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Professional Portfolio Management Integrity, Trust and Experience Professional PORTFOLIO MANAGEMENT Discretionary Portfolio Management Spring 2004 Economic Commentary China Syndrome Portfolio Manager D. Anthony G. Pringle, CFA (416) 842-7067 [email protected] Portfolio Manager John M. Lewis (416) 842-7034 [email protected] Portfolio Manager Douglas G. Dobson (416) 842-7228 [email protected] Investment Advisor Caroline Daigneault, CFA (416) 842-3257 [email protected] Fax: (416) 842-7362 Toll-free: 1-800-561-4468 RBC Dominion Securities Inc. BCE Place 181 Bay Street, 7th Floor Toronto, Ontario M5J 2T3 2004 might be called the year of the China Syndrome. With approximately the same landmass as the USA, it has a population of roughly 1.3 billion, about 4.5 times that of the USA. In a few short years, it has transformed itself from an under-developed country to a manufacturing giant. China, and other Indo-Asian countries are now massive manufacturers of just about everything for the world. The population is shifting from rural agrarian to more urban. With better paying jobs, workers are buying homes, furnishings, and cars. This consumption and household formation, as well as their growing manufacturing base, has turned China into a huge consumer of resources and commodities. For instance, China is now the second largest importer of oil in the world, behind the USA, and in 2003, it consumed one half of the world’s concrete. This is clearly a huge force in motion, and as world citizens and investors, we need to pay attention. China’s remarkable growth and development is helping Japan emerge from its decade old economic slump. China is very close to surpassing the United States as Japan’s biggest trading partner due to strong exports to China. Stateside, the US economy is growing well, fuelled by very loose money conditions including low interest rates. Tax cuts, and mortgage refinancing continue to propel consumer spending and new housing. Excess industrial capacity due to over-investment in the late 1990’s has kept job creation low until recently. However the latest data showed strong job creation and confirmed the strength of the economic recovery. This recent data will improve George Bush’s chances of re-election in November. In the currency markets, pressure is building for China to revalue its currency, the Yuan, upward. It is currently fixed to the US dollar, which was fine until the massive amounts of commodities it imports skyrocketed in price. Due to trade flows, the fixed Yuan/ US dollar peg has put unwanted upward pressure on the Euro and the Yen. We think that a Yuan revaluation is coming, and may have major negative implications for US bonds and the US dollar. To maintain its currency peg, China currently has a huge appetite for US bonds and dollars, which will likely diminish after a revaluation. With Continued on Page 2 Continued from Page 1 massive current account and trade deficits continuing, and budget deficits growing, we think that the US dollar may have further downside versus other currencies. Interest rates, currently at abnormally low levels, have begun to move up in North America as evidence of economic recovery mounts. As the weeks pass and growth continues, we think that rates will move up, perhaps dramatically. The massive stimulus created by the US authorities to re-start their economy will likely produce increased inflation at some point ahead. levels, worldwide growth, and rising corporate profits, we think this general trend is likely to continue. Many industries will benefit from new demand for resources, commodities and goods from the rapid expansion in China and the East. However, many areas of the market have bounced back to levels that appear to be beyond their fundamental value and prospects. Looking at the horizon, we see some risks arising from rising interest rates and the still unknown ramifications of currency revaluation and devaluation. For the moment, on balance, we are optimistic that the world wide economic expansion will remain on track. For this reason, we prefer to keep bond commitments short term, and are wary of the interest sensitive areas of the stock market, including income trusts. However, with several countries of the world now growing well, and with rates at historically low levels, we think it will be some time before rising rates slow economic growth. All in all, we remain optimistic that there will be good opportunities in the market in the year ahead. The world is enjoying its first synchronized recovery in ten years. As always, we will do our best to protect your interests, and to look for quality investments. World stock markets have enjoyed a welcome rally. With money supply very loose, interest rates at historically low Tony Pringle, CFA March 31, 2004 Canada & U.S. 10 Year Bonds CRB Spot Commodity Prices Index 320 7 300 6 280 260 5 240 4 220 200 3 99 00 01 02 03 Source: Federal Reserve Board, Statistics Canada RBC Dominion Securities Inc. 04 99 00 01 02 03 04 Source: Commodity Research Bureau is a member company of RBC Investments. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness.This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities.This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof.The inventories of RBC Dominion Securities Inc.may from time to time include securities mentioned herein.RBC Dominion Securities Inc. and Royal Bank of Canada are separate corporate entities which are affiliated. Investment Advisors are employees of RBC Dominion Securities Inc. Insurance products are offered through RBC DS Financial Services (Ontario) Inc., an insurance subsidiary of RBC Dominion Securities Inc. When discussing life insurance products, Investment Advisors are acting as Insurance Representatives of RBC DS Financial Services (Ontario) Inc. Member CIPF. ™Trademark of Royal Bank of Canada. RBC Investments is a registered trademark of Royal Bank of Canada.Used under licence. ©Copyright 2004. All rights reserved.