Friday, November 12, 2010

Stocks Quake As China Tightens

Global growth hinges on meeting the needs of the world’s largest country – China. Its economy is forecast to grow 8.7% in 2011 but things there are getting bubbly. With China's official inflation statistics up 4.4%, according to the Wall Street Journal, investors expect Its government to tighten by raising its interest rates on fears that inflation is out of control and a bursting real estate and stock bubble will create economic carnage.

What should investors do? The answer depends on whether you think the trend of the last several years is now shifting into reverse.

Moreover, China wants to raise the barriers to foreign capital which has been riding its real estate wave. China -- which in today's G20 meeting got agreement on the dangers of foreign capital flows -- has already cut its money supply by requiring banks to park more cash with the central bank; has raised interest rates once; and tightened controls on capital inflows into China.

China is certainly taking steps to stop the flow of what it considers hot money into China. Bloomberg reported that its State Administration of Foreign Exchange would tighten management of banks’ foreign-debt quotas; introduce new rules on their currency provisioning; and that the government will regulate "Chinese special-purpose vehicles overseas and tighten controls on equity investments by foreign companies in China."

China is also putting some brakes on its real estate market. It suspended mortgages for third-home purchases and pledged to speed up trials of property taxes nationwide. It also raised interest rates in October for the first time in three years on concerns of inflation and "relentless growth in asset prices," according to Bloomberg.

How China's Tightening Slams Stocks, Commodities

All this tightening has repercussions for investors. Gold is tumbling as investors wager that China’s demand will decline – and other commodities prices should follow. Stocks are also falling -- Chinese stocks plunged 5.7% -- as fears of slower growth in the wake of China’s declining appetite cascade through markets around the world.

Chinese stocks are tumbling limit down in commodity, airline and automobile sectors. As the Journal reported, these plunges included: China Southern Airlines (-10% maximum), Hong Yuan Securities (-10%), Jiangxi Copper (-8.9%), SAIC Motor Corp. (-8.6%), Yunnan Aluminium Co. (- 9.4%), Chinese property developers China Vanke Co.(-7.1%) and Poly Real Estate Group (-7.3%).

Does this mean that investors are not afraid of out-of-control inflation just around the corner? After all, they've been braying about apocalypse now due to Fed-fiat-money-printing for years. But that did not stop them from taking profits on gold, oil, and silver. Spot gold fell by over 2% to $1,380.20 per troy ounce, Nymex December crude-oil futures declined $2.08 at $85.73 per barrel; and Silver lost 2.5% of its value.

How Investors Should Respond

Does this represent a permanent shift in the investment climate or just an excuse to take profits before the bet on rising commodity prices resumes? If China's tightening was really a fundamental shift in policy that will lead to lower growth there, then it seems likely that today's moves would have been anticipated by investors.

But if these moves really are a surprise, then many of the bets that investors have been making over the last few years are likely to be poised to plunge. Those are bets on a dropping dollar and rising commodity prices based on demand from China. If those trades are reversing, then investors ought to be placing bets on a stronger dollar and weaker commodity prices.

That would be great for American consumers. But my hunch is that today's action is just an excuse to take profits and those who have missed out on the rally in commodity prices and Asian equities might use it as an entry point.


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