Prime China gateway Hong Kong leveled off this week after a long climb higher. Previous gains have been over done and the market is seriously overbought, according to a wide range of Hong Kong analysts. But there's a good chance headlong increases will start up again.

The blue chip Hang Seng Index, which includes many big Chinese companies, has shot up 81% since March 6. Last week through July 24 the HSI jumped 6.2% to cap a powerful July rally. The Chinese Enterprise index rose 5.4% last week. Then the market took a breather the first four days of this week. Analysts reiterated conclusions that stocks were overbought. On Friday the People's Bank of China (PBoC) indicated it would continue its relatively easy money policy, calming fears of tightening and triggering a healthy gain in Hong Kong stocks. The HSI closed the week up 3.0% at 20,573, and the Chinese Enterprise gained 1.2% to 12,124.

The question is, did the PBoC's announcement and Friday's nice gain jump start a long-term rally? Or were the doldrums in the first four days the beginning of an overdue correction? A spike in the U.S. dollar, fears of Chinese economic tightening and a growing stock price bubble held the market back early in the week, Ben Kwong, chief operating officer at KGI Asia, told the Weekly Report.

But that was just a blip, Kwong said. "The point is that interest rates are relatively low and investors continue to seek high returns, so we'll see more inflows of funds into the Hong Kong market," he said. There will be a additional temporary pull-backs and an inevitable bubble, according to Kwong, but central bankers won't ease efforts to stimulate the economy until they see sustainable growth. He doesn't expect that until the end of the year. Meanwhile, short-term declines will be buying opportunities.

With liquidity high, Kwong said, cyclical stocks such as banks, properties and commodities will lead the market.

Just early last week, the China gateway market of Hong Kong seemed to be teetering on the brink of a sharp decline after a period of slipping prices and weak turnover. Even after a big turn upward late last week, numerous observers saw little upside. But strong rises this week leave only one word to describe the market: Breakout.

Hong Kong's blue chip index, with its large share of big Chinese companies, rose 6.2% this week to 19,983. The Chinese Enterprise index surged 7.5% to 11,984. Daily turnover, stuck at the HK$50 billion level only a few weeks ago, regularly broke HK$70 billion.

"Hong Kong and Shanghai markets are breaking out above recent highs after a period of consolidation," Howard Gorges, vice chairman at South China Brokerage, told the Weekly Report. Lavish liquidity is feeding the big rise, according to Gorges and other experts. In Hong Kong, interest rates are at rock bottom, sending local investors on a nearly desperate search for returns. Overseas investors are attracted to Asia because they see the region emerging from recession faster than Europe or the U.S.

So will the investment spigot remain open next week? Gorges said: "It looks like there will be follow-through as the breakout develops, and then there will be a consolidation."

Tai Fook Securities takes a somewhat different view on their web site. Noting that they predicted a July rally, the brokerage said the market is getting close to being overbought. They point to recent "over-enthusiastic" IPO subscriptions" which "usually precede correction of an overheated market."

Gorges noted that financials and commodities led this week's surge and should continue to be strong next week.

The Hong Kong stock exchange, the major gateway to China companies, showed this week that like other big markets it is hostage to sentiment about economic recovery.

After drifting lower for a couple weeks, Hong Kong plunged Monday, July 13, when big doubts arose about the recovery. In the U.S., there was talk of a need for a second stimulus, and analysts worried China would have to slow its economy after a flood of bank loans in recent months. But China reported better-than-expected GDP growth, and Intel and other U.S. companies came out with good earnings reports.

The Hong Kong blue chip index, which includes many China heavyweights, rose 6.2% for the week to 18,802. The China stock index gained 5.4% to 11,146. The rise was even more impressive after Monday's big loss: a whopping 9.0% for blue chips and 8.4% for China stocks. And stocks finished the week with a flourish as both indexes gained more than 2% on Friday.

There was some talk in Hong Kong that this week's rally has legs. But there was also considerable caution. One worry was that the week's gains came on only modest rises in turnover. "Hong Kong may soon reverse its course, as current price level reflects all positive news," Alex Tang, chief market strategist for Core Pacific-Yamaichi, said on his Twitter page.

Benny Yu, an analyst at VC Group, told Weekly Report in an email that profit-taking may be ahead. "While trading turnover is subsiding, showing weakened momentum, we think there (is) strong resistance for the stocks ahead," he said. Yu also noted that China shipbuilder Guangzhou Shipyard and fertilizer maker Sinofert recently posted profit warnings. More such warnings are probably coming soon, weighing on stock prices.

Stocks in Hong Kong reversed a week and a half of slow declines late last
week and appeared poised to follow the Mainland Chinese economy and stocks
higher or fall through a critical support level. After ending the previous
week with a small loss, Hong Kong's blue chip HSI index, which features
numerous heavyweight Chinese companies, slid 2.6% from Monday through
Wednesday. The HSCEI index of China stocks fell even more, 3.7%.

The main drag on the market was growing concern the global economic
recovery, anemic to start with, was slipping. And support from surging
stocks in China faltered. "There were indications the Mainland was
tightening lending policies, and properties fell sharply," Francis Lun,
general manager at Fulbright Securities, told the Weekly Report.

Stocks continued to slip Thursday morning, but swung around in the
afternoon. They closed the week almost unchanged since Wednesday's soft
close. The blue chip index ended down 2.7% at 17,708, and HSCEI finished off
3.7% at 10,574.

VC Group's web site noted that the blue chip index stopped short of the
17,500 support level. But if it fell through, the brokerage said, a drop to
16,000 to 16,500 was likely.

However, there was strong sentiment that a stabilizing Chinese economy would pull the market higher. "The market underwent a mild correction this week and is poised to recover next week," Lun Said. The rebound Thursday
afternoon was led by car makers, he said. China reported that June car sales soared 36% from June 2008. Chinese insurers also rose sharply because
regulators allowed them to sell a new product. KGI Research reported that
Chinese home appliance makers surged Friday - Haier jumped 12.0%.

Lun predicted that Chinese manufacturers and insurance companies would lead
the market higher next week, with some bargain-hunting of Mainland
properties.

U.S. bears and China bulls fought a tug of war over Hong Kong stocks this week, with the bears on top -for the time being. Hong Kong's blue chip index (HSI) matched its recent high in early trading Thursday but plummeted on profit-taking. Then on Friday afternoon, stocks recovered nicely from further early losses caused by Wall Street's near-melt down on July 2. For the week, blue chips fell 2.1% to 18,203 and Chinese companies slipped 0.5% to 10,984.

The context was that Hong Kong, and particularly China plays, have already helped investors pile up healthy profits. The index of Chinese companies (HSCEI) surged 38.9% in the first half of 2009, while the HSI gained 35.4%. According to Howard Gorges, vice chairman of South China Brokerage, foreign fund managers watched Hong Kong struggle between 18,000 and 19,000 in recent weeks and then sold to lock in fat profits for the first half of the year.

But the pull of China's robust economy and stocks is strong. China's mainland stock index hit its 13-month high this week and rocketed 62.5% higher in the first half. The economy hums along, fueled by a huge stimulus program and lavish bank lending. "There's definitely more optimism China will hit its goal of 8% growth in the second half," Gorges said.

Chinese banks and properties, along with Hong Kong property companies, have led the market, he said, and may continue to do so.

Next week will probably be another struggle for stocks in Hong Kong. "Bears will see what get away with," Gorges said. "But if (the) Shanghai (market) holds, there may not be much downside."