Dirty Deeds in China

As the Chinese economy inhales a growing share of the
world’s natural resources, it also exhales a growing share
of the world’s pollutants. Cleaning up China’s industrial-
sized mess ought to become a lucrative business for
somebody.

Most investors – ourselves included – have been focusing
our attention on the companies that help to power China’s
rapidly industrializing economy. We have been investing,
for example, in the companies, that sell the iron ore that
feeds the country’s smoke-belching steel mills. But now, we
may want to begin thinking about investing in companies
that take the smoke out of the belch.

China boasts seven of the world’s 10 most polluted cities.
The rapidly industrializing Asian nation spews about 13% of
the world’s energy-related carbon dioxide emissions into
the atmosphere, second only to the United States. Now that
air pollution has become one of China’s principal exports,
we investors may want to consider investing in the
companies that will help China become cleaner…if we can
find them.

"We believe no industry in China will grow as quickly in
2005 – and for many years to come – as environmental
protection and improvement," predicts Donald Straszheim of
Straszheim Global Advisors, LLC. "China has no other choice
but to address this problem – and it knows it."

Nevertheless, identifying the problem is much easier than
identifying a publicly traded beneficiary of the clean-up
effort. Your editors at the Rude Awakening have not yet
pinpointed a "pure-play" on the nascent efforts by the Red
Chinese to become the "Green Chinese," but we are open to
informed ideas from our readership.

"There must be 1,000, maybe 10,000, ‘Love Canals’ in China
– absolutely toxic bodies of ‘water,’" Straszheim remarks.
The costs of this pollution – both human and financial –
are mounting.

"With a population well over one billion people," the
DisasterRelief.org observes, "the number of people affected
by pollution [in China] is considerably more than in any
other country in the world…an estimated 178,000 people in
major cities suffer premature death each year because of
pollution. Children in some major cities have blood-lead
levels averaging 80% higher than that considered dangerous
to mental development. Water pollution alone costs China $4
billion per year. Millions of people do not have access to
clean water."

The water falling from the skies over China is not much
healthier than what’s already on the ground. Acid rain
falls on about 30% of the country’s land mass. "Acid rain
in southern and southwestern China threatens to damage 10%
of the land area," DisasterRelief.org warns, "and may have
already reduced crop and forestry productivity by 3%."

In short, enterprising environmental services companies do
not lack for opportunities to ply their trades in China.
There is an "unprecedented opportunity" to correct the
damage, says Todd Johnson, lead author of a recent World
Bank report entitled, "Clear Water, Blue Skies."

"We see opportunities everywhere," says Straszehim, "air
pollution, water pollution and solid-waste landfill. China
needs to import high-tech environmental solutions – largely
from America, Japan, and Europe. There will be strong new
demand for a lot of environmental service providers.
Smokestack scrubbers are an obvious example, especially
with China’s almost 67% reliance on coal for energy.
China’s 26 million vehicles are extraordinarily inefficient
and polluting. China’s SEPA (State Environmental Protection
Administration) says 79% of China’s air pollution comes
from cars. There is great interest, but little activity
yet, in renewable (solar, wind, geothermal) energy – still
too expensive."

Three possible future beneficiaries of China’s clean up,
Straszheim suggests, might be Safety Kleen (SK),
Halliburton (HAL) or Asea Brown Boveri (ABB). Thus far,
however, none of these companies conducts a significant
amount of environmental service business in China. Your
editors are on the hunt for other companies well positioned
to benefit from the clean-up trend…but have yet to locate
any.

The hunt continues nonetheless, because we agree with
Straszheim when he asserts, "This market is too compelling
to ignore. As China increasingly dominates manufacturing,
environmental opportunities will flourish."

Did You Notice…?
By Eric J. Fry

The ghost of inflation’s future is spooking the financial
markets once again. The surprisingly high producer price
readings are aligning forces with stubbornly high oil
prices to terrify stock and bond investors. We think the
fear is justified. The recent dismal performance of
financial stocks suggests the haunting specter of inflation
may be more real than illusory.

Specifically, the recent breakdown of financial stocks
relative to "basic materials" stocks implies, according to
veteran technician John Murphy, "that the scale has finally
tipped in favor of inflation."

"When rate-sensitive stocks are in the lead," Murphy
explains, "deflation is dominant. When commodity-stocks
lead, inflation is dominant (or becoming so)."

The nearby chart presents an ETF for financial stocks
divided by an ETF for basic materials stocks. When the line
is rising, financial stocks are outperforming basic
materials stocks and when the lining is falling, financial
stocks are under-performing. At present, the financials are
clearly under-performing.

"The fact that the ratio has been trading sideways for
almost two years shows that deflation/inflation forces have
been pretty evenly balanced," says Murphy. But this week,
the ratio of IYG to XLB "broke down" to its lowest level in
three years.

This new inflationary trend, according to Murphy, "has
important implications for investors. For one thing, it’ll
be better to be in inflation-sensitive stocks (like basic
materials) than deflation-sensitive stocks (like
financials). It also hints at higher interest rates – both
short and long. All of which seems to strengthen my
negative view on the stock market and my preference for
cash, commodity-related stocks, and defensive stock groups
in general."

We would not quarrel with the veteran technician.

And the Markets…