Three ways to play Chinese inflation

published 22 January 2010

Ronald Reagan famously said: "Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man."He was talking about the double-digit inflation experienced at the beginning of his presidency. And if we see double-digit inflation in China, as we did during the early 1990s, then Premier Wen Jia Bao would be wise to heed Reagan's words.

Inflation can creep up on you. Not everyone has noticed that in China it has moved from -1.8% back in July 2009 to +0.6% just recently in November. And this is only the beginning given the amount of quantitative easing (money printing) that has occurred globally, this figure is likely to rise over the next few months.

Now, I am not suggesting we will see double-digit inflation in the major Asian economies in the near term. However, given that previous bouts of high inflation were driven by rapidly rising food prices, I am convinced that agriculture spending is a big priority for most of them as a way to keep it at bay. A global population that continues to grow and develop can only mean more mouths to feed. It takes around 7kg of grain to produce 1kg of beef, 4kg for a kilo of pork, and 2kg for poultry. Meat consumption is therefore having a multiplier effect on grain consumption, which reinforces the need to increase agriculture spending to avoid a nasty bout of inflation.

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That's why my first stock pick is Taiwan Fertiliser (Taiwan: 1722 available through an Asian broker, such as Boom.com). Not only is it a major manufacturer, but it also has a rich land bank in Taiwan. As one of the region's key developers, the firm will benefit from the recovery in property prices.

It has taken a year for exports to recover in China, due to the long-term fallout from the credit crisis. However, I believe that the worst is over and that both corporate and individual consumption will revive. The normal way to play this theme would be to buy shipping stocks. But I prefer the port operators as I think there's still an oversupply of shippers due to years of over-expansion. Thus my second stock pick is China Merchants Holdings (HK: 144), which has a presence in seven out of the eight major ports in China. It's recently signed a joint venture in Qingdao to strengthen its presence in the north, an area that encompasses major cities such as Beijing and Tianjin.

Finally, as China is destined to become the world's largest economy, it is inevitable that the renminbi (RMB) will also grow in international importance. Hong Kong is likely to become the offshore RMB clearing centre for China, due to its mature financial system and its currency peg to the US dollar. Therefore my final stock pick is BOC Hong Kong Holdings (HK: 2388). It is the second-largest bank in Hong Kong and will benefit from strong commercial ties to its parent on the mainland. A further bonus is that rising inflation can only lead to higher interest rates good news for the banking sector. That's because banks tend to increase the rates they charge for loans before ratcheting up savings rates on deposits.

Lastly, bear in mind that moderate inflation is good for equity markets overall the global economy will always evolve around rising consumption. It won't be turning Japanese.

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