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Commentary and Review by portfolio manager Edmund Harriss

November 2009

Asia

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October marked a period of consolidation in Asian equity markets, with generally

good third quarter corporate results, balanced against an increasing likelihood of

monetary tightening. Asian banks, autos and technology companies had partic-

ularly strong results, demonstrating that Asian household finances remain solid,

and there is a willingness and desire to spend. In addition, until monetary condi-

tions tighten in Asia, asset and property markets are likely to remain firm.

Highlights

Market Review

Market Outlook

China Economic Monitor

WWW.GAFUNDS.COM ASIA BRIEF 1

November 2009

This month the gains of the Asian equity markets began to slow down and consolidate, with pull-

backs in Australia, Japan, Taiwan, Korea, Singapore Thailand and Indonesia. By contrast, equities in

China, Malaysia and the Philippines continued to perform well, and rose during the month.

Given the exceptional monetary easing of recent months, market attention has now turned to when

policy will begin to tighten, and what the impact will be on any recovery in economic growth. On

October 6, Australia became the first of the major nations globally to change policy direction, and

increased short term interest rates by 0.25% to 3.5%. The rationale for the move was to cool local

asset markets, particularly property but the net effect has been to attract further capital flows in part

we believe, from those seeking to take advantage of Chinese demand via Australian resources.

Chinese resources imports have been strong this year, particularly for coal, but the danger is the high

correlation between the weakening US dollar and resources prices in general. Locally in China, there

have been calls to begin to tighten monetary policy, most notably from the chairman of China Mer-

chants’ bank, Qin Xiao, who called for a shift to a neutral policy to account for recent movements in

asset markets. The sharp increases in property and land prices in mainland China have been raising

concerns in some quarters.

Property prices have also been increasing in Hong Kong, where there have been some eye-catching

deals at record prices per square foot. However, it is important to keep this in perspective – Hong

Kong still has a currency peg to the US dollar, and thus is obliged to follow US monetary policy re-

gardless of its suitability for short term conditions. In the absence of flexibility in the currency, the

Hong Kong property market has taken the brunt of loose money through price increases. For China,

the same does not apply despite the lack of currency flexibility. The overall economy is much bigger,

and Hong Kong is a small territory with administrative limitations on supply of new land. By contrast,

improving home ownership in China is a policy target of the government, and land sales are an im-

portant source of revenues for local governments.

While it is likely the Peoples’ Bank of China will begin to tighten monetary policy in the coming

months, this is against the backdrop of an actual pick-up in economic activity, unlike many other

countries. In the third quarter, Chinese real economic growth (i.e. excluding the effect of inflation)

was 8.9%, suggesting that the stimulus policy has been able to keep growth around its recent trend.

The corporate earnings season has been going remarkably well for many Asia firms in our opinion,

most notably the banks.

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briefAsia

ASIA BRIEF 2

Highlights

November 2009

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Twelve months ago, many commentators were predicting a sharp spike up in non-performing loans

as a proportion of total loans (NPLs) in Asia, particularly in Korea, where household indebtedness

ranks along side that of the leading industrial economies. Looking at the first nine months of this

year, it is clear that the expected NPLs have simply not come to pass, and for some banks they have

actually fallen this year as a percentage of loans.

Similarly in Thailand, whose financial system was virtually destroyed during the Asian crisis of

1997/8, the latest results from the banks have indicated a level of balance sheet strength markedly

at odds with those in the developed world. Set against this, overall outstanding loans are 6.9% down

compared to the beginning of 2008. However, the overall picture in Asia is one of well capitalised

banks, and we believe that this is a good foundation on which to build future economic growth.

There was also some strength in the export sector this quarter, particularly in the Technology indus-

try on the back of solid growth in sales of high end handsets and Notebook PCs. Our discussions

with Asian distributors suggest that there was some order recovery in September for Notebook PCs,

suggesting that demand in the next few months from the developed world may be reasonable. Usu-

ally Asian technology firms have a one-year rolling forecast of likely orders from their customers,

which becomes a firm order 1-3 months before delivery – but this year, order visibility has been down

to 2-4 weeks for many firms. Now, however, visibility seems to be beginning to normalise. Firms in

the Asian technology supply chain from the semiconductor foundries, down to those firms that as-

semble the finished goods, are offering reasonable guidance for the last few months of this year, and

we expect that October and November are likely to be decent months compared to past years.

