Tag: finance

“Hope” And “Change” And This Time It’s Different…again…

 

 

(h/t Sunday Funnies via The Burning Platform blog)

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Submitted by Alasdair Macleod via GoldMoney.com,

 

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Many analysts today claim that Gold is dead as an investment due to its having fallen from a record high of $1900 per ounce to roughly $1200 per ounce today (a 36% drop).

 

However, this price movement, while dramatic, is quite inline with how commodities trade. Gold has already posted one drop of 28% (in 2008) during its bull market, before more than doubling in price. This latest drop is not much larger.

 

Moreover, a 36% drop in prices is nothing in comparison to what happened during that last great bull market in Gold back in the 1970s. At that time, Gold staged a collapse of nearly 50%. But after this collapse, it began its next leg up, exploding 750% higher from August ’76 to January 1980.

 

With that in mind, I believe the next leg up in Gold could very well be the BIG one. Indeed, based on the US Federal Reserve’s money printing alone Gold should be at $1800 per ounce today.

 

Since the Crash hit in 2008, the price of Gold has been very closely correlated to the Fed’s balance sheet expansion. Put another way, the more money the Fed printed, the higher the price of Gold went.

 

Gold did become overextended relative to the Fed’s balance sheet in 2011 when it entered a bubble with Silver.  However, with the Fed now printing some $85 billion per month, the precious metal is now significantly undervalued relative to the Fed’s balance sheet.

 

Indeed, for Gold to even realign based on the Fed’s actions, it would need to be north of $1,800. That’s a full 30% higher than where it trades today (see below).

 

 

 

Make no mistake, gold is not dead. Not by any means. The day is coming when its price will soar again.

 

For a FREE Special Report on a uniquely profitable inflation hedge, swing by….

http://phoenixcapitalmarketing.com/goldmountain.html

 

Best Regards

Graham Summers

 

 

 

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Treasury bears are at risk, is the ominous warning from BofAML's Technical Strategist MacNeil Curry, as bonds are on the verge of turning the near-term, and potentially medium-term, trend from bearish to bullish. USDJPY bulls should also take note as with the 3-month uptrend increasingly showing its age, a reversal in US rates could prove to be the catalyst for a USDJPY reversal lower.

 

Via BofAML,

10yr yields stall at support 

 

US 10yr Treasury yields are topping out against 3.000%/3.012% support. A daily close below 2.970%/2.965% resistance would complete a Head and Shoulders Top and confirm a near term turn in trend for 2.88% and potentially below. While the implications for the US $ in general are likely to be limited, $/¥ bulls should pay close attention.

The $/¥ uptrend is growing vulnerable to a reversal

The 3m $/¥ uptrend is increasingly vulnerable to a top and bearish reversal. The bearish daily momentum divergences and completing 5 wave advance from both Feb'12 and Oct'13 says that additional strength is limited before a top and turn. Given the strong correlation between $/¥ and US 10yr yields; a break down in yields could be the catalyst for such a reversal. See chart for key $/¥ levels.

US $ Index breakout

While a bullish turn in US Treasury yields could be seen as US $ bearish, it is unlikely to be the case this time. Friday's closing break of the 100d avg (now 80.65) says that the US $ Index has resumed its medium term uptrend after 2 months of range trading. Upside targets are seen to 82.15/82.55

Seasonals are also supportive for the US $ Index

In addition to the bullish breakout, seasonals are also very positive for the US $ Index. Since 1971 it has averaged a return of 1.02% (excluding carry) and risen 65% of the time. Given Friday's breakout and strong gains since the start of the year, this January should be no exception to the historical norm.

