China failed to intervene in the past few weeks, allowing the Yuan to fall to offset the impact of tariffs instead of selling foreign reserves to support the currency. Their actions risk further retaliation by the Trump administration and could spark a full-blown trade war.
A weakening Yuan is likely to increase demand for US Dollars, both as investors in the Middle Kingdom seek to withdraw and as borrowers with USD-denominated loans seek to hedge or repay.
The Dollar Index continues to test strong resistance at 95. Breakout is likely and would offer a target of 2016/2017 highs at 103.
Spot Gold is in a primary down-trend, consolidating in a narrow band above short-term support at $1220/ounce. Breach of support is likely and would offer a short-term target of $1200.
The Australian Dollar is also in a primary down-trend, consolidating above 73.50 US cents. So far, the weaker currency has cushioned local gold miners from the impact of falling spot prices.
The All Ordinaries Gold Index (XGD) recovered above support at 4950. Follow-through above 5100 would indicate another test of 5400.
But downside risk to Australian gold stocks is rising as the USD spot price falls. Gold is more volatile than the Aussie Dollar.
The Dollar price of gold breached support at $1240/ounce, signaling a primary down-trend. A long tail indicates active buyers and we can expect retracement to test the new resistance level at $1250.
The Dollar Index continues to test strong resistance at 95.
But Chinese selling to support the Yuan has not materialized in sufficient magnitude to reverse Dollar strength. Dollar Index breakout above 95 is likely to spur selling of gold.
The Australian Dollar has not weakened sufficiently to protect local gold miners, with the price of Gold in Australian Dollars falling sharply.
The All Ordinaries Gold Index (XGD) broke support at 4950. Expect a test of 4600.
Downside risk to Australian gold stocks is rising.
The yuan is falling as threat of a tariff war rises.
The Shanghai Composite Index is testing its 2016 low at 2700. Breach would warn of a decline to the 2014 low at 2000.
Commodity prices are plunging in anticipation of falling demand from China.
Chinese monthly iron ore imports are down at 83.24 mt, compared to earlier peaks of 100 mt earlier in 2017. Iron ore spot price is testing primary support $63/tonne. A Trend Index peak below zero warns of selling pressure. Breach of support is likely and would warn of a decline to $58/tonne.
A falling Aussie Dollar may cushion local resources stocks from some of the impact.
But ASX 300 Metals & Mining index continues to test medium-term support at 3800. Breach of support is likely and would warn of a correction to test the rising trendline.
Resources stocks remain in a primary up-trend but I am bearish on the medium-term outlook.
China continues to support the Yuan and we can expect consolidation around 15 US cents. Threat of trade tariffs is weakening the Yuan, forcing the PBOC to sell off foreign reserves to prevent a downward spiral as investors flee and borrowers hedge against the stronger Dollar.
PBOC sale of foreign reserves, mainly held in US Treasuries and mortgage-backed securities, would drive up yields and weaken the Dollar. The Dollar Index continues to test resistance at 95. Respect is likely and would warn of another correction. While unlikely, breakout above 95 would signal that the PBOC is sitting on its hands while the Dollar advances to an initial target of 100.
Gold is testing primary support at $1240/ounce. A stronger Dollar would breach support, warning of a decline to $1150. Respect of primary support is more likely and would signal another rally.
The price of gold in Australian Dollars has been edging up over the past few years as the Aussie Dollar weakens. But the monthly chart below shows that Gold (USD) has fallen faster than the Aussie Dollar over the last 3 months. Large bearish divergence on the Trend Index indicates selling pressure. Breach of support at $1650 (AUD) and the rising trendline would warn of a reversal.
The All Ordinaries Gold Index is a bit stronger, having broken through resistance at 5000. A correction that respects the rising trendline and new support level at 5000 would confirm the primary advance, with a target of 6000.
China’s Yuan fell sharply over the last 3 weeks, with the threat of US trade tariffs.
Risk of capital flight will force the PBOC to sell foreign reserves to support the Yuan. It took $1 trillion to stem the last fall, so expect a sizable sell-off in Chinese holdings of US Dollar assets, mainly Treasuries and mortgage-backed securities. The outflow is likely to weaken the Dollar, which is likely to strengthen Gold.
The Dollar Index encountered stubborn resistance at 95. Respect would warn of another correction.
Gold found support at $1250/ounce. Respect of the primary support level would suggest another rally.
The Aussie Dollar is likely to strengthen if the US Dollar falls.
A stronger US Dollar is expected to be mildly bullish for Australian gold stocks, with a stronger Aussie Dollar offsetting some of the gains.
The All Ordinaries Gold Index broke through resistance at 5250, signaling a primary advance with a target of 6000. Follow-through above 5300, after the recent retracement, would strengthen the signal.
A rapidly falling Chinese Yuan highlights the threat of trade tariffs to the Chinese economy.
Expect another sell-off of foreign reserves by China, as in 2015 to 2016, in attempt to stabilize the Yuan and head-off a major capital exodus. The sell-off would weaken the Dollar and Chinese exports.
