Chinese Burn – why Sino Forest might just be a tipping point.

June 27, 2011

Global Macro

I am an unabashed China bull and believe that the urbanisation trend is a long run phenomenon which will endure for a couple of decades yet and help power the mining sector here and elsewhere. But that does not mean that China is immune from the normal cycles of boom and bust nor the human frailties that are associated with operating businesses.

But I must admit that the Sino-Forest issues that have arisen over the past few weeks is a little out of left field but has massive repercussions.

If you’re not across the story Sino-Forest is a Canadian listed Chinese company which says that it runs its business “by cultivating and harvesting trees in a sustainable manner. Our principal businesses include the ownership and management of forest plantation trees, the sale of standing timber and logs, and the complementary manufacturing of downstream engineered-wood products.”

The issue now is that after publication of a report by Muddy Waters LLC, a Hong Kong based Hedge Fund and short seller, doubting the numbers Sino-Forest was reporting causing it to lose the confidence of the market and its share price crashed causing other noted hedge fund managers to exit its share register with pretty big losses.

Now in markets stuff like this happens all the time, there not supposed to but they do so on its own this issue isn’t that remarkable. Indeed writing in Bloomberg last week William Pesek Jr said

Why is it a surprise that some Chinese companies have dodgy finances? One reason we are so quick to assume the worst is that Lehman, after months of vehement denials in 2008, really was a house of cards. Before that, WorldCom and Parmalat really had cooked their books as Wall Street looked the other way.

So why are markets quick to believe a little-known investor such as Carson Block, the head of the Hong Kong research firm Muddy Waters, when he questions China? Few short-sellers make lots of money betting against China, but the ranks of Carson and his ilk are growing. That is partly a reflection of the fear that the great Chinese crash is coming.

One worry is that the first wave of bad loans from China’s huge 2008-2009 stimulus is about to hit. The bigger concern is how growth in recent years left the domestic financial system less resilient.

But right at the moment with Europe in such a state, the global economy clearly slowing and markets very close to going into full “risk off” mode Sino-Forest seems to have taken on an importance beyond its own relevance.

As Pesek notes some are pointing to this as the Chinese equity market’s “Enron” moment and as such the boom in its entirety is being questioned. I may be too sanguine but these are different issues for us here in Australia. Yes, certainly, if this is the thin end of some sort of Chinese accounting scandal we will see foreigners exit Chinese shares in droves – but it is not going to change the trend toward urbanisation in China one iota. But markets don’t care about that at the moment – any excuse to be bearish in the current environment is being taken.

Quoting Pesek again he says,

China is now the world’s second-biggest economy, but there is a growing sense that it is due for a setback. The country has proved it can live without consumers in Japan, Europe and the US for a couple of years. But a third or fourth year as the world heads into an economic soft patch or worse?

Everyone liked having a bright spot amid the gloom after the world financial crisis. Now China’s prospects are becoming as murky as the governance of its companies.

Markets everywhere are at really important junctures as we pointed out in our weekly wrap on Saturday where the positives are going to come from at the moment is hard to see but we are, as yet, not at a pessimistic crescendo either. So we are not at the type of extreme bearishness which would support a sustainable bounce.

It could be an interesting winter.   Circumspection remains our mantra.

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at or Greg directly on

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