Summing it up…

• US 10yr yields are at risk of a top & bullish reversal. A break of 2.970%/2.965% confirms, opening 2.88% & potentially below
• $/JPY bulls beware. A US Treasury yield reversal could be the catalyst for a top and turn lower in $/JPY.
• The US$ Index should remain unharmed from a Treasury turn. The bullish breakout & positive seasons point to higher prices

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It seems the adoption of major US-based vendors of the digital currency is trumping the Chinese clamp-down on Bitcoin as first Overstock and now Zynga confirm their adoption of the crypto-currency. For the first time since the PBOC issued its statement, Bloomberg reports Zynga is partnering with BitPay to test Bitcoin payments. As ConvergEx's Nick Colas notes, "Bitcoin has been remarkably resilient in the face of all the bad news out of China. The strength shows a continued interest, which is a very positive sign."

 

 

Via Bloomberg,

Dani Dudeck, a spokeswoman for San Francisco-based Zynga, confirmed a post introducing a plan to test Bitcoin payments by the company on the reddit.com community website. Players will be able to pay via the BitPay payments service for players of FarmVille 2, CastleVille and other games, Zynga said.

 

“We look forward to hearing from our players about the Bitcoin test so we can continue in our efforts to provide the best possible gaming experience,” Zynga said.

 

Victoria’s Secret Stores LLC has signed up with Gyft, an app that lets users buy gift cards with Bitcoins. Overstock.com Inc. plans to start accepting Bitcoins next summer, Chief Executive Officer Patrick Byrne said in an interview last month.

 

“We think there’s an underserved part of the market that wants to use Bitcoins and can’t,” Byrne said. The company needs time before it starts accepting Bitcoins in order to figure out how to process Bitcoin transactions and to hedge Bitcoin sales (the currency is highly volatile), he said.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/-u_vrzAP6VM/story01.htm Tyler Durden

It seems the adoption of major US-based vendors of the digital currency is trumping the Chinese clamp-down on Bitcoin as first Overstock and now Zynga confirm their adoption of the crypto-currency. For the first time since the PBOC issued its statement, Bloomberg reports Zynga is partnering with BitPay to test Bitcoin payments. As ConvergEx's Nick Colas notes, "Bitcoin has been remarkably resilient in the face of all the bad news out of China. The strength shows a continued interest, which is a very positive sign."

 

 

Via Bloomberg,

Dani Dudeck, a spokeswoman for San Francisco-based Zynga, confirmed a post introducing a plan to test Bitcoin payments by the company on the reddit.com community website. Players will be able to pay via the BitPay payments service for players of FarmVille 2, CastleVille and other games, Zynga said.

 

“We look forward to hearing from our players about the Bitcoin test so we can continue in our efforts to provide the best possible gaming experience,” Zynga said.

 

Victoria’s Secret Stores LLC has signed up with Gyft, an app that lets users buy gift cards with Bitcoins. Overstock.com Inc. plans to start accepting Bitcoins next summer, Chief Executive Officer Patrick Byrne said in an interview last month.

 

“We think there’s an underserved part of the market that wants to use Bitcoins and can’t,” Byrne said. The company needs time before it starts accepting Bitcoins in order to figure out how to process Bitcoin transactions and to hedge Bitcoin sales (the currency is highly volatile), he said.

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Submitted by George Reisman via the Ludwig von Mises Institute,

The efforts underway by the Service Employees International Union, and its political and media allies, to raise the minimum wage from $7.25 to $15 per hour would, if successful, cause major unemployment among low-skilled workers, who are the supposed beneficiaries of those efforts.

The reason is not only the fact that higher wages serve to raise costs of production and thus prices, which in turn serves to reduce physical sales volume and thus the number of workers needed. There is also another equally, if not more important reason in this case, and it is a reason which is only very inadequately described by reference to the substitution of machinery or automation for the direct labor of workers when wages are increased.

This is the fact that a low wage constitutes a competitive advantage for less-skilled workers that serves to protect them from competition from more-skilled workers. In other words, a wage of $7.25 per hour for fast-food workers serves to protect those workers from competition from workers able to earn $8 to $15 per hour in other lines of work. The workers able to earn these higher wage rates are not interested in seeking employment at the lower wage rates of the fast-food workers.

But if the wage of the fast-food workers, and all other workers presently earning less than $15 per hour, is raised to $15 per hour, then these more capable workers can now earn as much as fast-food workers as they can in any of the occupations in which they had been working up to now.

