LONDON European hedge fund managers are betting that China's once red hot economic growth will cool dramatically in 2012, hitting companies, economies and commodity prices that have been fuelled by the world's second largest economy in recent years.
Managers are taking bets ranging from short positions on equity markets or the currency to buying credit protection on companies that export to China. Others are shorting natural resources stocks in other countries that rely on Chinese demand.
"China is an inflated castle in the air," said Pedro de Noronha, managing partner at London-based hedge fund firm Noster Capital, who is using futures to short Chinese H-shares and is also holding a short position on the yuan.
"We're quite sceptical and worried," he added. "China needs a healthy U.S. ... consumer and it's not getting it right now.... China could be a catalyst for a severe leg-down in markets," he said.
He also cited recent cases of fraud in China and the country's booming real estate sector as issues.
"Corporate governance and the rule of law is very different from the West," he said. "(And) there's a huge bad loans issue in banks. The real estate market is probably in the biggest bubble in the world we have right now."
China's rampant economy, which recorded double-digit growth every calendar year between 2003 and 2007, has shown signs of cooling of late, as global demand slackens amidst slowing growth in major economies and Europe's deepening debt crisis.
GDP growth, set to be published on Tuesday, is forecast to have slipped to an annualised 8.7 percent in the three months to December, raising the possibility the Chinese government may unveil new policy steps to avert a hard economic landing.
Meanwhile data last week showed exports and imports grew at their slowest pace in more than two years in December and inflation fell to a 15-month low.
Some managers see growth slowing even further.
"I think China will slow down," said Victor Pina, chief investment officer at London-based hedge fund firm Javelin Capital. "China has no alternative to what it is doing, which is putting the brakes on credit expansion.
"If China slows down to 7 percent, that will be a dramatic slowdown for most people. The 8 percent contemplated by the bear strategies, that's the upper boundary."
Pina is shorting natural resources stocks in Hong Kong, as well as Brazil and Russia, believing the slowdown means the pullback in some commodities is "for real".
"If you look at copper, for the first time in ages there is overstocking. The price is high and inventory is high. Either the world is going to grow or the price is going to fall," he said.
"It's going to be a difficult year for BRICs (Brazil, Russia, India, China) markets in commodities."
A number of hedge funds have already racked up impressive gains betting against China in a largely drab 2011 for the industry, helped by a 21.7 percent slump in Hong Kong-listed Chinese shares .HSCE.
Among the winners was Eclectica founder Hugh Hendry's Credit fund, a leveraged "tail protection" fund, which returned 46 percent last year.
The fund holds credit protection on Japanese companies exposed to China, rather than a short position on Hong Kong-listed Chinese shares.
"He still has reservations regarding the Chinese economy," an Eclectica spokesman said.
However, not everyone agrees.
"The consensus is getting quite harsh. We think it may continue to grow," said Patrick Armstrong, head of investment selection at Armstrong Investment Managers, who has bought high-yielding Asian telecom stocks and an exchange-traded fund that automatically invests in high-yielding stocks.
"(China's) tried to pop the property bubble that's forming," he added. "They have so many reserves they can increase infrastructure spending."
(Reporting by Laurence Fletcher, editing by Sinead Cruise and Helen Massy-Beresford)