Caution About China

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There is no way any of us would get caught up in an Internet-like mania again after what happened in 2000, right? No way.

Not so fast, my friend. Over the last few months I have had concerns about the mania, of sorts, over anything to do with China. I buy into everything that is going on in China as far as growth, modernization, consumption, and demand for resources coming from there.

China is also playing an ever-important role in the world's economy. It is funding our deficit, having bought $470 billion, and counting, worth of U.S. Treasury debt. According to International Data Group, $400 million in venture capital has migrated to China. The U.S. has a $54 billion trade deficit, and $15 billion of that is with China. So there is no doubt that China, as an economic power, is finally on the map.

Investing in China seems like an obvious theme to me. This is where we start to have issues. Wall Street and Shanghai are keenly aware of the demand that exists in the States for access to Chinese equity markets. We have had several initial public offerings (IPOs) in the last few months. Some, such as Shanda Interactive (Nasdaq: SNDA), have been very successful, and some, such as China Life (NYSE: LFC), have been very mediocre.

Recently, China Power International Development Ltd. cut its planned IPO by about 20% to $267 million after a lukewarm response from investors.

On Thursday, we saw another IPO, Hutchison Telecom (NYSE: HTX), which is a spinoff from Hutchison Wampoa, come to market with a less than ideal response. This IPO has been in the works for months. Hutchison was hoping to raise $1.5 billion in the deal, but because of poor investor interest, the deal was reduced to $1.1 billion. Further evidence of poor demand was that the stock did not trade at or above the $11.67 initial price all day. Poor demand for IPOs was one of the signs of the end of the Internet mania.

Another thing to watch out for is the creation of products that offer ways to invest in a particular area of the market. On Oct. 8, Barclays Global, in conjunction with the Financial Times, created the iShares FTSE/Xinhua China 25 Index Fund (NYSE: FXI). The fund invests in 25 of the largest and most liquid companies in China and is a good proxy for exposure to China. In 1999, Merrill Lynch created the first of many new products when it rolled out the Internet HOLDRs (AMEX: HHH).

To be clear, I am not saying China is what the Internet was. I am saying that it makes sense to pay attention to the supply and demand for Chinese shares. Stock market manias all follow the same cycle. First there is huge demand by investors; the investment banks then shake the money tree, creating more and more supply. At some point, supply dwarfs demand and prices drop, so prudent investors should watch out.

Fool contributor Roger Nusbaum is an investment manager and wildland firefighter in Prescott, Ariz. At press time, neither he nor his clients owned any of the stocks mentioned .