Day 3

The third day of trading after the announcement allowing individaul Mainland citizens to trade HK stocks saw the HSI close up 617 at 22,346 with turnover of HK$80.07 billion. Buying was concentrated in H-shares i.e. shares of companies incorporated in the Mainlnad as these are expected to be the main beneficiaries of the relaxation.

There was some question as to the role of QDII now that individuals will be allowed to trade HK shares. QDII is aimed at the institutional market players with upwards of RMB 300,000 while individuals will be required to open accounts with at least RMB 100,000.

Effective today, interest rates on loans will rise by 0.18 percentage point (one-year) to 7.02% from 6.84%. Interest on deposits will go up 0.27 percentage point to 3.60% from 3.33%. The interest rate increase announced yesterday after market close by the Mainland authorities appears to have had little or no effect.

With the expiry of futures and options next week, there will be some interesting trading situations. Buy on weakness and sell into strength.

Note: As a matter of interest (pun strictly intended) interest rates and corresponding changes are divisible by 9. Mainland banks work on 360 days basis and using this makes it easier to calculate the interest.

Market Indices

• Hong Kong Hang Seng: 22,346.88 +2.84%
• Japan Nikkei: 15,900.64 -0.00%
• Shanghai Composite: 4,980.07 +0.50%
• Singapore STI*: 3,301.75 +2.26%
• South Korea Composite: 1,759.50 +1.34%
• Taiwan Weighted: 8,493.46 +0.17%

*Intraday trading

Up 1,020 then Pullback

As expected the market opened up, about 600, then it gapped up by 1,020 points on short covering. However, the momentumwas not sustainable and we finally closed up 200. Rather disappointing given the good news from the Mainland.

Actually, it is only natural that some investors will sell into rallies. I will be more worried if the market was up 1,020 today on top of yesterday. We finally closed up 133 at 21,729.

Consensus is that the Fed will cut Fed Funds rate soon. I believe that this will be the beginning of a string of cuts, and that eventually the turmoil will quieten down. At that time, the HK market will be driven by internal factors.

The Tianjin Factor

Yesterday, the Mainland Chinese State Administration of Foreign Exchange "SAFE" announced a pilot scheme that allows Mainland individual investors to invest directly in the HK market through the Tianjin special zone. This is the result of lobbying by the former Governor of the Central Bank Dia Xianglong who is now the mayor of Tianjin.

See http://www.gov.cn/english/2005-10/09/content_75318.htm

The scheme will allow Mainland investors to open foreign currency accounts with the Tianjin branch of Bank of China (or, any branch of BOC acting as agent for BOC for the Tianjin branch) and trade HK stocks. This was met with enthusiasm by Mainland investors who see HK as a more rational and "cheaper" market compared to Shanghai and Shenzhen. SAFE announced earlier this year that individual Mainland citizens may exchange up to US$50,000 per annumin foreign currencies. The Mainland has over US$1.33 trillion in foreign currency reserves.

The expected increase in investments and turnover will boost the HK market, and will act as an effective arbitrage mechanism for the Mainland and HK markets and close the gap in valuations of dual listed companies. The next step is to allow HK investors to trade in the Mainland markets through another "pilot" scheme?

The Bernanke Rally

The Federal Reserve cut the discount rate from 6.25% to 5.75% and encouraged banks to borrow at the discount window. The effect was stunning!

The HK market opend up 700 points and closed the day up 1,208 with turnover HK$105.3 Billion. The question is "Is this the end of the correction, or a dead cat bounce"?

The Fed has shown that it is ready to step in to correct market imbalances by providing much needed liquidity. Borrowings at the discount window can now be repaid after 3o days instead of the more usual 1 day. There is no question that the Fed will continue to inject liquidity until the storm blows over. That does not mean that it will rescue players from their own folly. By not cutting the Fed Funds rate at this time the Fed is treating this as a liquidity crunch only.

The worry is that this will spill over into the larger economy impacting the man in the street. It will certainly make it more difficult for unqualified buyers to get a mortgage which may not be such a bad thing. However, the homes market drives an increasingly large part of the economy, and a slowdown there will have an effect. This will affect US consumers and ultimately US imports of goods and services.

