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The Daily Reckoning | Wednesday, May 26, 2010 Markets buck and heave as commentators play pin the tail on the cause, An investment opportunity in the "most Russian" of all Chinese cities, Plus, Bill Bonner on the coming nightmare on Main Street and the Feds running  out of ammunition... Lower Lows and Lower Highs Buckling up for the bumpy ride down Joel Bowman A few quick words from Taipei, Taiwan... The Dow began yesterday in the doldrums, well below the psychological 10,000-point mark. By the close, it had posted a marginal loss, a victory of sorts. The remarkable intraday turnaround even led some commentators to suggest the bottom may be in, that the worst may be behind us. To these folks we quietly caution: Look out ahead! We have no way of knowing for certain, of course, if yesterday's sub- 10k flirtation marks some kind of post-bounce nadir for stocks, or if it is merely another, run-of-the-mill lower low; one to be followed by a painful succession of increasingly lower lows and disappointingly lower highs. If forced to guess, we'd say the action is just getting started and that those who haven't yet buckled in for a bumpy ride south may soon find themselves thrown from the rollercoaster altogether. But what do we know? If you want deft, surgical precision, you'd have to ask the neckties on television. In stark contrast to our own lack of omnipotence, the mainstream press knows exactly what's going on.  "Investor fears about the economic outlook eased," CNN announced this morning, witlessly explaining Mr. Market's reversal of fortunes. And if the market falls? Well, that's easy, they say: Investor fear about the economic outlook must have risen! Only the brain dead would employ these people to do their thinking for them...and even then it might not be an improvement.  But one shouldn't be disheartened, fellow reckoner. This kind of simplistic viewpoint is exactly what you would expect from a group who, collectively, misdiagnosed a crisis of overconfidence as a crisis of confidence; who believe fatal instances of insolvency can be cured with aimless injections of liquidity; and who routinely mistake their elbows for their knees.  Often times, the only way to get the real scoop on what's happening on the ground is to actually go there - to kick the tires, meet the locals and see the events unfolding for yourself. So that's exactly what a few of your editors did last week when we visited China's capital, Beijing. Bill Bonner, Addison Wiggin, Chris Mayer and Yours Truly spent the week shaking hands, asking questions and gathering some boots-on-ground analysis of one of the world's most important markets. In today's column, our resident value hound, Chris Mayer, makes the case for one Chinese sector that ought to be chugging along for a while yet. Please enjoy... And now for today's column... The Daily Reckoning Presents The "China Story" is Not Dead Yet Chris Mayer The city of Harbin lies on the banks of the Songhua River in the northeast of China, in what was Manchuria. This 10th largest city in China is a good place to see how some of the best opportunities in the next phase of China's expansion come together. In particular, there are huge profits sitting out there in the expansion of China's rail and subway systems. But first, a little context... Located near Siberia, Harbin is the most Russian of all Chinese cities. The skyline's onion domes and spires evoke St. Petersburg or Moscow. At one time, Harbin was home to the largest Russian enclave outside of Moscow. Today, it is a key rail hub and inland port like Chicago or Kansas City in the US. Harbin is the largest inland port in the northeast. Five major railways also converge here. They carry crops farmed from the black earth of Harbin and the surrounding countryside. The soil here is among the best in China, nutrient rich and fertile. Harbin is also an industrial city making all kinds of things. It may be best known for its power equipment. Harbin alone has cranked out about one-third of all the installed capacity of hydro and thermal power in China. It's this confluence of rail, light industry and agriculture that makes Harbin emblematic of some of the most exciting and promising new opportunities in China. Let's look at the rail network. Trains, like cars or aircraft, need lots of parts. They need a whole mess of stuff from motors to signaling equipment. China's market for rail components is booming. That's because the Chinese are laying track at a pace that would've made Cornelius Vanderbilt proud. The Financial Times reports that there are plans to lay nearly 19,000 miles of track over the next five years. At that pace, China will overtake Russia as the world's second largest rail infrastructure. Only the US will be bigger. These railroads will creak and groan under the weight of rail cars loaded with grains as well as coal from China's hinterlands and Mongolia. Harbin is in the middle of it all. China's market for rail components will grow fivefold in the next three years, to more than $50 billion, according to estimates by McKinsey. In 2010, more than half of all the money spent on rail equipment in the world will be spent in China. It's not just railroads; China's subway market is already the largest in the world, too. There are currently 10 cities that run 31 subway lines of more than 500 miles. In