China Inflation Drops, Signaling Materials To Boom

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 |  Includes: ANRZQ, CCIH, CLF, FCX, FXI, JOY, RENN, WLT, YOKU
by: Stone Fox Capital

Tuesday night, China reported October inflation close to expectations at 5.5%. Though the whisper numbers expected something possibly around 5.3% and could cause a minor market sell-off on Wednesday, the news was wildly bullish.

Short term the market always trades off estimates. Long term though, the trading is based on the trend. The trend for inflation in China is clearly downward.

Inflation in October eased from the 6.1% annual rate in September with food prices declining 0.2% in the month.

Investors long fretted this summer over the fast-paced inflation in China though simple math told a different story. The financial crisis in 2008 and plunging commodity prices in 2009 caused a void in inflation numbers that were resurrected when prices rebounded in 2010.

Prices only needed to cool the growth rate in 2011 for inflation to moderate through the year. Instead the summer swoon led to a major drop in the CRB index leading it back to the year-ago levels. Hence, no year-over-year inflation exists and with weaker comparisons going forward inflation could moderate even further.

In essence, without the 2009 collapse in oil, copper, and other commodity prices, would inflation have ever been such an issue? One needs to understand that copper prices need to increase by 5%-10% a year for inflation to remain high. The move from $2 to $4.5 isn't what creates inflation. It's the continued price increases to above $5, $6, or even $7 that are needed for those fears to be realized.

Now that China inflation has clearly peaked and is now falling, what stocks should be bought?

Clearly the best bets are mining, material, emerging market, and possibly even China-based tech stocks. Some of the leading options are listed below:

Alpha Natural Resources (ANR) - 3rd largest producer of metallurgical coal used in the production of steel.

Cliffs Natural Resources (NYSE:CLF) - leading domestic miner of iron ore and metallurgical coal both used in the production of steel.

Freeport McMoRan (NYSE:FCX) - largest independent miner of copper with a minor focus on gold.

Joy Global (JOYG) - leading producer of mining equipment used in extraction of coal, copper, iron ore, oil sands, and other various minerals worldwide.

Walter Energy (NYSE:WLT) - largest independent domestic producer of metallurgical coal for the steel industry.

China tech - any domestically listed China stocks still remain at a high risk of fraud. The larger internet plays appear the most unlikely to get snagged in a massive fraud scenario, but one can't invest in the sector without a high degree of risk. After significant drops since 2010 post IPO peaks, internet leaders like Yoku.com (NYSE:YOKU), China Cache (NASDAQ:CCIH), and Renren (NYSE:RENN) appear cheap or at least substantially cheaper now.

All of the above mentioned stocks remain well below 52-week highs due to fears of a hard landing in China. Now as China manufactures a soft landing and potentially opens the door for monetary easing the above stocks could recapture 2011 highs.

Inflation details per CNBC report:

  • China's annual inflation rate eased to 5.5 percent in October, a third straight month of decline from July's three-year peak and Premier Wen Jiabao said prices had fallen further since then.
  • Producer prices rose 5.0 percent in the year through October, compared with an increase of 6.5 percent in the year through September.
  • "Since October, overall domestic prices have been falling noticeably," Wen was quoted as saying by a government website.
  • The data showed that food prices, a major source of inflationary pressures in China, fell in October by 0.2 percent from September, adding to expectations that inflation may well be on a solid downtrend.

Disclosure: I am long FCX, ANR, CCIH.

Disclaimer: All data is for informational purposes only. Please consult a financial advisor before making any investment decisions.