Right now, the Mainland is insulated from the worst of the battering. In fact, the correction comes at an opportune time for Mainland funds to start acquiring quality assets in HK at much lower valuations than 2 weeks ago. The market basically took off on the announcement of QDII relaxations even before Mainland funds were able to put in their applications to invest overseas.

The current problems in the US is also good news for the HK stock market because Mainland investors will prefer t5o stay closer to home and to invest in companies that they are more familiar with rather than exotic instruments. When QDII was first conceived, it was supposed to invest only in fixed income products on the assumption that they are "safer" than stocks. How time changes!

A "perfect storm"? How about 1,300 points down?

The market opened weak and was down 200-300 points. Tokyo was down over 900 in the morning and in the afternoon the Hang Seng Index followed Tokyo's lead and was down almost 1,300 points to under 20,000. It recovered with short covering and was down some 280 points at the close.

On Thursday, the trading pattern was very similar and there were rumours that futres brokers were receiving margin calls in mid trading as market volatility was outside expected norms, "a perfect storm". We saw many quant funds taking huge hits because the volatility was outside their parameters. When will we learn? This happened in 1997 with the Asian Financial crisis, the LTCM debacle, and the Russian meltdown. It's always the tail end of the bell curve that gets you.

Just as in the LTCM debacle, and the Russian meltdown fiasco (and in South America before that) we can expect the US Cavalry to ride to the recus. By that, I mean the US Federal Reserve. And right on cue, the Fed cuts the Fed Funds rate by 50 basis points. The "Greenspan put" is again in effect. There is really not much choice. Either you save US financial institutions from their own follies, or you watch the market implode from lack of liquidity and credit concerns. Unfortunately what happens on Wall Street will after Main Street. George Bush and the Republicans have enough to worry about in the Middle East. With an election year coming up, the last thing they need is is an economy that tanks.

So where does that leave us? Rumours have been flying around that Chinese money is poised to come in. The market got ahead of itself on the announcement of QDII and went straight up to almost 24,000. We are now back at the pre-QDII announcement levels at the beginning of the year. QDII applications are being approved. The current levels will let QDII money buy in a favourable levels now that hedge funds speculators have been shaken out.

HK Shares End Roller Coaster

Yesterday, HK shares ended almost flat after 5 days of volatile trading. The Hang Seng Index closed down 12 points at 22,443.

Last Thursday saw the HS Index down over 200 followed by down over 400 on Friday. When the US market closed down on Friday, everyone expected Monday to be a bloodbath. Monday was up over 200 followed by over 400 up on Tuesday on the back of good results from HSBC and Hang Seng Bank (which against all expectations reported net profits up lover 50%).

But this was not to last. Wednesday followed with over 700 points down giving back the gains over the last 2 days.

The worries were of course related to the sub prime loan fiasco in the US. Major concerns were that hedge funds will need to liquidate in order to meet margin calls in the US, or at least taking profits. Since, most major funds are also exposed to hedge funds, this can turn into a snowball.

Over the longer term, with the liquidity in Chiona, HK will weather this through as more funds are diverted our way via the QDII. But over the shorter term, we should expect to see more volatility.

The China Syndrome

How to Profit from the Chinese Boom
Over the past few 2 weeks the Chinese Government has taken several steps to cool the economy.

Last week, the China Banking Regulatory Commission (“CBRC”) announced that the Qualified Domestic Institutional Investors (“QDII”) quota can be invested in HKG stocks last week (previously only in fixed income products).
This week, the CBRC raised interest rates and banks reserves at the same time.
Does this mean the end to the “Rise of the Dragon”? The answer, as always, is yes and no.

Yes
The CBRC is showing that it is taking the surge in the stock market seriously. It understands that it would take very little to tip the market over the edge and the result is mass market hysterical boom which can only end in a very painful bust.
We can expect that the CBRC will continue to try to calm the market. However, the tools available are limited.

No
The Chinese market is in the beginning stage of a boom. Forget about the years before 2005. The Chinese Government was experimenting with the stock market in the early days. A lot of rubbish were listed and this lead to several major busts and scandals resulting in loss of confidence in the market.