December, the Chinese government approved 22 new subway lines that will cost at least $129 billion to build. The growth in this sector is simply staggering. By the end of 2010 alone, China will have 53 subway lines totaling more than 1,000 miles in length and requiring over 6,000 cars. In the next five years, China will add another 600-plus miles to the system, bringing the total number of systems to nearly 90. So the opportunity for the makers of rail components is obvious. There is an added wrinkle here, though. The Chinese government mandates that 70% of the components have to be produced by Chinese companies. Therefore, the biggest beneficiaries will be you-know-who. The Chinese rail outfitters are already tough international competitors. They are the low-cost providers. They are also becoming world-renowned for their rail exploits. The Chinese, after all, finally conquered the great permafrost on the road to Lhasa, Tibet. China's companies are also competing effectively abroad, bidding on work in South America and the Middle East. The main constraint is capacity. Their home market is giving them everything they can handle. It should stay hot for the next few years, at least. In any event, the best way to get a piece of the action is to buy a Chinese company that makes the stuff the railroads and subways need. Hearing the phrase "buying a Chinese company," an investor might wince. Investing in China sounds risky, but I wonder how risky it really is and compared with what. The US, for instance, is hardly a safe haven anymore. The line that separates the US and Europe from emerging markets like China may be less than is supposed, at least from an investor's viewpoint. All this is to say don't let your prejudices blind you to opportunities in so-called emerging markets. Most people still have little idea of just how big the so-called emerging markets have become. Marko Dimitrijevic, who runs Everest Capital, pointed out in a recent Barron's interview: "The BRIC countries [Brazil, Russia, India and China] are larger than developed Europe. But strikingly to us, the other emerging markets, the non-BRICs, are now larger than US or developed Europe." Even though emerging markets have been growing fast for years, these facts seem to have snuck up on us. A good analogy might be the old bit about the lily pads on a pond that double their population every day. One day, the pond is half full of lilies. The very next day, lilies cover the whole pond. The biggest emerging market of all is China. I liked what Eric Kraus, the astute observer and Moscow-based money manager writes about China in his latest letter. He says he is "now almost embarrassed to go on about the secular rise of China - we would not bother were this not the single greatest economic and geopolitical shift of our lifetimes..." Admittedly, China has its own problems, and it will have dramatic ups and downs. But China in 2010 is something like the US in 1910. It has lots of room to grow. Some of the cheapest stocks in today's market are the US-listed securities of China-based companies. It's here you can pick up stocks in good companies, with strong balance sheets and owner-operators, growing 25%-plus a year for less than 10 times earnings. I recently alerted the subscribers of Capital & Crisis to a Chinese company that has the inside track on those metro trains and freight cars. In fact, it's the only Chinese company to have met international standards - and at half of the cost of imports from the competition. It is in prime position to be the vendor of choice in China. In fact, its equipment is so good, it is the only Chinese company exporting to blue chip US companies. This world-class company is just one example of a "China Story" that is just getting started. But please bear in mind that the investment road ahead in China will not be smooth. Chinese stocks will certainly subject investors to gut-wrenching volatility. But that's just the price of admission to the "single greatest economic and geopolitical shift of our lifetimes." Chris Mayer,  for The Daily Reckoning Joel's Note: Chris is currently putting together a report detailing his best ideas from the trip just gone for Mayer's Special Situations subscribers. We'll let you know as soon as this information hits the virtual shelves. In the meantime, you might like to check out his introductory newsletter, Capital & Crisis. It goes for a fraction of the price of his premium MSS service and provides excellent, though inexpensive, insights into the global investment landscape. Give it a try today, here. Bill Bonner Crisis or Recovery: Tales From a Conflicted  Economy Bill Bonner Reckoning from Paris, France... "Call it a nightmare," says Dave Rosenberg. Markets all over the world went down again yesterday. The Dow dropped below 10,000 in the morning trading...then came back to give up a modest 22 points by the closing bell. The Wall Street Journal says it's time to start worrying about a "double dip recession."  We suspect that output will dip below zero again - giving us, technically, a 'double dip' recession. But calling it a recession misses the point. It's not just a pause. It's a change...a Great Correction. There's something else going on...something much more important and much harder to deal with than an ordinary recession. The feds have thrown everything into the battle to stop this downturn. No matter how you look at it, the ammunition spent in this fight has been spectacular.  