The news out of China hasn’t been very good of late. On Tuesday, we found out that the country’s central bank, the People’s Bank of China, raised bank reserve ratios for the ninth time since last October. The move essentially to constrict lending by banks is part of the country’s ongoing effort to quash soaring inflation, which in May rose to 5.5%, the highest level in nearly three years. And while some China bulls argue that policymakers are focused increasingly on quality of growth, rather than simply quantity, those policymakers also are concerned about the possibility of widespread social unrest.

In fact, during the past couple of days there have been riots in the southern China province of Guangdong, a region which accounts for about one third of China’s exports. This unrest began last Friday night, after security guards pushed a pregnant migrant street vendor to the ground as they tried to move her food cart off the street. Now, I know this sounds bizarre, but it does illustrate the kind of potential social unrest that’s brewing in the world’s second largest economy -- unrest that’s been fueled largely by a toxic mix of rising food prices and very low wages.

Given the high inflation, tighter monetary policy and social unrest -- oh, and industrial output which recently slowed to a 30-month low -- it’s no wonder we’ve seen a sizeable sell-off in the iShares FTSE China 25 Index (FXI). The chart below shows that this measure of big-cap Chinese stocks has now fallen below its 50- and 200-day moving averages.

 
I like to keep a constant watch on this index, because its fate is generally correlated with that of many other global and emerging markets. I actually use this fund as a kind of barometer for the emerging markets trade, a trade which has been tough since April.

My take here is that while Chinese stocks have definitely felt the sting of sellers, it’s not time to declare China dead. Despite the recent decline, I still think there’s plenty of upside in store for this sector. And while I wouldn’t rush into any new China positions right now, I think that if we do see bargain hunters step up and add FXI to their portfolios, it could translate into another round of buying akin to what happened in late-February through March.

For now, keep a close watch on FXI, as the action in this China fund will let you know if the current cry off in the sector is the beginning of a new bear, or just an evanescent breeze.