The launch of Windows 7 on October 22 further highlighted the potential for growth in PCs into

2010, and we are particularly excited about potential for corporate spending in this sector. Given the

failure of Windows Vista to drive a new hardware replacement cycle, many corporate users are still

on Windows XP, launched on October 25, 2001. Given the advances in hardware and application

software since then, many firms are likely to refresh hardware this time to take advantage of the new

operating system. This should be a positive for the Asian personal computer manufacturers, and

their component suppliers.

On the currency front, we note that the Japanese Yen has strengthened to Y90.09 against the US

Dollar at month end, which we believe offers an opportunity for Korean and Taiwanese exporters,

against their Japanese peers.

briefAsia

ASIA BRIEF 3

November 2009

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October saw the announcement of a number of economic growth figures for the third quarter of

2009, including China with real Gross Domestic Product (GDP) of 8.9% and Singapore, whose econ-

omy grew 0.8% compared with the same three-month period last year. While China looks to be re-

turning to trend growth following a significant monetary and fiscal stimulus, the return to growth of

Singapore is almost more impressive, we believe. This is because Singapore is a small, open econo-

my, and is heavily exposed to money flows through the financial industry, and through physical trade.

Singapore is therefore highly sensitive to international conditions, and we are very encouraged by a

return to growth after a contraction lasting a year and a quarter.

briefAsia

ASIA BRIEF 4

Market Review

At the company level, we are seeing signs that Japanese electronics component suppliers are becom-

ing less competitive as a result, and indeed Sony Corp (held only in the Guinness Atkinson Global

Innovators Fund with a 4.55% of net assets as of 9/30/09) has recently launched a plan to overhaul

and streamline its own component supply chain. In our view, there is the potential for a further wave

of Japanese outsourcing of these types of components, and this could create growth opportunities

for firms we have under observation in both Korea and Taiwan.

Market Performance Ending October 31, 2009 October

2009 2009 YTD 2008 2007 2006

Australia -0.57% 65.66% -49.20% 30.92% 33.93% China 6.44% 57.76% -50.43% 66.02% 82.91% Hong Kong 2.73% 58.18% -50.75% 42.06% 30.37% Indonesia -3.68% 109.69% -56.63% 55.81% 73.79% Korea -6.99% 58.76% -57.11% 32.14% 11.17% Malaysia 4.99% 49.73% -41.11% 48.02% 38.26% New Zealand 0.51% 51.76% -53.26% 11.20% 19.43% Philippines 1.90% 54.42% -52.04% 41.60% 59.48% Singapore -1.00% 56.50% -47.20% 28.86% 47.89% Taiwan -4.12% 59.88% -46.04% 9.16% 20.73% Thailand -6.34% 63.66% -54.01% 64.08% 11.88% MSCI AC Far East Free ex Japan

-0.10% 58.19% -50.56% 36.91% 31.86%

MSCI AC Pacific ex Japan *

-0.04% 61.34% -50.32% 34.96% 32.54%

*MSCI AC Pacific includes Australia & New Zealand (MSCI Indices were used for regional & individual market performance)

November 2009

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briefAsia

ASIA BRIEF 5

Korean economic growth was also better than the market had expected rising 0.6% compared to the

third quarter of last year. A decline of 0.3% had been expected. Auto sales in Korea were also strong

in October rising up 25% compared to last year to 130k vehicles. This is partly due to tax breaks for

car scrapping, but also speaks to underlying strength in household finances in Asia’s most indebted

economy. Given these decent economic results, Korea may be the first Asian country to explicitly

tighten policy in Asia. Although they did not increase policy rates in October, the outcome of the next

monetary policy meeting will be keenly watched by us.

Indonesia’s economy and stock market continue to look in reasonable condition, following the re-

election of President Yudhoyono in July. The President named his new cabinet on October 21 and, as

part of his drive against corruption, has required its members to sign a pledge of personal integrity.

On the monetary front, the central bank held policy rates steady at 6.5% this month, although it in-

creased its economic growth target for this year to 4-4.5% from 3.5-4%, and to 5-5.5% from 4-5%

for 2010.