Significant monetary easing by the PBOC is also likely, to stimulate domestic demand. Driving the Debt-to-GDP ratio into the stratosphere.
The Aussie Dollar would act as a shock-absorber, following the path of the Yuan.
Cushioning the blow to Australian exporters.
So far, Resources stocks are unfazed. The ASX 300 Metals & Mining index is consolidating below 4000.
The ASX 300 Banks index ran into stiff resistance at 8000. Expect another test of primary support at 7300 but this is not related to trade tariffs.
The ASX 200 appears unperturbed by the international turmoil, retracing calmly to test its new support level at 6150. Respect would signal another primary advance, with a target of the October 2007 high at 6750.
The All Ordinaries Gold Index broke through resistance at 5250, signaling a primary advance with a target of 6000. I remain cautious while the Dollar-price of Gold is falling; respect of Gold support at $1250/ounce would strengthen the bull signal.
The Aussie Dollar continues to fall, boosting local gold stocks.
Despite the Dollar-price of gold heading for a test of primary support between $1240 and $1250. Trend Index peaks below zero flag selling pressure.
Largely because the Dollar is strengthening, with the Dollar Index breaking through resistance at 95 to signal continuation of the recent advance.
A sharp fall in China’s Yuan is unsettling global financial markets.
The normal response to uncertainty is a flight to safety which boosts the Dollar, Yen and Gold. But this looks like a straight arm-wrestle between the Yuan and the Dollar, with strong demand for the greenback weakening the Dollar-price of Gold.
Copper is testing long-term support at 5400, suggesting weak demand from China. Breach would signal a primary down-trend.
The Yuan has enjoyed a respite, consolidating in a narrow line for several weeks. But this is likely to prove temporary, with further advances of the Dollar against the Yuan eroding PBOC foreign exchange reserves.
Shanghai’s Composite Index broke support at 3100, signaling a primary down-trend, but the long tail indicates buying support. Recovery above 3100 would suggest a false signal (or government intervention) while respect of resistance would confirm the down-trend.
While we, as well as the few bearish peers we have, have warned of a pending “credit event” in China for some time now – admittedly incorrectly (China has proved much more resilient than expected) – the more recent red flags are among the most profound we’ve seen in years – in short, we agree with fresh observations made by some of the world’s most famous iron ore bears. Thus, while it is nearly impossible to pinpoint exactly when the credit bubble will definitively pop in China, a number of recent events, in our view, suggest the threat level is currently at red/severe.
WHERE IS CHINA AT TODAY VS. WHERE THE US WAS AT AHEAD OF THE SUBPRIME CRISIS? At the peak of the US subprime bubble (before the failure of Bear Stearns in Mar. ‘08, and subsequently Lehman Brothers in Sep. ’08, troubles in the US credit system emerged as early as Feb. ’07), the asset/liability mismatch was 2% when compared to the total banking system. However, in China, currently, there is a massive duration mismatch in wealth management products (“WMPs”). And, at $4tn in total WMPs outstanding, the asset/liability mismatch in China is now above 10% – China’s entire banking system is ~$34tn, which is a scary scenario. In our view, this is a very important dynamic to track given it foretells where a country is at in the credit cycle.
WHAT ARE THE SIGNS WE ARE SEEING? In short, we see a number of signs that point to what could be the beginning of the “popping” of the credit bubble in China. More specifically: (1) interbank rates in China are spiking, meaning banks, increasingly, don’t trust each other – this is how any banking crisis begins (Exhibit 1), (2) China’s Minsheng Bank recently issued a ghost/fraudulent WMP (they raised $436mn in funds for a CDO-like asset that had no assets backing it [yes, you heard that right] – link), (2) Anbang, the Chinese conglomerate who has used WMP issuance as a means to buy a number of assets globally (including the Waldorf Astoria here in the US), is now having issues gaining approval for incremental asset purchases (link), suggesting global investors may be getting weary of the way in which Anbang has “beefed up” its balance sheet, (3) China’s top insurance regulator, Xiang Junbo, chairman of the China Insurance Regulatory Commission, is currently under investigation for “severe” disciplinary violations (link), implying some/many of the “shadow” forms of transacting in China could become a bit harder to maneuver (which would manifest itself in higher rates, which his exactly what we are seeing today), and (4) as would be expected from all of this, as was revealed overnight in China, bank WMP issuance crashed 15% m/m in April to 10,038 from 11,823 in March, a strong indicator that faith in these products is indeed waning.
Exhibit 1: Interbank Rates in China
Source: Bloomberg.