Starting in 2005, under the guidance of the State-owned Assets Supervision and Administration Commission (SASAC), several major state-owned enterprises (“SOE’s”) were restructured and listed in HK. The process started with the banks and insurance companies ending in 2006 with the listing of Industrial and Commercial Bank of China (ICBC #1398) which became the largest IPO in the world ever. Only the Agricultural Bank of China is left to be listed but the restructuring is expected to take until late 2008, and even then we expect that this may be the first all A-share bank IPO.

During 2006, we have seen A-shares and H-shares listed in both HK and Shanghai. This will continue as the Chinese Government is under pressure to ensure that Chinese citizens share in the “bounty”. All privatizations overseas have ensured that local citizens benefited from the rise in stock prices after the IPO, and China should not be expected to be any different.

In the 2 years, we will see more SOE’s listed on both HK and Shanghai.
Where Do We Go From Here?

The Taiwan went up 5 times in 9 months in 1986/7. It then proceeded to defy all predictions of a crash rising another 4 times before finally plunging. Will the Chinese market be a repeat of this?

The conditions are very similar indeed. Except for a very small Qualified Foreign Institutional Investors (“QFII”) quota of USD10 billion and a failed experiment with B-shares (foreign owned and denominated in foreign currency), there is no foreign participation in the market. With daily turnover exceeding USD40 billion, it is clear that the bulk of the funds invested in the market are local.

Since until recently, banks and insurance companies were banned from investing in the stock market, the bulk of the investing is retail oriented. There are over 100 million stock trading accounts with over 200,000 new accounts opening daily.
Some companies are reported to be giving staff “trading breaks” to allow them to place their orders with brokers.

Are We Set For A Bust?
By Western standards, the Chinese market is way overheated trading in excess of 40 times forward price-earning ratio (“P/E”). However, it was explained to me last week in Beijing by a local investor that Chinese citizens have no where to put their money. A rate of return of 2.5% implicit in a P/E of 40 times is still better than bank deposits, and there is no need to explain to the tax man where it came from.
China has a huge trade surplus, foreign direct investments (“FDI”) is growing rapidly, and the RMB is appreciating against the USD. The end result is a booming property and stock market.

An Arbitrage Strategy
For the same company listed in both HK and Shanghai, the A-shares in Shanghai attract a higher P/E because of the lack of supply. With the lifting of restrictions on QDII, we are already seeing more Chinese money moving into the H-shares on HK market. We expect this to continue as the QDII quota is expanded.
The Chinese Government appears to have decided that the combination of QFII and QDII can serve as an appropriate arbitrage platform between the currently highly valued A-shares and their H-shares counterparts. Thus, we will see the valuations converging with the H-shares catching up.

The Chinese banks are a relatively safe bet as they are under the supervision of the CBRC in their banking operations i.e. an additional layer of supervision. The state-owned banks are trading at a lower valuation: CCB (#939), Bank of China (#3988), and ICBC (#1398).

Return of the Red Chips
There are a number of “red chips” i.e. companies which have re-domiciled outside of China and listed in HK. The China Securities Regulatory Commission (“CSRC”) announced last week that “red chips” with more than RMB1 billion in annual earnings will be allowed to list A-shares in China.
Several names have been mentioned as possible candidates: China Mobile (#941), China National Overseas Oil Co. “CNOOC” (#883), China Netcom (#906), Citic Pacific (#267).

Companies which were listed in HK in the 3 years are exempted from the RMB1 billion profits requirement e.g. Tianjin Port (#3382) is an example.
Restructuring

We expect that there will be massive restructuring in the non-bank SOE’s over the next 4 years.

The Chinese Government is looking to build some of these companies into world class competitors through injections of assets. We have seen in the past that assets injected into SOE’s have been beneficial in terms of shares prices and do not see any reason for this not to continue.

The following should be considered prime candidates for asset injections: China Coal (#1898), China Shenhua (#1088), and China National Building Materials “CNBM” #3323.

Conclusion
You cannot afford not to be invested in Chinese shares. Take advantage of market pull-backs to accumulate and trim your portfolio when valuations appear to be getting out of hand. But invest, you must.