Looking ahead, the key variables for us are whether Chinese growth will continue to be strong, and

whether export sales will pick up as demand and inventories begin to normalise in developed mar-

kets.

On the first point, the data indicates to us that the extraordinary monetary loosening and fiscal

spending has so far been able to get the Chinese economy back around its recent trend growth.

The indicators from the consumer sector suggest that relatively small changes in policy have driven

significant improvements in demand for autos, IT and consumer electronics products. This suggests

that the underlying consumer demand is there, and that improving this is a policy objective for the

authorities.

Balanced against this, there are some grounds for caution. The property market has inflated quickly

this year, but as we have discussed earlier, we view this as an overall positive. In addition, there has

been some build-up of steel inventories, as Chinese producers have increased production to meet

the expected demand from infrastructure projects. Finally, it is clear that some of the monetary stim-

ulus and exceptional loan growth has flowed into asset markets, with anecdotal evidence suggesting

this is often through State-owned enterprises. This implies to us that these State-owned enterprises

have used the disruption of the last year to enhance their position in the Chinese economy.

Market Outlook

November 2009

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briefAsia

ASIA BRIEF 6

Secondly, our discussions with Asian exporters in the technology sector suggest that there are al-

ready some grounds for optimism into 2010, although clearly any recovery will be slow and fragile.

Whether this will translate into a broader based recovery remains to be seen. So far, there is little in-

dication of a recovery in container traffic or in industrial demand from the world’s leading economies.

Until this happens we must remain relatively sceptical on Asian exporters.

Source: Bloomberg

November 2009

WWW.GAFUNDS.COM

briefAsia

ASIA BRIEF 7

China Economic Monitor

China has produced decent economic performance in the face of a global slowdown in economic

growth. Our data indicate that the monetary stimulus continues, with M2 growth once again reach-

ing new highs in the month of September, at 29.3% YoY. The absolute amount of new lending has

increased again, to RMB 517bn from RMB 410bn in August – although this is well below the levels

of earlier this year. We would expect this to slow somewhat in the coming months, and a continued

re-acceleration in loan growth would be concerning to us. Historical seasonality suggests that the

second half of the year is much slower than the first half, and there should be some slowdown, given

the calls from senior banking figures to take account of the impact the monetary stimulus is having

on asset markets.

However, inflation appear to be under control in China, with August consumer price inflation of -1.2%

YoY and the narrower Retail Price Index of 2.0% YoY.

China M2 Money Supply (% Chg YoY) and Monthly New Loans Extended (RMB bn)

0%

5%

10%

15%

20%

25%

30%

35%

Jul-9

9

Jan-0

0Ju

l-00

Jan-0

1Ju

l-01

Jan-0

2Ju

l-02

Jan-0

3Ju

l-03

Jan-0

4Ju

l-04

Jan-0

5Ju

l-05

Jan-0

6Ju

l-06

Jan-0

7Ju

l-07

Jan-0

8Ju

l-08

Jan-0

9Ju

l-09

% C

hang

e Yo

Y

-500

0

500

1,000

1,500

2,000

RMB

bn

New Loans (RMB bn) (RHS)

M2 Money Supply Growth (LHS)

Source: The People’s Bank of China

November 2009

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According to the official statistics, steel production remains buoyant in spite of the fact that com-

modity steel prices in China are below recent peak levels, and there are signs that inventory is accu-

mulating. We would expect some slowdown in production, with China’s largest foundry this month

announcing that it plans to cut 1m tons on an annualized basis from its 30m annual production,

expected for this year. In addition, Deng Quilin, chairman of the Chinese Iron and Steel Association

revealed in an interview this month that the government was pushing to support prices by shutting

down smaller, obsolete mills. This should help industry consolidation, and may reduce the number

of iron ore importers in the country.

