Chinese stocks, the second-best performers in Asia this year, are approaching records as a strengthening currency and a surging economy draw overseas investors.

A stock investor monitors the changes of stock and fund indexes at a securities trading office in Beijing November 20, 2006. [newsphoto]

Strategists at JPMorgan Chase & Co. and UBS AG have picked Chinese shares, which dropped in four of the previous five years on the mainland, to outperform the rest of Asia in 2007. Funds focused on the country's equities may have record inflows this year, according to Emerging Portfolio Fund Research in Boston.

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"Money continues to pile into Chinese equities and not only because of the yuan," said Franki Chung, who oversees $700 million of Asian equities at CIBC Global Asset Management (Asia) Ltd. in Hong Kong. "The continuing inflow of money is also a recognition of how strong Chinese growth can be."

The Hang Seng China Enterprises Index, tracking the shares of Chinese companies traded in Hong Kong, extended its lead over the Morgan Stanley Capital International Asia-Pacific Index last week as stocks rose across the region.

China Life Insurance Co., the nation's biggest insurer, and Bank of Communications Ltd., China's fifth-largest lender, have led a 62 percent jump in the index of so-called H shares this year. It's within 10 percent of a record set in December 1993, eight months before the benchmark was officially introduced.

The Shanghai Composite Index of yuan-denominated A shares and dollar-based B shares is closer to a record. The gauge is 6.6 percent shy of a peak in June 2001 after surging 80 percent this year, more than any other Asian benchmark except for the Ho Chi Minh Stock Index in Vietnam.

Best Since 1992

For the week, the H-share index added 0.7 percent, beating a 0.2 percent gain in the MSCI Asia-Pacific Index. The Shanghai Composite lost 0.4 percent. It dropped 2.9 percent on Dec. 8 on speculation the government would raise borrowing costs.

Shanghai's index is set for its best year since 1992, the exchange's second full year of trading. The benchmark for the mainland's biggest stock market had its only gain of the last five years in 2003.

Mainland investors are sinking more of their $1.9 trillion of savings into equities as Chinese government, which controlled much of the economy during the 1990s, pursues the sale of state shareholdings. Securities firms such as Goldman, Sachs & Co., the biggest US brokerage by market value, work with local firms through partnerships and invest in Chinese companies.

Investors based abroad can only purchase yuan securities through a qualified foreign institutional investor, or QFII, program. Fifty-two firms have approval to buy a total of $8.65 billion in stocks and bonds. Shanghai's market is valued at $701.6 billion, according to data compiled by Bloomberg.

`Pretty Cautious'

Funds focused on China have taken in $8.96 billion more cash than they have paid out this year, according to Emerging Portfolio. The firm has tracked these funds since 2000 and the current full-year record inflow is $2.45 billion, set in 2003.

Some analysts said Chinese companies' shares have risen too far, given the outlook for earnings. The H-share index is valued at 15.8 times next year's profit, more than double the 6.6 times five years ago. The Shanghai Composite is at 25.6 times. Both are higher than the 14.7 for MSCI's Emerging Markets Index.

"A lot of investors are buying but at the same time, they're pretty cautious," said Henry Ho, Hong Kong-based head of China research at UBS AG. "Stock valuations are high and there is a problem finding value stocks."

Speculation that China will allow the yuan to strengthen at a faster pace has fueled the gains. When US Treasury Secretary Henry Paulson last visited China, on Sept. 19-22, the H-share index had its best week in three months and the yuan rose the most since its peg to the dollar was dropped in July 2005.

Paulson, Bernanke Visit

Paulson and US Federal Reserve Chairman Ben Bernanke will visit Beijing on Dec. 14-15 for talks with officials including central bank Governor Zhou Xiaochuan.

"The No. 1 topic will be the currency," said Tony Dolphin, director of global strategy at Henderson Global Investors in London, which oversees the equivalent of $124 billion. Stocks may "shoot up and then, as the talks progress, they will settle back down again."

China has $1 trillion of foreign-exchange reserves, the most in the world, and buys dollar-denominated assets to limit gains in the yuan. The currency has risen 3.7 percent versus the US currency since the peg was scrapped.

As the yuan appreciates, returns that dollar-based investors derive from assets denominated in yuan increase. China's booming economy, which last year replaced the UK as the world's fourth largest, is also drawing stock investors.

'Growth Story'

Third-quarter gross domestic product climbed 10.4 percent, the fastest pace among the top 20 economies. GDP has risen at least 10 percent in each of the past three years.

Economic expansion is contributing to accelerating earnings growth at Chinese companies. Profit of the nation's industrial companies rose 30 percent in the 10 months through October, an increase from 21 percent in the first quarter alone.

"We do like the growth story," Henderson's Dolphin said. "The consumption and export side will continue to do quite well." Henderson's holdings in Chinese stocks exceed the country's representation in global indexes, he said.

China Life has given the H-share index the biggest boost this year by surging 172 percent. Shares of Ping An Insurance (Group) Co., China's second-biggest insurer, have rallied 112 percent. Both companies are benefiting from rising demand for insurance policies in the world's most-populous nation.

'Really Positive'

Demand for loans has aided Chinese banks such as Bank of Communications, the third-biggest contributor to the H-share index's rally.

Bank of China Ltd. the nation's oldest lender, has gained 27 percent in Hong Kong from its initial public offering price in May. Industrial & Commercial Bank of China Ltd., the biggest, has rallied 31 percent since trading started in October after a $22 billion IPO, the world's largest ever.

PetroChina Co. and China Petroleum & Chemical Corp., China's biggest oil producers, are benefiting as the nation's energy demand boosts sales and drives crude-oil prices higher. PetroChina is the second-biggest contributor to this year's rally in the H-share index. China Petroleum, or Sinopec, has lifted the Shanghai Composite more than any other stock.

For Lei Wang, who helps manage $30 billion at Thornburg Investment Management in Sante Fe, New Mexico, China's growth prospects and currency gains make it too good a bet to ignore.

"I'm really positive on Chinese stocks," Wang said. He and his firm are "looking at the big picture instead of being nervous for the short term."