Moreover, the widespread rise in wage rates to $15 per hour will cause unemployment in all of the occupations affected. The unemployed clerks, telemarketers, factory workers, and whoever, who otherwise would have earned between $8 and $15 per hour, will have no reason not to apply for work in fast food, which will now pay as much as any other occupation that is open to them. And since those workers are more capable, it is overwhelmingly likely that to the extent that they do seek employment as fast-food workers, they will be preferred over the low-skilled workers who presently work in fast-food establishments. Thus, the rise in the wage of the fast-food workers will serve as an invitation to the competition of large numbers of workers who do not presently think of working as fast-food workers and who, being better qualified, will almost certainly take away their jobs.

Between less employment overall in the least-skilled lines of work such as fast food, and the incentive created for vastly increased competition for employment in those lines coming from more qualified workers, the effect could well be to close those lines altogether to the employment of workers at the low end of skill and ability. That, of course, would deprive these people of the opportunity to acquire skills and abilities from work experience that otherwise would have enabled them to become capable of performing more demanding jobs later on.

What the demand for a $15 an hour minimum wage represents is a case of low-skilled workers being led to reach for a high-wage “bird in the bush,” so to speak. Unfortunately, at the high wage, there are both fewer birds in the bush than are presently in hand and most or all of them will fly away into the hands of others, who possess greater skills and abilities, if the attempt is made to reach for them.

This must ultimately be the result even if somehow the present fast-food workers and the like could be enabled to keep their jobs for a time. Even so, practically every time that it became a question of hiring someone new, the new employees would almost certainly be drawn from the ranks of workers of greater skill and ability than those who had customarily been employed in these jobs. Thus, even if not immediately, in time there would simply be no more room in the economic system for workers at or near the bottom of the skills ladder.

No one can question the desirability of being able to earn $15 an hour rather than $7.25 an hour. Still more desirable would be the ability to earn $50 an hour instead of $15 an hour. However, it is necessary to know considerably more than this about economics before attempting to enact sweeping changes in economic policy, changes to be achieved by attempting to organize a mass movement that is based on nothing but a desire for economic improvement and no real knowledge whatever of how actually to achieve it.

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In the first full week of 2014, we identify four main sets of drivers for the foreign exchange market:  the significance of last week’s price action, interest rate differentials, central banks, and data releases.  

 

1.  Significance of last week’s price action:  Many observers have been discussing the dollar’s weakness since the Fed announced its decision to begin slowing its long-term asset purchases.  Instead, we have emphasized the divergent performance of the greenback, noting that its weakness was concentrated against small number of currencies that move with the euro and sterling’s orbit.  Against the yen, dollar-bloc currencies and many emerging markets currencies, the greenback has been fairly strong. 

 

Yet last week, this pattern was reversed.  The four strongest major currencies were Antipodean currencies, the Canadian dollar and Japanese yen.  The four weakest major currencies were the Swiss franc, euro, Danish krone and sterling.   

 

The key question is whether this price action reflected a bout of position adjustment exacerbated by thin market conditions or a reversal of the underlying trends.   While wary of attributing too much significance to last week’s price action, we recognize some fundamental developments that will likely underpin the US dollar.   These fundamental considerations include the trajectory of interest rate differentials and the data surprises, which for important releases, have surprised on the upside in the US, but the downside in the euro area and UK.  This means that the dollar may be vulnerable if there is disappointment with the employment data at the end of the week.  

 

2.  Interest rate differentials:  We grappling with the euro-dollar exchange rate, we have often found the 2-year interest rate differential between the US and Germany and useful guide.  That differential has widened from just below 7 bp in mid-December to almost 19 bp presently, which is the highest level since mid-November.  

 

The reason for the widening is also important.  The US 2-year yields has crept higher from about 25 bp on November 20 to almost 40 bp now, perhaps helped by the positive data surprises.  There is also a sense among some money managers that the market is vulnerable to stronger US growth and a more hawkish Federal Reserve.  