Looking at this month’s data, iron ore imports increased again to reach a new high, while coal im-

ports also increased marginally after a pullback in September. Given the previous discussion on an

industry-wide cutback in steel production, we would expect to see some pullback in iron ore and

coal imports in the coming months.

briefAsia

ASIA BRIEF 8

China's Monthly Steel Production and Imports of Iron Ore and Coal (tonnes)

-

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

Jan-

99Ja

n-00

Jan-

01Ja

n-02

Jan-

03Ja

n-04

Jan-

05Ja

n-06

Jan-

07Ja

n-08

Jan-

09

0

3,000,000

6,000,000

9,000,000

12,000,000

15,000,000

18,000,000

Steel Production (LHS)Iron Ore (LHS)Coal (RHS)

Sources: National Bureau of Statistics, China Customs General Administration Looking at base metals, we note that Copper imports began to pick up again in September, while

Zinc and Nickel imports remain depressed relative to recent levels of imports. This pullback is not

a concern for us, given that imports of all three metals are reasonably high relative to our long-

run observations. The most striking observation for base metals, iron ore and coal is the seemingly

synchronized nature of the pick up in Chinese import volumes over the course of this year. Electric-

ity production is a useful indicator of the health of underlying economic activity. This pulled back

slightly in September, but is still up 10.7% compared with last year, suggesting the economic figures

we have observed this year are not outlandish.

November 2009

WWW.GAFUNDS.COM

However, once again investment is leading the way in China’s economic activity, and as we have men-

tioned in the past, our thesis is that consumption is the real driver for growth in the coming years.

Looking at the consumption data for the month of September, retail sales have continued to grow

but the rate of increase has slowed from the break-neck speed of last year. Passenger vehicle sales

have remained strong with 1.015m vehicles sold in the month of September, a new high. To put this

in perspective, this is almost double the 552,000 passenger vehicles sold in China in September

2008 and well above the figure for September 2007 of 560,000 units.

The next leg of the consumption story should become clearer with the forthcoming release of wages

data later this month. Although the data so far are suggesting inflation is under control, we have an-

ecdotal evidence from our discussions with firms of labour shortages already re-appearing in elec-

tronics manufacturing. If this develops into a broader trend, we would hope to see at least mild wage

inflation, which will help to support improved consumption in the coming months.

briefAsia

ASIA BRIEF 1

ASIA BRIEF 9

China's Monthly Imports of Zinc, Nickel and Copper (tonnes)

-

25,000

50,000

75,000

100,000

125,000

150,000

175,000

200,000

Jan-

04Ju

l-04

Jan-

05Ju

l-05

Jan-

06Ju

l-06

Jan-

07Ju

l-07

Jan-

08Ju

l-08

Jan-

09Ju

l-09

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

Zinc (LHS)Nickel (LHS)Copper (RHS)

Source: China Customs General Administration

November 2009

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briefAsia

ASIA BRIEF 10

China Retail Sales Growth (3 Month Moving Avg YoY change) and Monthly Passenger Car Sales (Number of Vehicles)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

Jan-9

9

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

90

200,000

400,000

600,000

800,000

1,000,000

1,200,000

Passenger Car Sales (RHS)

Retail Sales (LHS)

Sources: China National Bureau of Statistics, China Automotive Information Network

In our view, the key metrics to watch in the coming months in China will be steel prices and imports

of basic materials, to confirm that fixed asset investment is moving into the construction phase. In

addition, we will be closely watching inflation numbers to check whether the monetary stimulus has

spilled over and caused inflation in the real economy.

Commentary for our views on Alternative Energy and Energy markets is available on our website.

Please click here to view.

November 2009

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briefAsia

ASIA BRIEF 11

Performance data quoted represents past performance and does not guarantee future results.

Index performance is not illustrative of Guinness Atkinson fund performance and an invest-

ment cannot be made in an index. For Guinness Atkinson Fund performance visit gafunds.com.

Mutual fund investing involves risk and loss of principal is possible. Investments in foreign

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ited liquidity and greater volatility.

The MSCI All Country Far East Free ex-Japan Index (MSCI AC Far East free ex-Japan Index) is a

free float-adjusted, capitalization-weighted index that is designed to measure equity market perfor-

mance in the Asia region excluding Japan. The Index is made up of the stock markets of China, Hong

Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand.

The MSCI All Country Pacific Free ex-Japan Index (MSCI AC Pacific Index) is a free float-adjusted,

capitalization-weighted index that is designed to measure equity market performance in the Pacific

region. The Index is made up of the stock markets of Australia, China, Hong Kong, Indonesia, Korea,

Malaysia, New Zealand, Philippines, Singapore, Taiwan and Thailand.

The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as

representative of the equity market in general.

The Dow Jones STOXX 50 Index is a capitalization-weighted index of 50 European blue-chip stocks

using free float shares in the index calculation.

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