National Council for Social Security Fund (NSSF)

The NSSF has opened an account with the CCASS to hold their allocation of H shares in the future. The NSSF receives 10% of the funds raised by floating state owned shares. In the past, this had been paid out in cash. By starting now, the NSSF is entitled to receive shares. The first company to fall under this is Hunan Non Ferrous Metals (#2626) which will be listed on Friday 31 March 2006.

This is a good thing for the HKG stock market because we have always lacked a big local long term investor. Now with the MPF and the NSSF, we should start to see steadier markets. Also, pensioners, current and future, will be able to benefit from dividends and capital gains on the HKG market.

The NSSF bought RMB 10 billion of Bank of Communications in July 2004 at $1.80. This is now trading AT $4.65 and the stake is now worth $25.8 billion. The NSSF has RMB 191.7 billion under management mostly in cash earning 3% interest. Some of it will find its way into the HKG market.

HK Services Mission to Dubai

I represented the HK Stockbrokers Association on the Mission to Dubai organised by the HK Trade Development Council. The Mission was led by Mr. Frederick Ma Si-hang Secretary for Financial services and the Treasury.

We left HKG on Saturday 25 March 2006 in the afternoon and arrived at Dubai (via Bahrain) after mid night. After checking in, we finally got to bed around 3am Sunday.

Sunday is a working day in Arabic countries and so we had a seminar on doing business in HKG in the morning. In the afternoon, we met with the Dubai Investment Group which owns most of the major projects in Dubai including the world famous hotel. Cocktails was hosted by the Chinese Consul General at the Shangri-La Hotel. In between we were shown some of the projects. Real Estate is cheap by HK standards.

On Monday morning, we met with the Chamber of Commerce, the Municipality Government and the Minister of Finance.

Mr. Paul Chow and I then left the group and met with the Dubai Financial Market (DFM) which is the domestic exchange. We then rejoined the group for a visit to the Dubai Financial Services Authority (DFSA) which is equivalent to our SFC. Paul and I then stayed behind while the group went off to Jeddah for the second leg of the Mission.

We visited the Dubai International Exchange (DIFX) which intends to be the international exchange for the middle east. The DIFX is situated in the Dubai International Center (DIFC) which is almost an autonomous part of Dubai with its own legal system (for commercial, properties, and securities) and courts. Settlement is in USD in contrast with the DFM. Apparently, they have a "remote membership" category and I am exploring this to see if our members can trade Dubai stocks.

Philippine Stock Exchange Chairman's Cup

On 4 March 2006, Edward Kwan and I were invited by the PSE to play in their Annual Chairman's Cup. It was held on the Midlands Course of Tagaytay Golf Course which, by the way, is bulit on the edge of a volcano.

We did not win any prizes (Filipinos play golf almost everyday) but we made a lot of friends. Edward even managed an "eagle" on a par 5 hole.

We were on the 1st tee with Francis Lim the CEO of PSE and Omar Cruz treasury Secretary of the Philippines.

#939 China Construction Bank

After touching a high of $3.875, CCB has settled into a very narrow trading range of $3.450 thru $3.500. Waiting for a breakthru here. Daily turnover is high.

HK Stockbrokers Association Golf Day

Our Golf tournament this year was held on 12 March 2006 at the Mission Hills on the very challenging Vijay Singh Course. The course was in great condition and the staff at Mission Hills were very attentive. Thanks to Mr Tenniel Chu and his staff for the arrangements.

A total of 49 golfers took part in the tournament including our special guests Mr Frederick Ma Si-hang Secretary for the Financial Sercives and the Treasury, Mr Martin Wheatley Chairman of the Securities and Futures Commission, Mr Peter Au-Yang Executive Director of Securities and Futures Commission, Mr Fong Hup Director of the Hong Kong Exchanges and Clearing Limited, and Mr Gary Cheung CEO of the Hong Kong Securities Institute.

