China and India are two tremendously important countries to the future of the world economy. They are both growing rapidly. They account for about 1/3 of the world’s population. Their evolving business enterprises and resource consumption patterns are disruptive to the world business order. They are displacing developed countries in terms of GDP ranking.

However, China and India are not a unit and thinking about them as “CHINDIA” is probably not a good portfolio management idea. They are quite different and should probably be thought of and dealt with separately in a portfolio.

The Chindia concept is a really good marketing concept for fund sponsors seeking various ways to attract investors, but the packaging may not be best for portfolio management purposes.

We believe that China and India are more competitors than partners; each developing from opposite ends of the manufacturing to services spectrum. They are sufficiently different in our view that investors should invest in them through single country funds such as INP (or IIF) for India; or FXI (or CAF) for China.

Buying a single Chindia fund, such as First Trust ISE Chindia (FNI) locks the investor into a particular country allocation (2/3 China and 1/3 India today) which may or may not be ideal and which limits allocation flexibility. We also expect that many investors in Chindia funds do not know the country allocation they are getting.

In practice, we recommend investing in single country funds of any kind only after first establishinga core emerging markets position through a diversified emerging markets index fund such as iShares EEM or Vanguard VWO.

The qualitative arguments for equivalency or difference abound. This article presents objective, quantitative differences that support our argument that the two countries should be dealt with separately.

Some Qualitative Arguments for Difference:

BARRON’s December 24, 2007, Arjun Divecha, Partner, GMO said, “India has benefited hugely from this misperception of Chindia. By linking China and India together, people think that India is in the same league as China when, in fact, it is not.”

Divecha says that India is where China was 15 years ago and is overvalued as a result of being tied so much to China in investor’s thinking.

WikiPedia says, “The economic strengths of these two countries are widely considered complementary - China is perceived to be strong in manufacturing and infrastructure while India is perceived to be strong in services and information technology. China is stronger in hardware while India is stronger in software. China is stronger in physical markets while India is stronger in financial markets. … However, there are also geopolitical differences between China and India that some argue would make this term [Chindia] inappropriate … [including] effects of the Sino-Indian War of 1962 … Their political systems are also vastly different, with China being ruled by a single party and India being the world’s largest democracy.”

Also of great importance, India has a larger problem with terrorist attacks and violent independence movements than China. Pakistan and its vulnerability to Al Quaeda and related movements is a specific risk to India for which there is no comparable risk for China.

QUANTITATIVE PERSPECTIVE:

These data are taken from several sources, including the U.S. Census Department, the CIA Factbook, the United Nations, the International Monetary Fund, the Economist Intelligence Unit and some others.

Country Risks:

India presents lower country risk than China. The Economist ranks the banking risk of India BBB and China B. It ranks the Political risk of India BBB and China B. Both countries are ranked BBB in terms of sovereign debt default risk and currency risk.

Country risk here does not speak to market risks associated with valuation.

Stock Markets:

The market capitalization of the 10 largest companies today in China is $1.8 trillion, whereas the market capitalization of the 10 largest companies in India is only $0.5 trillion.

Similarly, at year-end 2006 the total stock market capitalization of China was $2.4 trillion versus India where it was only $0.8 trillion.

Direct Investment:

China has received more than 10 times the total foreign direct investment as India ($700 billion versus $68 billion).

China has made direct investments abroad that are more than 3 times that of India ($67 billion versus $21 billion).

GDP:

The Chinese GDP expressed in US dollars is three times the Indian GDP ($2.5 trillion versus $0.8 trillion). On a purchasing power parity basis, the Chinese GDP is two and a half times the Indian GDP ($10.2 trillion versus $4.2 trillion).

Growth in per capital GDP has been quite different as the multi-year chart below shows:

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Current Account Balance:

China’s current account balance is positive and growing strongly, while India’s has meandered and recently gone negative, as the chart below shows:

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Energy:

China produces 3 times the electricity of India; more than 4 times the oil; and more than 1.5 times the natural gas.

On the consumption side, China consumes more than twice the oil of India and almost 1.5 times the natural gas.

Other Resource Consumption:

China recently accounted for 29% of global zinc consumption compared to 3.8% for India. China accounted for 25% of world aluminum consumption compared to 2.6% for India. China’s share of global oil consumption was 9% versus 3% by India.