 

On the other hand, the German 2-year yield, which had fallen to about 5 bp in early November as speculation that ECB would adopt a negative deposit rate reached a crescendo, peaked around 26 bp in mid-December and has trended a bit lower since.  Softer euro zone data and some growing ideas that with low inflation and the continued contraction in private sector lending, the ECB may move again.   

 

Another force at work here are spreads within the euro area.  In particular, the spread compression between Spain and Italy (and Portugal), on one hand, and Germany on the other is noteworthy.   Over the past month, Italian and Spanish 2-year yields have fallen 22 and 44 bp respectively, bringing both within spitting distance of the one percent threshold (Portugal’s 2-year yield has fallen a little more than 60 bp in the same period).  

 

This pattern is repeat through the entire yield curve, with one notable exception, the Germany yields curve had a bearish steepening, meaning that yields rose more tat the longer tend of the curve.   The move in the Italian and Spanish yield curve was much more symmetrical.  Its benchmark 5-year and 10-year bonds rose 16 and 13 bp respectively over the past month, compared with 4 bp in the benchmark 2-year yield.  

 

As we have argued, France is a weak link in the euro area.  It had neither the fall of the Berlin Wall as Germany did to spur reforms, nor an intensive financial crisis as the periphery to incite change.   While the periphery appears to be recovering, France appears still mired in contraction.  The divergent economic performance though has hardly been reflected in the debt markets. 

 

Over the past month, the premium France pays over Germany on 10-year bonds widened by about 2 bp (to about 60 bp).  Over the past three months, the premium has widened 8 bp.  At the 2-year sector the spread has narrowed.  It has been cut by a third to 6 bp over the past month is half of what is was three months ago. Where the disappointing French performance is more evident is in the equity market.   Over the past month, both the DAX and CAC are up almost 3%, but over the past 3-months the CAC is among the worst performing EMU equity markets, up a mere 2%, while the DAX is up 9.4%.  

 

Turning to the dollar-yen exchange rate, we tend to find more interesting insight from the interest rate differential at the longer-end of the curve.  In September, when so many had expected the Fed to taper, the US 10-year premium over Japan was around 220 bp.   After narrowing on the disappointment, the spread widened again to new high just above 230 bp, keeping the long-term trend intact.  

 

One of the under-appreciated developments that has prevented a more dramatic widening of the US premium is that Japanese 10-year yields have also been trending higher.  The 10-year JGB was yielding about 60 bp in early December and was near 75 bp at the end of the month.  This represents 3-month highs and comes despite speculation that the BOJ is likely to step up its efforts to reach the 2% inflation target.  

 

3.  Central Banks:  The Bank of England and the ECB meet this week.  The BOE is largely a non-event. When it does not do anything, it rarely says anything.    The ECB is not expected to announce any new measures, leaving the focus on Draghi’s press conference.    The head of the ECB is likely to remain dovish, recognizing downside risks to growth and emphasizing that there are a number of policies that could be adopted if needed.   

 

The EONIA has trended higher in December, reaching nearly 45 bp at the end of the year, but has quickly fallen back and at just above 11 bp is at its lowest level since November 21.  The tight year-end liquidity conditions may have made it more difficult for the ECB to sterilize the SMP purchases (Trichet’s peripheral bond purchase program).  It failed to do so for three consecutive weeks.  This week’s attempt will be important and is likely to be discussed by Draghi. 

 

Some observers expect the sterilization effort to end as a way the ECB can provide additional liquidity.  We are less convinced.    The purchases themselves were quite controversial, leading to the resignation of the two German members of the ECB.   The end of the sterilization would likely be controversial and the lasting benefits suspect.  

 

Judging from various ECB official comments, the problem, as they see it, is not liquidity per se, but the lack of funding, especially for small and medium-size businesses.  The financial sector may have more excess liquidity without sterilization, but to what end?  And won’t that excess liquidity to quickly offset as banks return their LTRO borrowings (especially French and Italian banks were appear to have lagged behind others) ?  

