China's Inflation Starting to Spike - Investors Beware

As indicated in the chart below, China’s inflation rate rose to 5.1% in November from 4.4% in October. Though down from the 8.5% rate that existed in early 2008, the spike in prices is clearly starting to worry Chinese government officials – hence the two interest rate hikes over the last ten weeks. Even more concerning, is that food inflation is running well into the double digits, and though food accounts for only one third of the CPI, it accounts for 75% of the increase. As an example, soybean oil, a key ingredient in Chinese cooking, rose approximately 25% last year, with most of the gain coming since July (“Cooking Oil's Surge Shows How Inflation Hits Chinese “).
While Chinese officials are hesitant to slow down the economy, the recent spike in inflation will force their hand. Just as we saw in 2006-2007, it may take some time for interest rate hikes to work their way through the Chinese economy, but inevitably they will work their magic. Given the rebound in the commodity and equity markets, investors seem to be ignoring the residual effects of China’s deliberate attempt to engineer a slowdown. With many industrial and agriculture commodities making parabolic moves over the last few months, I think it is prudent for investors to start taking off risk.

While the easy money policies of the US Federal Reserve are starting to coax people back into equities, the 2011 theme for most of the developing world is one of tightening. China, Brazil, India, and Australia are among the largest economies that have recently raised interest rates and more are coming. As an example, in Dilma Rousseff’s inauguration speech yesterday (new Prime Minister of Brazil), she specifically mentioned controlling inflation as one of her top priorities. I think it is fair to say that when inflation becomes a key theme in an inauguration speech, investors should take notice – I know I certainly am.