Top 10 China Stocks, While They're Hot

Speculation is easier to spot. Property values in cities such as Shanghai have soared, leading to massive overbuilding as investors rush in to get a piece of the boom. The Shanghai stock market is up 41% this year and 274% from its 2005 low, but money is still pouring in.

Tellingly, most of the cash now is coming from individual investors who know only that people can get rich on stocks. Individual investors have opened 14,000 new trading accounts this year. The average Class A share in Shanghai now trades at 35 times projected 2007 earnings.

Speculation in real estate and Chinese stocks has the same source as the continued boom in industrial expansion: Money is too cheap and too easy to borrow. Tentative attempts by the Beijing government to temper speculation by raising interest rates and increasing the amount banks need to keep on reserve -- three times so far in 2007 -- have been ineffectual to date, to put it mildly. Chinese banks extended 1.4 trillion yuan in fresh loans in the first quarter of 2007; that's half the total lent in all of 2006.

Food Prices on the Rise

Officially, inflation in China is running at a very modest 3.3% annual rate. But that's still the fastest rate of increase in prices in two years. And higher inflation is starting to show up in food prices, a very worrying development for a government that is all too aware of the huge and growing gap between the haves and the have-nots in China's economy.

In the short run, though, the government may actually be in favor of higher food prices, since that's one way to raise rural incomes. Not much else is working in the government's efforts to close the gap between the industrialized and export-linked coastal regions and the relatively impoverished interior. In fact, despite government plans to close that gap, in the first quarter it actually got worse. Major coastal areas such as Shanghai and Guangdong grew at 12.6% and 13%, respectively, in the first quarter of 2007, faster than the national economy as a whole.