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Chinese shares decline most in 2 months, market seen as overheating

Chinese stocks capped their biggest drop in two months, amid concerns liquidity may tighten and as a technical indicator suggested the mainland market is overheating.

The Shanghai Composite index fell 1% at the close, paring this month's rise to 4.8%. Yanzhou Coal Mining Co. led a gauge of energy companies lower on the CSI 300 index, while Jiangxi Copper Co., Aluminum Corp. of China Ltd. and Angang Steel Co. each dropped more than 3.3%. Metals dropped with steel and iron ore as industrial commodities extended Tuesday's slump. The Shanghai equity benchmark's 14-day relative strength index on Tuesday was at its highest level since May 2015 and above the threshold some traders consider as being overbought.

China's interest-rate swaps are heading for the biggest monthly increase in two years on speculation that rising inflation and the authorities' plan to curb excessive borrowing will drive money rates higher. The People's Bank of China continues to use longer term reverse-repurchase agreements in open-market operations, which effectively raises the cost of funds injected into the financial system.

“The market is pretty sensitive to any perceived tilt in liquidity stance from the PBOC, particularly into month-end,” said Bill Bowler, a sales trader at Forsyth Barr Asia Ltd. in Hong Kong. “Tight liquidity can reverberate across asset classes. We've seen weakness in bond futures and particularly commodity futures, which could be feeding into stock market weakness.”

The PBOC may keep underlying liquidity relatively tight in the near term, with the occasional nudge higher to encourage deleveraging, Goldman Sachs Group (GS) Inc. said in a note on Tuesday.

Despite Wednesday's drop, the Shanghai gauge capped its best month since March. Commodity producers and construction companies climbed in November amid optimism that China's authorities will lift fiscal spending to stimulate growth, while the rollout of property curbs boosted the lure of equities. The Hang Seng China Enterprises index also capped a monthly advance as insurers surged amid bets that their investment returns will improve along with surging mainland markets.

“There is some profit taking after recent gains,” said Sam Chi Yung, senior strategist at South China Financial Holdings Ltd. in Hong Kong. The rising turnover shows “people are interested in the stock market again since the government is trying to slow down speculation in the property sector.”

The Shanghai Composite index dropped to 3,250.04. The Hang Seng China Enterprises index fell 0.1%, paring its November gain to 2.9%. Volume on the CSI 300 index was 37% above its 30-day average, according to data compiled by Bloomberg.

The Hang Seng index fell 0.6% this month as local property companies slumped on higher stamp duty and expectations that the U.S. Federal Reserve will raise interest rates in December. With the city's dollar pegged to the greenback, borrowing costs track those of the U.S.