And it hasn't worked. Unemployment has actually gotten worse. Private sector credit has declined. And what's this? "Falling home prices raise fears of new bottom," says a headline. People talk of 'recovery,' but it's now three years after the crisis began and there is no recovery. Instead, there's another crisis on the horizon. And now the trouble is, the feds don't have much ammunition left. Interest rates are already at zero; they can't go lower. And the federal deficit is already as much as 10% of GDP.  Besides, it's becoming clear that all that ammunition fired off so far was wasted! It got us nothing but more debt.  The problem was never a recession. It was too much debt in the private sector. But the feds misunderstood it. They thought it was a regular recession that they could 'cure' with more credit and more spending. So, they added trillions of new debt in the public sector! They claimed to have spared the world economy a worse disaster. But now that worst disaster is happening anyway. The bad dream has turned into a nightmare. Because it's not just the private sector going broke; governments are going broke too. Not that we have any new information on the subject. And we wait to be proven wrong. But we can add and subtract. And when we add up the debt totals in the developed world - the US, Europe, and Japan - what we get are some pretty big numbers. Government debt alone is $32 trillion. That's for a combined economy of about $34 trillion.  Right now, with the lowest interest rates in 30 years, it's still possible for most 'western' governments to pay the interest and finance their deficits. But Europe has already run into trouble. Every government in Europe is scrambling to come up with a credible plan for budget cuts. David Cameron announced his plan just yesterday. "Austerity plans multiply in Europe," says the headline in yesterday's Figaro. And those poor French bureaucrats! They're supposed to cut expenses by 10% next year.  In Japan and America, on the other hand, deficit spending still looks easy. Aside from a few cranks, clairvoyants and Daily Reckoning readers, everyone seems to think things will be all right forever. There is no serious pressure to cut budgets - except at the state level. The Pentagon still has a blank check - it just fills in the amount each year. Health care expenses still grow like weeds without winter. Few people realize that America's finances are already no better than those of Greece. Fewer still care. But heck, we're not going to go around with a long face about it. Nope. So what if the stock market begins the terminal phase of its long bear market - the one that began ten years ago? So what if the real estate market takes the next stairway down towards more foreclosures and lower prices? So what if the feds go broke?  We're not going to sweat it. Instead, we're going to enjoy it. But how? Ah... Well, first, we're going to stay out of US stocks in the short run. Then, we're going to get out of US bonds and the US dollar...too. We're going to stay in cash and gold... And maybe we'll learn to speak Chinese... And more thoughts... Deep Do-Do Horizon... Well, Rand Paul, Ron's son, has already put his foot in his mouth.  He's quoted in the news telling the media to back off and give BP a break. "Everybody makes mistakes..." he says. Of course, Rand is right. Even huge oil companies err. And anyone who tries to drill a hole in the earth's crust a mile below the surface of the water, is bound to have a few 'uh oh' moments. The size of the 'uh oh' in this case could be breathtaking. Who knows? On the one hand, the oil company acts like our son, Edward, 16, when he drops a glass or forgets to do his homework. "It's no big deal... Don't get all excited about it..." he says. On the other, there are 'experts' predicting an EE - an 'extinction event.' If enough black goo oozes out of the hole, they say, it could poison all the oceans...and make the planet uninhabitable! The continental US will be a land crowned with brotherhood from slick to shining slick.  We don't know what to think. So we don't think anything at all. Besides, the newspaper tells us that Kevin Costner has invented a new technology for cleaning up the ocean - called "ocean therapy." No kidding. But the media is on BP's case. And the politicians too. Nobody likes a big oil company. And Rand Paul's comment - according to the press - just proves the man is not fit to sit in the US Congress. The press wants someone who knows how to fake outrage when the moment calls for it. We don't know Rand Paul; we only know his father. Pere Paul is the kind of politician the country needs but won't accept. He offers real 'change.' That is to say, if he had the power to do so, he would unwind the welfare/warfare state. He would more-or-less, let people alone to get on with their own lives again. But that is not what Americans want...neither Republicans, Democrats, nor Tea Party members. Nor is it what voters want. What the man on the street seems to want is cheaper gasoline, free health care, food stamps, Social Security, wars and boondoggles. At least, that's what the evidence suggests. He wants protection from everything and a free lunch too. We don't know about Rand. But as for Ron...the country doesn't deserve him.  Regards, Bill Bonner,  for The Daily Reckoning