Population:

Approximately 1/3 of the world’s population is either Indian or Chinese, but the populations of China and India are quite different from each other.

India’s population is smaller than China’s, but is growing more rapidly. In 1995, China had nearly 33% more people. By 2005, China had less than 20% more people. By 2025, their populations will be about equal. After that, India will have a larger population.

You can see from the chart below that China and India have quite different population structures.

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India has a population that is growing younger and that will continue to supply young people to the labor force for a long time. China has an aging population that will show labor supply problems without net inflow of migrants.

India today has 6 times the number of people migrating out of the country as China.

China has a 40% lower infant mortality rate than India, and a longer life expectancy.

Labor and Income Distribution:

China and India have roughly equal acreage of arable land, but China has a much smaller portion of its people in agriculture than India (45% versus 60%). China has twice the proportion in industrial jobs (24% versus 12%), and a similar portion in service jobs (31% versus 28%).

China has a lower rate of urban unemployment (4.2% versus 7.8%) and far fewer below the poverty line (10% versus 25%) – although we don’t know how reliable that may be. Both have about 1/3 of total income in the hands of the top 10% of households.

Literacy:

Literacy is dramatically different. Only 61% of Indians over the age of 15 can read and write, while nearly 91% of Chinese over 15 can read and write. The development and therefore economic value of women is higher in China where 86.5% are literate, whereas in India only 47.8% of women are literate.

Religion:

The religious composition is dissimilar.

Hindus account for over 80% of the Indian population, but are negligibly represented in China. Muslims account for over 13% of the India population, but are only about 1% to 2% of the China population. Christians are about 2.3% in India and 3% to 4% in China.

China does not report religious composition as thoroughly as India, but China is greatly influenced by Taoism and Confucianism which have ancient roots there.

India and China do not have similar populations in terms of guiding belief systems.

Languages:

India has numerous regional languages with English as the official government and business language. China has one basic language with regional variations. Mandarin Chinese is the standard language.

Legal system:

India’s legal system is based on English common law while China’s is based on civil law derived from the Soviet Union and continental European legal principles.

India’s judiciary reviews legislation, while China’s legislature retains the right to interpret its laws.

India accepts compulsory International Court of Justice jurisdiction, while China does not.

Political System:

India is a multi-party democracy. China is a single-party controlled state.

Land:

China has 3 times the land area and 2 times the coast line length of India. China has a lower percentage of arable land, but the total acreage of arable land is about the same in both countries.

Natural Resources:

India has the fourth largest coal reserves in the world, while China has the world’s largest hydropower potential.

Transportation and Roadways:

India and China have roughly equal mileage of paved roads, but with 3 times the land area, the density of roads in China is much less than in India. The rail density is closer to parity, but India does have higher rail density than China.

In terms of major airports (those with paved runways over 3,000 meters), China has 58 and India has only 18.

Telecommunications:

India has more than 3 times as many cell phones as China, but China has 7 times as many land lines as India. Combining cell phones and land lines, India has twice as many phones as China, yet a slightly smaller population.

China has more than 2 times as many internet users as India.

Military:

China spends 4.3% of its GDP on its military versus 2.5% by India. In total US dollars, the Chinese military budget is five times the size of the Indian military budget.

* * *

From almost every metric, China and India are very different countries. They are neighbors. They are important and disruptive to the old order of things. They are interesting investments, but they are not unified and “Chindia” is a portfolio concept that could lead to unwarranted conclusions and allocations.

We recommend analyzing and treating India and China as separate portfolio investments.

Richard Shaw
QVM Group LLC

Disclosure: author does not own any named security.

The US Department of Energy “Annual Energy Outlook, 2008″ predicts that oil prices will decline to $58 by 2016, measured in constant 2006 dollars, in their most likely scenario.  They predict real prices will rise from 2016 through 2030 to $72 in constant 2006 dollars. 

Today’s West Texas Intermediate crude prices are about $93.

The Dept. of Energy is therefore predicting an approximate 38% decline in oil prices over the next 8 years.

Their short term prediction for 2007 back in 2006 was for crude to be around $57 — way off the mark.

An interesting perspective is the $30 break-even price for Saudi Arabia, as reported by the National Bank of Kuwait in mid-2006.  The table below shows the break-even oil price for the Gulf Cooperation Council countries, showing an overall break-even price of $38. 