DOES CHINESE PRESIDENT XI JINPING HAVE ALL OF THIS UNDER CONTROL? In a word, increasingly, it seems the answer is no. What’s the evidence? Well, in March, interbank rates spiked WAY past the upper corridor of 3.45% to ~11% (Exhibit 2), a strong indicator that the PBoC is losing its ability to “maintain order”. And, admittedly, while there are levers the PBoC can pull, FX reserves are at scary low levels (discussed below), suggesting the PBoC is quickly running out of bullets. Furthermore, corporate bond issuance in China was negative in C1Q, which means M2 is going to be VERY hard to grow (when MO is negative); at risk of stating the obvious, without M2 growth in China, economic growth (i.e., GDP) will undoubtedly slow – this is not the current Consensus among market prognosticators who think things are quite rosy right now in China; yet, while global stock markets are soaring, the ChiNext Composite index is down -7.5% YTD vs. the Nasdaq Composite Index being up +12.8% YTD. In our view, given China’s importance to the global commodity backdrop, we see this as a key leading indicator (the folks on the ground in China are betting with their wallets, while global investors continue to place their hopes on: [a.] a reflationary tailwind that we do not believe is ever coming [China is now destocking], and [b.] hope that President Trump will deliver everything he’s promised [which, in this political environment, we see is virtually impossible]).
Exhibit 2: Overnight Reverse Repo Rate
Source: Bloomberg.
CHINA’S FOREIGN EXCHANGE (“FX”) RESERVES ARE DANGEROUSLY CLOSE TO LOW LEVELS THAT WILL LIKELY CAUSE AN INFLECTION LOWER IN THE CURRENCY. Based on a fine-tuning of its formula to calculate “reserve-adequacy” over the years, the International Monetary Funds’ (“IMF”) approach can be best summed up as follows: Minimum FX Reserves = 10% of Exports + 30% of Short-term FX Debt + 10% of M2 + 15% of Other Liabilities. Thus, for China, the equation is as follows: 10% * $2.2tn + 30% * $680bn + 10% * (RMB 139.3tn ÷ 6.6) + 15% * $1.0tn = $2.7tn of required minimum reserves. Furthermore, when considering China’s FX reserve balance was roughly $4tn just 2 years ago, we find it concerning that experts now peg China’s unofficial FX reserve balance somewhere in the $1.6-$1.7tn range. Why does this differ from China’s $3.0tn in reported FX reserves as of Feb. 2017? Well, according to our contacts, when adjusting for China’s investment in its own sovereign wealth fund (i.e., the CIC) of roughly $600bn, as well as bank injections from: (a) China Development Bank (“CDB”) of roughly $975bn, (b) The Export-Import Bank of China (“EXIM”) of roughly $30bn, (c) the Agricultural Development Bank of China (“ADBC”) of roughly $10bn, as well as capital commitments from, (d) the BRICs Bank of roughly $50bn, (e) the Asian Infrastructure Investment Bank (“AIIB”) of $50bn, (f) open short RMB forwards by agent banks of $300bn, (g) the China Africa Fund of roughly $50bn, and (h) Oil-Currency Swaps with Russia of roughly $50bn, the actual FX reserve balance in China is closer to $1.69tn (Exhibit 3).
Stated differently, based on the IMFs formula, sharply contrasting the Consensus view that China has years of reserves to burn through, China is already below the critical level of minimum reserve adequacy. However, using expert estimates that $1.0tn-$1.5tn in reserves is the “critical level”, and also considering that China is burning $25bn-$75bn in reserves each month, the point at which the country will no longer be able to support the renminbi via FX reserves appears to be a 2017 event. At that point, there would be considerable devaluation in China’s currency, sending a deflationary shock through the world’s commodity markets; in short, we feel this would be bad for the steel/iron ore stocks we cover, yet is being completely un-discounted in stocks today (no one ever expects this event to occur).
The early 2007 analogy is a good one. This is coming at some point in the next few years. I remain on guard but skeptical at this point given China does have other levers it can pull to keep the credit running and is indeed pulling them in fiscal policy. As well, the problem can always be made worse before it’s made better. Authorities are, after all, bringing this on.
It’s a fascinating question. Could China endure a “sudden stop” in credit if counter-party risk exploded, much like happened to Wall St in 2008? The usual analysis reckons that China’s publicly owned banks can always be ordered to lend more but what if they lose faith in each other? It’s probably true that Chinese authorities could still force feed credit into the economy but, equally, it’s difficult to see how an interbank crash in confidence would not slow the injection, at minimum via choked off-balance sheet vehicles like WMPs.
There is no doubt, at least, about what happens when it does arrive:
the final washout of commodity prices;
Australian house price crash;
multiple sovereign downgrades, and
an Aussie dollar at 40 cents or below.
It’s the great reset event for Australia’s bloated living standards. That is why we say to you get your money offshore today. We can help you do that when the MB Fund launches in the next month with 70% international allocation.
Comment from Colin:
I share Macrobusiness’ skepticism over the timing of a possible Chinese crash, especially because they have in the past shown a preparedness to kick the can down the road rather than address thorny issues – making their problems worse in the long run. But I do see China’s stability as a long-term threat to the global financial system which could precipitate a major down-turn on global stock markets.
The Dollar Index continues to test support at 100 despite strengthening interest rates. China’s sell-off of foreign reserves to support the Yuan may be contributing to this weakness.
Spot Gold is consolidating below resistance at $1300/ounce. A more confrontational US foreign policy is contributing to global uncertainty and demand for precious metals.
Breakout above $1300 is likely and would signal a test of the 2016 high at $1375.
