The Shanghai Composite Index was recently up +103% since its November low, handily outperforming most indices. Is this kind of performance sustainable, or is it a bubble that's about to pop? (Full Story Below)

The U.S. market has climbed 50% from its March bottom. But that's small potatoes compared to China. The Shanghai Composite Index was recently up 103% since its November low.

The Chinese economy is awash in cash. Banks have doled out $1 trillion as part of the country's stimulus package. However, about 15% of that ($145 billion), analysts say, went directly into the stock market. Hence the super bounce.

Andrew Gordon believes the Chinese market is a bubble looking for a pin.
He envisions a grim scenario:

"China could be facing its worst nightmare - the combination of a strengthening dollar (fed by rising interest rates) and a weakening U.S. economy. The Fed likely won't be raising rates this year. But next year it could. And its actions will have as big an impact on China as they do on the U.S."

Some air is already seeping out of the bubble. Since hitting its high on August 4th, the Shanghai index is down by 10%.

While the Chinese stock market may be deflating, its economic juggernaut rolls on. Imports of crude oil and iron ore hit record highs in July, MarketWatch reported.

Wall Street sees this as bullish. Merrill Lynch raised its economic forecast for China, from 8% expected growth in 2009 to 8.7%. Goldman increased their forecast from 8.5% to 9.4%.

On the surface there appears to be nothing but good news coming from China. But before you strap in and climb on the Chinese bull, there's something you should know. The Baltic Dry Index - which tracks bulk shipping costs - is pointing in the opposite direction.

Here again, we turn to Andrew Gordon, whose value investing credentials are supported by a 20-year career in international business, some of which involved working in and around China.

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During periods of high demand for commodities, bulk shipping costs go up, Andrew points out. When demand is soft, they go down. This fluctuation is measured by the Baltic Dry Index. It is the best leading indicator, Andrew says, of commodity demand. "And China's industrial activity," he says, "is the main driver of the index."

At the peak of the credit crisis last October, the index fell 90%. Then it staged a recovery, hitting new highs on June 3. Recently it fell over 17% in a week - the worst week for the index since October. The Baltic Dry Index is down 35% in the last two months.

Some suggest shipping rates may be declining as Chinese steelmakers delay imports while they negotiate with suppliers of raw material like Rio Tinto.

But there could be an even better indicator of Chinese industrial activity than the Baltic Dry Index... McDonald's.

Worldwide, the fast food restaurant had a good month last month, but the numbers would have been better were it not for China, where same store sales have been negative for seven consecutive months.

The weakest sales in China are based in the south, where the country's thousands of export-oriented factories are clustered. When those factories start hiring again, McDonald's will show improving sales. And that will be an advance sign that China's export-driven economy is reviving.

We'll call it a new twist on the "Big Mac Index" and you can thank Andrew Gordon for the insight. If you want access to more of Andrew's money-making ideas, click here to check out his research service, INCOME.

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