Official inflation in March was 3.6% higher than in March 2011; more ominously, it is a rise from the trough recorded one month prior. We can see the effects of inflation in the rise in the China Purchasing Managers' Index for March. The index of activity is rising despite evidence that US-based manufacturers are departing China's increasingly costly factories for cheaper sourcing elsewhere in Asia. "Activity" measurements can be nominally skewed upwards by rising prices even if real activity is declining.
China's shipping industry is beginning to feel the squeeze of higher costs at home and weakening demand abroad. China Cosco lost $1.66B in 2011. China Shipping Container Lines lost $428M in 2011. Shippers' weakness will eventually pass through to port operators as China Merchants Holdings sees its profits dropping despite rising container volume. Chinese shipping companies pay more for fuel because China's previously secure oil supplies from Iran are now jeopardized by the US-EU policy of embargoing Iran. Hong Kong insurers are now refusing to fully cover shortfalls in oil shipments from Iran to China.
Tight oil supplies and declining world demand mean the Chinese growth train is off its rails. Domestic demand will not materialize until China gets inflation under control. With no end in sight to the curtailment of Iranian oil, relieving inflationary pressure on the average Chinese consumer demands a hawkish central bank orientation that would put severe pressure on the Chinese economy in the short run. Any remaining China bulls need to think of a case for buying and holding longer than the next five-year plan.
Full disclosure: Long FXI with covered calls.