PLA link a plus for stocks

For Asia Times Online www.atimes.com
By Jens Kastner

TAIPEI – While the prospect of a trade war between China and Japan over the latter’s move to buy the disputed Senkaku/Diaoyu Islands excited analysts – without being quite sure who the winner would be – holders of Chinese shares with even the remotest connection to China’s People’s Liberation Army (PLA) are laughing up their sleeves.

Chinese shipbuilding and defense share jumped on September 11, the day Japan decided to purchase the islands from its private owners.

China-defense-mashup, a blog run by military-enthusiasts, is one outfit that keeps a firm eye on the Shanghai and Shenzhen A shares. On September 11 the overall index tumbled 0.67%, but the bloggers, evaluating the category of shares of companies that produce about anything that keeps the PLA going, took note of a relatively impressive 1.78% rise.
While China’s policymakers face sleepless nights from the prospect of conflict, the myriad Chinese enterprises that supply the PLA are enjoying handsome gains.

“Conflict is good for the defense sector,” said Ronald A Edwards, an expert on China’s political economy and professor at Tamkang University in Taipei. “For such companies, as in many countries, there are no ‘bad foreign engagements’.” These companies make money when their sales go up, and the motivation behind their products’ use is “irrelevant from an accountant’s point of view”.

It is arguably true for all countries with a developed military-industrial complex that defense-related stocks offer distinct and attractive characteristics to investors. An important one of which is counter-cyclicality, meaning that while the fortunes of most economic sectors rise and fall with the commercial business cycle, defense stocks do particularly well in times external negative factors, such as diplomatic tensions, make all others suffer.

There also is the weighty plus of political protection, as sales by and large depend on the state, which, to make matters even more promising, tends to make them relatively insensitive to price increases. China’s defense stocks are also benefiting from the PLA’s spectacular recent modernization, helped by a budget that will officially top US$100 billion this year but is believed to actually be much higher

There is also the country’s somewhat precarious strategic position: China is embroiled in a handful of unresolved territorial maritime and land issues, and whenever tensions flare up because one of them, related developments are set to leave their a mark on Shanghai and Shenzhen A shares.

For example, shipbuilding and defense stocks rose in June 2011, when Vietnam held live-fire exercises in the South China Sea. The received a similar boost around the same time when news broke on China’s construction of aircraft carriers that could possibly be intended for patrolling disputed waters, and also earlier this year, during a high-profile stand-off with the Philippines around the Scarborough Shoal.

Earlier, in October 2010, the launch of China’s unmanned lunar probe Chang’e 2, which came along with weighty military implications, was accompanied by sharp rises of defense stocks at a time when all other indexes turned downward. Similar gains were made on the death of North Korean leader Kim Jong-il.

But while China’s geopolitical troubles can make timely investing in the country’s defense shares a comfortable activity, there are significant obstacles to making easy money from the PLA. The most obvious is that the A shares on the Shanghai and Shenzhen exchanges are denominated in yuan and are closed to foreign investors with the exception of a very few select foreign institutions.

Professor Edwards holds that those restrictions alone are hardly an overwhelming turn-off to the determined foreign investor. “Everything in China is in the grey area until the spotlight gets turned on, which is rare,” he said. “As long as someone does not draw undue attention to themselves, there is likely a way around it.”

The bigger issue could be the relevant shares’ identification. Many of the recent Senkaku/Diaoyu dispute winners at Shanghai and Shenzhen are plainly obvious, such as China Shipbuilding Industry Corporation (CSIC), which is among the country’s two largest shipbuilding conglomerates and whose shares rose more than 6% on September 11. China Aerospace Science and Technology Corporation (CASC), the main contractor for the Chinese space program, Zhongyuan Special Steel and Fushun Special Steel are also readily identified – shares in the last two rose by their daily limit of 10% that day.

Spotting others takes more imagination, as it involves seemingly harmless dual-use goods. Changchun Yidong Clutch Co, which is listed as a manufacturer of automobile clutches for cars, buses and farm vehicles, rose on September 11, also bucking the general downward trend, as did Zhongbing photoelectric, which officially deals in computer embroidery machines but whose technology plays a crucial role in space craft and night vision goggles. Yaxing Anchor Chain, the proud maker of, well, anchor chains, was among those that reached its daily limit that day.

According to Professor Edwards, given China’s increased military spending and the prominent role of military leaders in policy, there is a tighter link between the defense sector and the state than in Western countries as well as Japan and Korea. This can make the who-is-who somewhat blurry.

“I doubt anyone really is that clear how many private and other state companies are linked up with the PLA, since many of these relationships and transactions are not made in a fully transparent way,” he said.

Jens Kastner is a Taipei-based journalist.

(Copyright 2012 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

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