Expecting Upside In Chinese Energy Stocks

My view towards the Chinese market and Chinese stocks remains positive (it will take a lot for me to change my optimism). However, with that said, my view is over the long-term and not the short-term. Over the coming weeks I expect a healthy correction, giving another opportunity for investors to get back in cheap (we’ve already been observing daily dips with Chinese stocks since last week).

Note that Chinese companies normally list on a few exchanges. Domestically in Shanghai with their A-shares, in Hong Kong with what’s called their H-shares, and then here in the US with their ADRs. It’s interesting to note that on average, A-shares have been trading as high as 50x EPS, while their sibling H-shares trades substantially 50% lower at an average of 22x EPS.

I’d say the Chinese market is running ahead of fundamentals. The Chinese government is evidently getting concerned with a bubble burst. A little under a month ago the China Banking Regulatory Commission clarified on the Qualified Domestic Institutional Investors [QDII] rule by allowing individuals to buy foreign listed shares with a minimum entry of RMB300,000 (USD39,220) and capped at a maximum of 50% of their total equity portfolio. If you think “so what?” think about being locked up in a cage and only eating rice, and then finally set free and permitted to eat burgers and pizza – there will be an influx of customers.

So with that news, I’m expecting two things –

1) Money to come out of A-shares, and with that, a drop in their prices and a correction and

2) Money to flow to the closest foreign market. Hong Kong, and Hong Kong listed companies will benefit – as will their ADRs listed here.

Overall though, one area that I believe will survive a pop will be China’s energy sector. So focus on ADRs like CNOOC Limited (NYSE: CEO), PetroChina Company Limited (NYSE: PTR) and Sinopec Shanghai Petrochemical Co. (NYSE: SHI). On a global-scale, crude prices have always been volatile. As we enter into the hurricane and summer driving season and together with US inventories hitting historical lows (according to The Shrok Report, domestic output 7.7% below historical norm), does US$70 a barrel make sense? I’d put money on it! Keep your eyes open on a few other factors that may drive up prices:

– Will we finally be leaving Iraq? Though that’s what we all want, it will leave Iraq in a bigger mess than before Bush created the disaster – further destabilizing prices and oil supply.

– What about Iran? The nuclear standoff still persists and fears will exponentiation of prices. According to The Daily Telegraph, Iran already raised petrol price by 25%.

– Does every one remember Borat – the funny character from Kazakhstan? His president Nursultan Nasarbayez has made himself president for life (imagine if Bush did that). A number of oil companies have assets there and about 1.3M barrels are produced a day.

– How about Nigeria and the rebel attacks? Their situation will affect world prices.

In my opinion, these price increases will substantially help Chinese energy companies.