BEIJING -- For generations, Chinese men looking for a dose of vigor have sworn by a traditional remedy: fungus harvested from dead caterpillars, known in some quarters these days as Himalayan Viagra.

Now Chinese investors are using the rare fungus to try to boost something else -- their investment returns. The fungus has doubled in price over the past two years and the top grade now fetches more than $11,500 a pound, according to Fuzhou-based brokerage firm Industrial Securities.

With Chinese stocks falling, real-estate markets flat and bank deposits offering measly returns, Chinese investors have been looking for help in strange places. Besides traditional medicinal products, they are plowing money into art-based stock markets, homegrown liquors, mahogany furniture and jade, among other decidedly non-Western asset classes.

"On a micro level, speculation has appeared," says Long Xingchao, president of the information center of the China Association of Traditional Chinese Medicine. The association says prices of traditional medicines, including red ginseng and false starwort, have surged since 2010, partly because of speculators. Mr. Long insists, however, that a price bubble isn't forming. "There's nothing to pop," he says.

Newfangled exchanges are sprouting across China to take advantage of the excitement. Nanjing Pharmaceutical Co. set up an exchange last year for trading traditional medicines such as deer antler. In November it extended hours so investors could trade when they get home from work. "Expanding the hours gives investors more time to make a profit," the exchange said on its website.

David Fuller's view China's last stock market bubble (monthly, weekly & daily) occurred in 2007 and central government officials tightened monetary policy in a successful effort to deflate it. Consequently, most of the decline occurred before the global stock market crash in 2008.

When China led the global stock market recovery in 2009, following a massive infusion of liquidity by all leading central banks, the country was first to tighten monetary policy once again in order to prevent another equity bubble from occurring. To increase liquidity China also sold some of its previously non-tradable government held shares in a number of industries (see also Tuesday 17th January Comment).


These measures capped China's stock market rally in August 2009 and investors switched their speculative interest to that other perennial favourite, property. Faced with another bubble China's central government officials raised reserve requirements, necessitating large secondary offerings from banks and other financial companies. This new supply was approximately twice the size of equity issuance on Wall Street during 2010-2011, despite China's stock market being much smaller.


With China's stock market underperforming while the central government also reins in its property bubble, it is not surprising that speculators have turned their interest to exotics mentioned in the WSJ article above. My guess is that both the government and speculators will soon loose patience with some of the 'pump-and-dump' fringe promotions, markets and exchanges that have opened up in China recently.

So where will Chinese investors and speculators turn next?

There is always gold and the Chinese like the yellow metal as much as anyone. However, gold is no longer cheap and China has a mostly appreciating currency. Therefore the need for a hedge against the profligate printing of their currency is less urgent than in many other countries, not least those in the west.

China's stock market seems like the most obvious candidate to me, now that valuations are historically low and the government is beginning to relax its monetary tightening bias. There will be fewer new issues and secondary offerings in the current environment and at these valuations, so supply will not be a problem. There is no reason for the government to prefer an even more undervalued stock market but it might well favour a recovery, if only to reduce talk of a possible hard landing.

Meanwhile, there is clearly plenty of liquidity in the Chinese economy. Its legions of increasingly prosperous investors should flock to a momentum driven stock market uptrend, once this becomes apparent. Overdue for a reversal of form, I would not be surprised if China proves to be one of the better performing stock markets in 2012 and probably beyond.

Note the recent form shown by Hong Kong's HSI (weekly and daily) and HSCEI (weekly & daily) indices. The former appears to have completed a support building phase which commenced last October and it has now moved back above the 200-day MA and psychological 20,000 level. HSCEI shows a very similar pattern and the previously declining MA has now flattened out. In the near term we may see a reaction and consolidation of January's gains before the recovery continues.