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Canada’s oil sands are the second largest oil reserves in the world.  The largest oil sands syncrude producer is Canadian Oil Sands Trust which reports a current break-even cost of about $33 per barrel.

The table below shows the oil reserves of key countries.  Note that the Canadian reserves are overwhelmingly oil sands. 

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Oil sands have not come into full productive capacity, but their cost is significant.  Canadian Oil Sands Trust is a large, if not the largest, player in the oil sands / syncrude market.   While their break-even costs are about $33, Kurt Wulf of McDep Associates recently reported that PetroCanada’s new oil sands project will have a break-even cost over $50 per barrel up from $25 per barrel five years earlier.

Given these break-even figures and the willingness of producers to fund projects with $50 break-even costs, we should not expect to see much in the way of long-term supply below about $40 or $50, even in low price scenarios.  

The GCC countries have undertaken substantial development of their non-hydrocarbon economies.  They depend on profits from oil to fund much of that development.  They cannot afford to sell oil near cost and still support their non-oil development programs.  Don’t count on sacrifice plays from Saudi Arabia or other OPEC countries.  Oil is way up and we think it will stay well above break-even costs for a long time.

There were periods in the past when oil was cheap, but then OPEC was non-existent or weak, and there was no global rise of emerging economies. With China and India alone needing ever more oil to grow their economies, and the possibility of peak oil being here or near, we don’t see any long-term scenario other than high oil prices.

Regardless of your view of whether we have hit “peak oil”, the fact of rising costs of production is clear.

With rising break-even costs and no clear evidence of near-term abatement of geopolitical risks and fears, we find the price predictions by the Department of Energy to be difficult to believe.  We hope they are right, but doubt they are right. 

This is probably bullish for oil commodity funds  and for oil royalty trusts  and certain other companies rich in oil reserves.

On the other hand if the Department of Energy is correct about a slide to $58 per barrel through 2016, oil commodity owners will see significant losses.

Whether directly or indirectly, your portfolio is senstive to the price of oil to some degree.

We think the Department of Energy is too optimistic about prices coming down. They are energy experts and we are not.  Nonetheless, we have to make a bet within our portfolio and maybe you do too.

Richard Shaw
QVM Group LLC

“Frontier markets”, those stock markets not yet evolved enough to be called “emerging markets”, will become the next emerging markets. This is part of a natural progression as today’s emerging markets are reclassified as “developed”.

Israel (ISL) and Singapore (EWS) are examples of former emerging markets now viewed as developed. Countries go through a growth path from having no market, as was recently the case in Russia (TRF), through frontier status to emerging status to developed status.

Early recognition of new opportunities is one potentially rewarding approach to investing. Knowing about and watching trends is part of early recognition. That’s one reason you may want to keep and eye on frontier markets.

MSCI recently published an index of 19 frontier markets: Bulgaria, Croatia, Estonia, Kazakhstan, Romania, Slovenia, Ukraine, Kenya, Mauritius, Nigeria, Tunisia, Bahrain, Kuwait, Oman, Qatar, U.A.E., Lebanon, Sri Lanka, and Vietnam.

In a recent article, we published information about the size of those country markets and about personal income and economic growth rates in those countries.

In this article, we provide the name, industry and web address of the largest public company (with a website) in each frontier market. (click image to enlarge)

Generally, the top company is a bank or telecommunications company.

There are not many opportunities for pure frontier market investments. Direct access to the countries is possible, but not at all easy.

T. Rowe Price has a new mutual fund (TRAMX), launched in September, that focuses on the Middle East and Africa that is interesting for frontier markets. Barclays has a developed country ETF for Austria (EWO) that has companies that do a lot of business in frontier markets of Europe. A small Vietnam based asset manager offers a closed-end fund available to U.S. investors through the London Stock Exchange. The fund is called Vietnam Opportunity Fund (VOF:LN) — note high expenses approaching 8%. We are not providing any positive or negative recommendation on these stocks, just noting their existence for those interested in researching them further.

We anticipate the publication of the MSCI frontier markets index and similar current or future action by S&P and FTSE will spur the introduction of other frontier market funds.

Keep your eyes and ears open to new developments in this evolving investment area.

Richard Shaw
QVM Group LLC

Disclosure: The author does not currently own any security named in this article.