China's Inflation Risk Is Growing Fast

Includes: FXI, PGJ, YINN
by: Zhong Jin

China’s CPI in October is 4.4%, much higher than the consensus forecasting 4%. While the PBOC only raised the bank reserve rate, not the official interest rate, risky assets rallied. With a large part of the $600 billion from Fed’s QE2 leaking into China and other emerging markets, the inflation pressure for China will only become stronger.

As a net commodity importer, China’s demand drives the market price and trend for many commodities. Australia is one of the biggest exporters to export raw materials to China. Its commodity price index, the Reserve Bank of Australia Commodity Price Index (RBA Index) could be used as a leading indicator of China’s inflation rate.

The following graph shows the y-y change of the RBA Index and the Shanghai Composite Index (2000-2010, monthly). It is quite obvious that the change rate of the RBA Index has a negative correlation with the Shanghai Composite Index. The turning point of the Shanghai Composite Index usually has a two-three month lag to the change rate of the RBA Index.

Going forward, the RBA Index is at a turning point again. The Fed will keep the easy money policy until inflation goes up. China's inflation risk is growing fast. Before the QE2, China's stock market was up and the change rate of the RBA Index was trending down. If history is any guide, the Shanghai stock price index will lag behind the turning point of the RBA Index by two to three months. Even if the change rate of the RBA Index returns to its previous upward trend, the Shanghai stock market will still need a month or two to reach its own turning point. So in the medium term, the China Shanghai stock market still is a buy.

Disclosure: No position