market has largely been stimulated – and sustained – by the commodities boom emanating from China. Will it continue?
How might future developments in China affect opportunities for South African investors?
Trilinear Investment Managers, based in Cape Town, went there to find out.


In China, this is the year of the rat. It will be key in China’s history. About to host the Olympics, with all the controversy over its human-rights record coming to the fore, and challenges over its integration into the global economy coming to a head, what happens there affects us all.

The sheer size of the Chinese economy (about to overtake Germany as the third largest), its continued rate of growth (beginning to slow) and the adjustments it will have to make (partly because of higher inflation and reduced export demand) will impact on economies worldwide.

We nevertheless expect that its ongoing demand for resources will underpin firm commodity prices. Also, its policy to protect its own natural resources, and exploit those of others, will continue. With commodity prices remaining high, faster appreciation of its currency should alleviate higher costs of its imported agricultural and energy inputs.

But the greatest risk to the Chinese consumer, and potentially the broader economy, lies in the asset markets and specifically the stock market. The bulk of new participants into the stock market have no real understanding of the risks and believe that its past meteoric rise can continue indefinitely.

Some facts about China

  • It is one of the world’s most resource-rich countries. It is the largest producer of lead, zinc, tin, aluminium and coal; one of the top five producers of gold and silver, and one of the top 10 producing copper, nickel and oil. It is also one of the largest agricultural producers, from rice and tea to wheat and rubber.
  • With 1,35 billion people, it has the world’s largest population. With 21,4% of them under age 15, and only 10,9% over age 60, it does not suffer the problems of ageing demographics found in many developed nations.
  • Although some 800 million of its people still live in rural communities, there are no fewer than 49 cities each with over a million people. Shanghai, the most populous with 17 million people, alone has more than 5 000 buildings higher than 20 floors.

Front row L-R: Krishna Sathee, Head of Fixed Income;
Zandie Mlambo, Business Development Director;
Megan Davids, Fixed Income Analyst; 
Craig Titus, Dealer;
Back row: Menzi Nkosi, Head of Alternative Investments;
Junaid Bray, Portfolio Manager; Bruce Anderson,
Head of Equities; Arthur Johnson,
Head of Research; Mechael Crain,
Investment Systems

The weight of their investments has caused a bubble. On the ‘A’ market (which lists shares in Shanghai and Shenzhen almost entirely for investment by Chinese citizens), the average price is at a multiple of 43 times earnings.

By contrast, the ‘H’ share market (which lists the shares of China-incorporated companies in Hong Kong) trades at an average multiple of 27 times historic earnings. Were capital controls and prohibitions on short selling to be relaxed, the gap is likely to diminish and the ‘A’ bubble could burst.

The ‘A’ share market holds the most risk as a result of its artificial pricing and high multiple. Even with a 31% growth in earnings, being the upper end of expectations, the forward price/earnings ratio is still 33 times. It is vulnerable to dramatically accentuated movements.

Further, the 60% pricing gap between the ‘A’ and ‘H’ markets creates massive potential for arbitrage. Should the Chinese authorities want to drain excess liquidity, they could induce a sell-off of ‘A’ shares in Shanghai and Shenzhen for investors to buy exactly the same shares at a lower price in Hong Kong.

South African investors might want to consider investing in the Chinese market by investing in:

  • Funds exposed to the ‘H’ share market, or in Asian markets (as well as Australia) that benefit most from China’s rapid growth;
  • Companies (notably resource companies) whose main source of growth is from supplying Chinese companies;
  • Companies exposed to what China most wants to buy outright, which obviously requires identification of potential targets for its global buying sprees (e.g. the recent purchase by Chinese bank ICBC of 20% in South Africa’s Standard Bank).

The discerning investor might well conclude that the potential returns are still worth the risks.

Trilinear is an Authorised Financial Services Provider
Registration Number: 566