The HKSBA Cup (decided on the New New Peoria Handicap Method) was won by our Vice-Chairman Mr Edward Kwan, while the Best Gross Winner was won by Mr. Stephen Wong. The ladies winner was none other than Ms Yao Sze Ling who has won this so many times in the past. The individual winners were:

The Second New New Peoria - Mr. Alec Tsui
The Third New New Peoria - Mr. Gary Cheung

The Second Best Gross - Mr. Gilbert Leung
The Third Best Gross - Mr. Andrew Tsui

The Nearest to the Pin - Mr. Edward Kwan
The Longest Drive - Mr. Chris Li

The Second Best Lady - Ms. Rosanna Lee
The Third Best Lady - Ms. Alice Chan
The Fourth Best Lady - Ms. Kitty Lee

One of our members, Mr Kent Tong arranged for each participant to receive a copy of “Pearl River Delta Golf Course Guide”. Thanks Kent.

Finally, we must thank Mr Jimmy Fong and Mr Wilfred Wong for making all the arrangements. Without their help, we would not have been able to have such a great outing.

HKSBA Donation to HK Police

On 19 December 2005, the securities industry gathered together at a dinner to congratulate Charles Lee (Independent Non-executive Director of the Year), Paul Chow (Executive Director of the Year), the HKEx Board (Board of the Year)and Charles Lee, Marvin Cheung and Henry Fan joining the Executive Council, and Paul Chow receiving the Silver Bauhinia Star.

During the evening, many comments were made as to the excellent job that the HK Police had done during the WTO. In particular, the restraint that they showed in the face of violent provocation, and the expedient way they handled the clearance of Gloucester Road was a credit to HKG. The efficient way they handled the WTO protestors contributed to the stability, prosperity and harmony of our community.

The HK Stockbrokers Association (HKSBA) expressed our appreciation to Charles Lee and hoped that he and the other members of the Executive Council (i.e. Henry Fan and Marvin Cheung) would express our gratitude to the appropriate authorities in their capacity as Exco members.

The HKSBA announced during the dinner that we would try to raise an amount for the police welfare fund as a token of our appreciation. We decided to put up HK$100,000 in the name of the Hksba and called for further donations. We had a further donation of HK$100,000 on the morning of Tuesday.

Some members of the committee, together with Charles Lee, met with Dick Lee, Commissioner of Police on Tuesday and delivered a cheque for HK$200,000 in the name of the Hksba.

WTO Conference in HKG

Well, what have we done here? We invited the WTO Conference to HKG and forgot that they come with a bunch of militant Korean demonstrators. Today is the first day, and they are already attacking the Police who were remarkably tolerant. Watching it on TV, I wanted to go and crack a few heads! The Korean farmers are protesting that WTO is depriving them of a living and that we should either go back to isolation or they should get MORE government subsidies. But why demonstrtate in HKG? Go home!!!

#27 Galaxy

The stock started to recover after an article in the SCMP today said that their US$600 million bond issue was oversubscribed. They now have more than enough money to fund their development until the new casino opens.

#939 China Construction Bank - 2

Not a good day for the stock. Today 24 warrants on CCB started trading but unfortunately, the stock trended down instead of up. High of $2.575 and low of $2.475. Spent most of the day at $2.50 down $0.05.

#939 China Construction Bank

After briefly trading below issue price, CCB has moved up slowly but surely to HK$2.60. The first warrants on CCB will be traded on 19 December 2005, and I expect the price to move up. Remember the performance of Bank of Communications when the warrants are traded?

(Note: I own CCB shares)

#823 LINK REIT

The performance of the Link REIT is over and above all expectations. This morning the high is $12.10, and currently $12.00. For retail clients, this is a $2.30 profit assuming no interest costs. Not too shabby for a punt.

Hutchison #13 3G Harvest Time!

Finally, it looks like Hutchison #13 will start getting pay back from its long investment in 3G. The Italian operations will be listed in November 2005. Hutchison could gain up to HK 18 billion (depending on valuation).

(Note: I own Hutchison.)

HSBC Announced Good Results

HSBC #5 announced good results at the top end of analysts expectations. The market react positively to the news and is up 90 as of 10:22am. Bank Of Communications #3328 is benefiting from its relationship with HSBC.

Cheung Kong #1 (up 0.70 to 85.300 and Hutchison #13 (up 0.35 to 76.35) are still the market leaders.

(Note: I own all of the above except for HSBC.)