How Sugar and Coffee Are Telling Us Inflation’s

“Ahead of the Street” Column, by Mitchell Clark, B. Comm.

It’s pretty difficult to come up with a solid reason why the stock market is going up right now. There is earnings optimism among large-cap companies of course, and I suppose that big institutional investors don’t really have anything else to do but buy stocks. There’s no other mandate for the vast majority of mutual funds.

I view Dow 11,000 as basically being a full recovery from the financial crisis. In 2007, the Dow got up to the 14,000 level, but was really ahead of itself in terms of price relative to earnings. When we get to 11,000, a solid consolidation around this level would be a healthy development for the market. I think we can tick higher yet if we don’t get sideswiped by another crisis of confidence in global capital markets.

Going forward, we have to keep a close eye on what happens in China. That country now has the financial strength to affect global markets, and any major changes to expectations for China’s growth would immediately hurt domestic investor sentiment. China has a lot going for it of course, but with growing power comes growing responsibility. So, if the bubble were to burst, rather than be deflated slowly, the rest of the world would be in trouble.

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A big part of China’s story is the country’s voracious demand for commodities. If you haven’t noticed, Chinese companies have been buying up a number of global precious metals producers in order to guarantee the long-term supply of raw materials. We’re also seeing significant commodity price strength in items like sugar, coffee and copper, with gold and silver staying relatively strong at current levels. All this price strength is due to increasing demand from China and other Asian countries, combined with static levels of supply. This is definitely an inflationary signal for the future.

One of the best ways to follow the equity market action in China is to watch the iShares FTSE/Xinhua China 25 Index (NYSE/FXI). This highly liquid U.S. dollar exchange traded fund mimics the FTSE/Xinhua China 25 Index, which represents 25 of the most liquid Chinese companies, all of which trade on the Hong Kong Stock Exchange. A lot of these large-cap companies are names you might have heard before. They include PetroChina, China Construction Bank, China Telecom, China Mobile and Industrial & Commercial Bank of China, to name a few. I like to follow this index on a weekly basis, because it gives me a good sense as to what is happening in the Chinese equity market.

Just recently, China approved the trading of its own stock market futures contracts. On April 16, Chinese stock futures will begin trading on the Shanghai and Shenzhen stock exchanges and this represents a real maturation for the Chinese equity market.

If you want to know what’s happening with Chinese stocks, follow FXI on the New York Stock Exchange. If you want to know what’s happening with China’s Main Street economy, follow China Agritech, Inc. (NASDAQ/CAGC), E-House (China) Holdings Ltd. (NYSE/EJ), and China Automotive Systems, Inc. (NASDAQ/CAAS) on U.S. stock exchanges. Make no mistake; the prices of food staples like coffee and sugar are going up for a reason — demand exceeds supply. The inflation storm is on the horizon.