 

The Federal Reserve does not meet, but the minutes from the meeting in which the tapering decision was made will be released.  The discussion surrounding it will make for interesting reading.  However, one should not forget that the minutes are carefully crafted as it part of the Fed’s communication strategy (in contrast the ECB does not yet publish minutes,but some kind of general record is expected to be forthcoming this year).  

 

Separately, Janet Yellen is expected to be confirmed as the next Chair of the Federal Reserve as early as January 6.  Bernanke is likely to resign shortly thereafter; before the FOMC meeting later this month.  We continue to believe that it would have been better for the Federal Reserve as an institution, to have had Yellen announce the tapering and the new forward guidance.  

 

That she agreed with it is beside the point. The market impact was modest and the real economic impact likely less so.  With many (though not us) perceiving her to be a super-dove and/or Bernanke-lite, the timing of the decisions will make it more difficult for her to exert strong leadership.  This is all the more true is Bernanke (and Draghi’s) Ph.D dissertation adviser, and more recently, the head of the Israeli central bank, Stanley Fischer becomes the vice chairman, as apparent trial balloon from the White House has it.  

 

4.  Economic Data:  Japan does not have much data in the week ahead to note.  This is a big week,though, for Chinese data.  Three reports in general are the focus for investors:  the trade, inflation and lending figures. The risk is that exports slow after the suspicious surge in November, as the government cracks down on such deception to disguise capital flows.  Consumer prices are expected to ease from the 3% pace seen in November.  New yuan loans and aggregate funding are expected to have ratcheted down.  

 

Arguably, the most important report from Australia is the November retail sales reading due out on Thursday, January 9.  Australian retail sales have been particularly robust since mid-year and have beaten expectations consistently in recent months.   The three-month average gain through October was 0.6%, twice the 12-month average.  The RBA easing appears to be having some impact.  However, the greater recovery in the Australian dollar and Australian yields rise, the greater the risk that the RBA cuts rates again, especially if inflation remains tame (Q4 CPI due out January 21).  

 

In Europe, the service PMIs and composite readings will be reported at the start of the week.  The general pattern of continued recovery in the periphery and strength in Germany is expect to continue.  France, as noted above, has been the major disappointment.  On Tuesday, the preliminary December CPI will be announced.  The year-over-year rate is expected to be unchanged from the November reading of 0.9%.  In December 2012, it stood at 2.2%. 

 

While price increases have slowed, retail sales have generally improved, in the sense that they are no longer contracting.   Retail sales are expected to have risen by 0.3% in November from a year ago.  It would be the second positive reading in three months and the strongest since April 2011.   

 

Separately, the November unemployment rate is expected to remain unchanged from November at 12.1%. It has stood at 12% of above throughout 2013.  

 

The economic highlight of the week, the report is often associated with the most dramatic market reaction, is the US monthly jobs report.   The thunder of the January 10 report may be stolen by the January 8 ADP estimate.  The three and six month average of each time series dovetail nicely.  The 3 and 6 month average ADP job growth is 195k and 181k respectively.  For the private sector component of the non-farm payroll report, the averages state at 193k and 180k respectively.  

 

A report near these averages, which the consensus expected, will most likely be seen as sufficient for the Federal Reserve at its meeting late this month that it will slow its purchases by another $10 bln in February to $65 bln.  

 

From a larger perspective, we note that many economists are revising up their Q4 GDP forecasts toward 2.5%.  The Bloomberg consensus stands at 1.5% (no doubt will be updated shortly).  Although headline GDP is unlikely to match the 4.1% in Q3, final demand appears to be stronger.  

 

That said, we suggest two caveats.  First, lost in the Northeast storm disruptions before the weekend, the US reports very disappointing auto sales figures for December.  Instead of selling at a 16.0 mln unit pace that was expected, the pace was 15.3 mln and the disappointment was nearly completely accounted for domestic producers.  A less obvious reason why this is important (not just the coming knock on retail sales) is that the inventory build up has been especially pronounced in the auto sector.  

