Mark Lister: Getting ahead of the investor herd in China

A growing middle class in China is expected to increase demand for protein, providing more export opportunities for the dairy sector. Photo / Christine Cornege

China's ongoing growth, rising incomes and urbanisation, and its consequent demand for Australasia's hard commodities and foodstuffs, is a much talked about investment theme in this part of the world.

Like any theme based on extrapolating trends, investors should tread warily. That said, the numbers behind China's growth are staggering and compelling.

New Zealand, blessed as it is with high rainfall, is well placed to benefit from a China that is expected to become a major importer of food.

China is facing what could be described as a perfect storm in food, with demand rising for nutritious foods such as dairy products and meat as incomes rise, at the same time as food production faces constraints as the country's water resources become depleted.

We hosted two interesting speakers recently. China-based Li-Gang Liu, head of China economic research for ANZ, provided great insights into long-term economic trends in China, and Murray Gibb, the chief executive of Water NZ, explained the scale and value of New Zealand's water resources.

Liu believes economic growth in China has slowed from the 11 per cent-plus seen in recent years. He expects growth of 9.6 per cent next year. Importantly, he sees this lower rate of growth as being sustainable for at least the next five years without causing undue inflationary pressures. Compare that with New Zealand, where it only takes the economy to grow by 3 per cent for inflation to rear its head.

He regards urbanisation as a major trend in China. It is forecast that 350 million people in China will migrate from rural areas to urban areas over the next 15 years. This is three times the 103 million rural Chinese who have migrated to urban areas since 1990.

Urbanisation is a major driver of Chinese demand for hard commodities such as iron ore. The infrastructural development needed to accommodate such enormous urbanisation is vast.

Planned development in coming years includes construction of one million km of roads, 28,000km of metro rail, 170 mass-transit systems, 97 new airports and 40 billion sq m of floor space (that is, two Chicago's every year) for the next 15 years.

Of course, demand for energy will also rise. Energy usage is expected to more than double by 2025. All of which is good news for Australia and its resources and energy sectors.

For New Zealand, the main development to watch is the growing middle class. Chinese GDP per capita is US$4000 ($5700), although there are now 120 million people who have incomes of US$7000 a year. This growing middle class and rise in incomes should see an increase in demand for higher-value food products, such as protein foods like dairy produce and meat.

This was a trend seen in Japan in the 1960s, when per capita income grew rapidly and, with it, demand for agricultural imports.

Also in New Zealand's favour is that water shortages should see China become a major food importer. China has only one-third of the freshwater per capita of the global average. Unfortunately the worst water shortages occur in the most populous northern region, which has only 19 per cent of China's naturally available water resources, but 46 per cent of the population.

The north also accounts for nearly half the arable land, so a water shortfall has major implications for food production. As urbanisation increases, a higher proportion of China's water will be required for residential consumption, rather than be available for use in agriculture.

China's growing demand for energy, hard commodities and high-value agricultural products bodes well for Australia and New Zealand over the long term.

Australia is a low-cost producer of bulk commodities and has a geographic advantage over other producers in South America and Africa. It also offers a stable political and regulatory environment.

Although New Zealand doesn't have Australia's iron ore, we do have more water than our neighbour. According to Water NZ, New Zealand receives 500sq km of rainfall a year, the same as Australia.

Our rainfall averages 2m a year, more than double the world average of 0.8m. What is sometimes overlooked is that food production is water intensive. One litre of water is required to produce a calorie of food, and 2000l to 3000l is required to satisfy one person's daily dietary needs.

You could argue that when New Zealand exports food, we are essentially exporting water.

This ample rainfall underpins New Zealand's position as a low-cost producer of protein - we are adept at turning grass into protein. Our farming methods are efficient, we have a reputation for producing safe food, we are relatively close to China and, like Australia, offer a stable political and regulatory environment.

With total GDP of US$5 trillion, China has just overtaken Japan as the world's second largest economy behind the United States, which has GDP of US$14 trillion. As is already clear, China is increasingly important on the global stage.

The New Zealand and Australian economies are increasingly dependent and leveraged to China. China takes 10 per cent of New Zealand's exports, about the same level as the United States. Australia is still our most important market, taking 23 per cent of our exports.

However, we effectively have further exposure to China through Australia, as China is Australia's second largest export market behind Japan. China now takes 13 per cent of Australia's exports.

When you look at the numbers behind China's growth, and combine that with New Zealand's wealth of water and Australia's commodity reserves, it is not difficult to build an optimistic case for the Australian and New Zealand economies.

Adding to the case is that similar growth to that seen in China is occurring in many other Asian countries.

Investors can gain access to the China theme by buying companies in New Zealand involved in farming and exporting, and by holding resource stocks in Australia. But it's not without risks.

Firstly, it's no secret. Investors are well aware of China's potential and much of the future growth from China is possibly already built into share prices.

Secondly, any number of issues could undermine China's growth trajectory and, given Australasia's increasingly high level of dependency on this market, it would have a negative impact Downunder.

And finally, as any farmer will tell you, we need to get the rain.

* Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice.