China Keeps Moving Forward, Stock Market Grows Up

By: John_Derrick

Regulators in Beijing have approved a variety of investment products and strategies that are commonplace in mature stock markets: margin accounts for trading, stock index futures and short selling.

A trial period will come first, so it’s not yet clear when the millions of investors in China will be able to execute a short sale or buy stocks on margin. But just the decision to move forward on this front indicates that the government recognizes that its highly liquid markets are ready for more sophisticated strategies.

Chinese investors now have only one direction to go – long-only. If they don’t like a particular company’s prospects, they can either avoid it or, if they own it already, they can sell.

The result is that the country’s stock market is subject to wild mood swings – the Shanghai Composite index, for instance, saw a 130 percent gain in 2006, followed by a 97 percent gain in 2007, a 65 percent tumble in 2008 and an 80 percent gain last year.

Until the measures are fully implemented, we won’t know for certain the benefits and the risks of giving investors more tools to work with.

China’s regulators are optimistic about the impact of the changes. “This improves the stability and the healthy development of the capital markets,” the China Securities Regulatory Commission said on its web site.

Some market observers, however, say that the typical Chinese investor is not ready to take their game to a higher level, perhaps not unlike elevating a decent high school basketball player into the NBA. Their worry is that small-time investors won’t be able to keep up with their better-equipped professional competitors, and that an already volatile market could become even more volatile.

One risk is that, without the proper regulatory structure on shorting, the potential exists for selling pressure similar to what we saw in the U.S. market after the “uptick” rule was removed a couple of years ago. On the other hand, futures and margin-buying could allow speculation that would drive markets higher, which would be a positive.

Overall, we think approval of these new products and strategies are a clear sign that the Beijing leadership believes the worst of the 2008 financial crisis is behind them and that China is ready to refocus on its goal of becoming an important global financial center.

By John Derrick

John Derrick, CFA, is director of research at U.S. Global Investors, which manages mutual funds specializing in natural resources, emerging markets and global infrastructure. 

For more insight on global markets, read the most-recent version of the U.S. Global Investors Weekly Investor Alert or visit CEO Frank Holmes’ investment blog Frank Talk.

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