 

Second, the expiration of emergency jobless benefits at the end of last year may bite income and consumption now and is likely to spur less participation in the work force and a lower unemployment rate. There are proposals in Congress that can be voted on to renew the emergency program, but some are demanding it to be funded by other spending cuts, making for greater near-term uncertainty.  

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Contrary to ongoing attempts by the administration to refocus the public’s attention on such focal points as guns, an imminent external cybersecurity threat (until it was revealed that the biggest cyber terrorist is the NSA itself), and climate change, the three still remain, pardon the pan, at the cold end of the spectrum when it comes to what issues most concern the US public. On the other end, for one decade and counting, the “top priority” for the US public was and continues to be “the economy”, stupid.

And since “the stock market” did not have its own separate category, we can only assume that to most American leaders, the economy and stocks continue to be interchangeable, even though as we have shown over the past 5 years, the broader public – also known as the ‘retail’ investor – has largely shied away from the stock market entirely either because of the realization that it is a rigged casino benefiting a choice group of Wall Street (neither admitted nor denied) criminals, or simply because as the middle class expires, ever fewer Americans have the disposable income to wager on 1,000x forward P/E gambling chips, promises of untold riches by the Fed chair(wo)man notwithstanding.

Some more from Third Way which broke down the numbers sourced from Pew:

Headlines and breaking news may drive news cycles, but according to Pew Research Center polling, the public’s #1 “top priority” has remained steadfast over the past nine years: “Strengthening the U.S. Economy.” Proving that James Carville’s blunt admonishment is as true today as it was back in 1992.

 

To illustrate how other top public priorities have shifted, we’ve created a heat map of 2013 priorities, which you can use to track the public mindset through three presidential elections and the wave midterms of 2010.

The heatmap is shown below. However, since the poll did not account for either Dancing with the Stars, X-Factor, reality TV, or Sunday Night Football, we would take anything shown below with a substantial grain of salt.

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Is China’s economy headed for a crash in 2014? It’s an extreme question that would be laughed at by many. After all, most believe that China is the world’s new powerhouse off the back of near 10% annual growth over the past decade. And the vast majority of economists and policymakers are sanguine about the country’s economic prospects, pointing to still healthy data and confidence in recently-announced structural reforms to steer China in the right direction.

But as Asia Confidential outlined in a recent post, the bulls’ arguments are looking much weaker post two spasms of credit stress.  And there are four crucial things that these arguments seem to ignore: 1) the investment-driven, debt-laden economic model of China simply isn’t sustainable 2) extraordinary credit growth is yielding less and less benefit as investment returns deteriorate 3) the recent spikes in inter-bank rates and high-profile debt defaults (China Everbright Bank) and bankruptcies (coal mining group, Liansheng Resources Group) point to severe stresses within the financial system 4) the structural reforms are a long-term positive, but short-term net-negative for the economy.

For the record, we’re not predicting a China crash this year. We’ll leave sure-fire predictions (which are often wrong) to others. What we are suggesting though is the odds appear to favour a more serious economic downturn in China over the next few years. And that those odds have increased given recent events.

Today we’re going to look at the bulls’ views in depth and what’s wrong with them. We’ll also delve into the countries and sectors which seem most vulnerable to a China downturn. While the Chinese stock market has been a dog for years and told a large tale about the country, many of those most reliant – either directly or indirectly – on China investment demand still seem to be priced for better times ahead.

The bull case
First, let’s take a look at the bull case for China’s economic prospects. In simple terms, it goes something like this:

1) GDP growth accelerated in the third quarter to 7.8%, up from 7.5% in the prior quarter. According to the bulls, this shows that the economy is recovering, or stabilising at worst, thanks to various stimulus measures and government interventions into the inter-bank market.

2) Chinese exports beat forecasts in November, up almost 13%. This indicates that the world’s second-largest economy is benefiting from a recovery in developed markets. That’s important given China’s reliance on exports.

