Is the China Story Over?

If you read the financial press, then you've seen at least one pundit declare that China is done.

Heck, the Shanghai Composite dropped 8% Tuesday and another 2% Wednesday. In its U.S. listing, megacap stalwart PetroChina (NYSE: PTR  ) has shed 25% of its value since the year began, while Suntech Power (NYSE: STP  ) has been cut in half. In just the past week, New York-listed Chinese stocks Ctrip.com (Nasdaq: CTRP  ) , LDK Solar (NYSE: LDK  ) , and Focus Media (Nasdaq: FMCN  ) have dropped 10% or more.

Many -- particularly, the unsophisticated investors who trade on China's domestic markets -- are selling as though the jig is up.

And maybe it is ...

After all, the China story is almost a decade old now, and we've devoted conferences, books, magazines, and TV specials to telling and retelling it in the States. In addition, China's 25-year streak of double-digit GDP growth will be coming to an end this year. Its economy today is starting to look more like that of a developed superpower than a souped-up growth story.

What China is and isn't
If you travel to Shanghai or Beijing, the story looks like it's in its final chapter. Skyscrapers stand tall as far as the eye can see (which is, admittedly, not that far given the air pollution), and luxury storefronts -- the real stuff -- line the main avenues. In Beijing, the CCTV (China Central Television) building -- with its two Rem Koolhaas-designed cantilevered towers that come together more than 700 feet above the ground -- may be the most advanced architectural marvel on the planet.

You might be asking yourself, "What more is there to do?"

What you have to remember is that Beijing and Shanghai do not equal China any more than New York equals the United States. Beijing and Shanghai have more than 30 million people between them; China has 1.3 billion.

The Chinese financial experiment launched 30 years ago did not contemplate turning a few big cities into world-class financial centers. Rather, it contemplated improving the financial lives of everyone in the country. And on that score, there's a long, long way to go. You can see this a few miles outside of Beijing. You can really see it in a massive second-tier city like Xi'an.

But first, about the volatility
The Chinese stock market was among the hottest in the world from 2003 to 2007. Since last autumn, the Shanghai Stock Index (made up of the country's largest companies traded in China) has dropped by more than half. The "traded in China" part is important, as it provides almost all the context you need to know about what happened earlier this week.

You see, China's stock markets are essentially closed to foreign investors, and Chinese citizens have minimal to no access to any stock markets outside of China. Plus, there are no short-sales and no derivatives markets. This means, quite simply, that the Chinese stock market is not economics-driven. It's liquidity-driven, pushed up and down by millions of unsophisticated investors who plowed their money into the market in search of the next sure thing.

What happens in Shanghai or in Shenzhen has almost no impact at all on the U.S. listings of Chinese companies, companies like Ctrip.com or PetroChina. (Although, as mentioned at the start, these companies have been sold off here in the States, too.) In November, PetroChina's Chinese IPO valued it at $1 trillion. Its U.S. share price hardly moved, though it was valued in New York at scarcely one-third that amount. Point being: Ignore the wiggles and waggles of the Chinese market. It's still an adolescent, reacting more to hormonal shifts than anything approaching logic.

Man, this is hard work
Right now, we are on a Motley Fool Global Gains research trip in Asia. Our goal in coming here was to get the investor's view from the ground. That's why we went to Xi'an -- to see "the real China."

When we visited Xi'an earlier this week, we took a ride out to see Emperor Shi Huangdi's -- the first emperor of China's -- Terracotta Army. Built and buried 1.5 kilometers from the emperor's tomb back in 210 B.C., the 8,000 soldiers -- constructed by 700,000 workers -- were to serve as his protectors in the afterlife. And every soldier was unique.

Most amazing, however, is that no one knew they were down there until a farmer digging a well uncovered a head in 1974. There was no written record of the army's existence, and nearly 2,200 years passed between the time a shovel concealed them and the time a shovel revealed them.

Yes, China is that old
When the Terracotta Army was constructed, China was a burgeoning power with the aspiration to control vast territories in Asia. This is why, when you talk to many Chinese, particularly those with a sense of history, they call China a re-emerging nation.

Because Xi'an is not just ancient history. It's also a modern Tier Two city southwest of Beijing that the government has anointed the hub for its planned western migration. That makes it a tipping point ... a place where China's past comes face to face with its future.

In the area just north of the city, you can see the small, struggling agrarian villages of 20 years ago, as well as the massive factories of 10 years ago. They're situated side by side as though they were a spectrum for Chinese development.

Yet when you drive past these places, you're the only car on a modern and massive six-lane highway ... a ghost road.

The mystery of the ghost road
Despite the volatility that has characterized the Chinese stock market this year, China is very much a planned economy. This is why -- as investors -- we're told to pay attention to the government's five-year plans. (They're a cheat sheet for identifying promising investment themes.)

So when the government decided that Xi'an would serve as the center for westward migration, it also set to making sure that it would turn out that way. That means tax incentives, forced consolidations, and -- the explanation for the ghost roads -- billions of dollars of infrastructure investment.

As a result, the foundation for the next chapter of Xi'an's story has been laid. It will be a different city in a few years. When we asked Johnnie Wang, assistant president of China Green Agriculture (OTC BB: CGAG) and our host during much of our time in Xi'an, what would happen to villages and small stores that currently compose much of the north side of the city, his reply was simply, "In three years, they will all be gone."

They are to be replaced by the industrial parks that will drive the move west, and by the massive apartment complexes that will house the millions of rural villagers who will move to the city to find work.

When the past meets ...
But there's tension in Xi'an. Given the role that the city has played in China's history, the people are particularly cognizant of their traditions ... traditions they stand to lose to rapid urbanization. Johnnie is one of those guys. He's torn. When he took us to see the Terracotta Army, he made sure we got a tour guide because otherwise, "we'd just see the figures without understanding their significance."

Yet he works for a company that has earned a rich valuation by making organic fertilizers from state-of-the-art R&D and manufacturing facilities. That rich valuation isn't that much of a shock, truth be told -- it's what you get when you cross the runaway success of industry players Potash (NYSE: POT  ) and Monsanto (NYSE: MON  ) with China's massive market opportunity (population 1.3 billion).

This business plan straddles the line between the past (sustainable farming) and the future (pursuing the means necessary to feed an enormous population).

But China Green isn't just on the right side of China's move to more sustainable and environmentally friendly growth. It's the first company in the space to get nationwide distribution and target industry consolidation ... to use Western processes to subvert an otherwise traditional industry. (You can read all of our notes from the meeting with China Green by clicking here. If you're not a Global Gains subscriber, just sign up to become a free guest member.)

It's history hanging in tension with the future. That's how it goes in China ... where the story is very clearly not over.

Sign up for a free 30-day trial of Global Gains to get additional notes and the team's favorite investment ideas from the trip, along with our best stock picks worldwide!

Tim Hanson and Bill Mann really are in Asia right now searching for new investment opportunities. Neither Tim nor Bill owns shares of any company mentioned. Ctrip is a Hidden Gems recommendation. Suntech Power and Focus Media are Rule Breakers recommendations. The Fool's disclosure policy is always open for business.


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