3) Despite all of the concerns about potential bad debts from the massive 2009 stimulus, non-performing loan (NPL) ratios remain low.

4) The new Chinese leadership announced a bold reform agenda late last year, which should help re-balance the economy away from investments towards consumption. Those positive on China suggest this should be a smooth re-balancing and ensure strong economic growth for years to come.

5) Most, including this author, think Xi Jinping may be the man to make the tough decisions to propel China’s long-term growth after the previous regime neglected much-needed reform. Clearly, he’s been focused on consolidating his own power; economic reforms should come next.

6) If the economy does suffer a major downturn, China has ample resources to fight such an occurrence, in the form of almost US$3.7 trillion in foreign exchange reserves. This should ensure China doesn’t have the so-called hard economic landing which critics predict.

What’s wrong with it
The weaknesses in the bull case are the following:

• Almost everyone agrees the that export-led economic model used by China over the past 30 years is unsustainable going forward.
• Previous transitions from export-led models in Japan and South Korea have led to sharply lower economic growth.
• Faith in government to engineer a smooth economic transition is also contrary to much historical experience.

Let’s run through these one-by-one.

It’s important to understand how China’s economy got to be so big in a short space of time. The speed of economic ascent has no parallel in modern times and it’s been the result of a classic export-led growth model.

What this means is that China has been able to mass produce goods on an unprecedented scale given the appetite for these goods abroad. This has helped lift industrial investment well beyond the level which would be needed if it focused solely on the domestic market. And it’s been aided by a key competitive advantage on the global stage: cheap labor. The end result has been that China has been able to suppress domestic demand and pour resources into investment.

The reason why this export-led model is unsustainable is that China now produces so many goods that the rest of the world cannot possibly absorb them all. China’s gotten to big for its own good, in crude terms.

When the 2008 financial crisis hit, Chinese exports plummeted and the limits of the model became apparent. However, China cushioned the blow by implementing massive stimulus measures. In effect, it sunk even more money into investments, such as infrastructure, property and factories. The problem to this day is there hasn’t been the end-demand for these investments. In other words, export demand has remained soft and domestic demand for goods hasn’t been able to pick up the slack.

And a bigger problem is that the much of the investments via the stimulus were debt-financed, principally to state-owned firms. These firms were deemed less risky by banks.

That’s created an issue for small firms which haven’t had access to bank financing. Given reduced export and domestic demand, they’ve had to resort to financing from outside the banks, the so-called shadow banking system. They’ve had to pay much higher interest rates as a consequence. And it’s widely known that the collateral used for non-bank financing is less-than-solid, on average.

As you may be able to see from the above, the export-led model which China has used over the past 30 years is running into a dead-end. What the new leadership is now trying to do is transition the economy towards more domestic consumption, so that it can perhaps make up for the drop-off in export growth.

The history of transitions from export-led models doesn’t make for pretty reading. These transitions for Japan in 1973 and South Korea in 1991 led to sharp slowdowns in economic growth, as seen in the chart below.

Lastly, faith in the new leadership to deliver a successful transition appears misplaced. As noted above, we think Xi Jinping is the right leader to steer the country for the next decade. And many of his proposed reforms have merit and should help in re-balancing the economy.

However, the fact is that China has hemmed itself into a corner where there are limited solutions in the near-term. Cut back on credit-driven investment and GDP falls sharply. Keep the party going and risk a larger blow-up in the not-too-distant future. Moreover, the bulls conveniently downplay that implementation of structural reforms would be a net-negative for growth in the short run.

As for the argument that China can always use its foreign exchange (forex) reserves to provide further stimulus to prop up the economy, the people who purport this have little knowledge of basic economics.

If China were to use substantial forex reserves in this way, it would become a large net-seller of U.S. Treasury bonds. To prevent a spike in interest rates, the U.S. central bank would have to significantly step up purchases, funded ultimately by private citizens savings. Less of these savings would dampen U.S. consumption and ultimately, Chinese exports to the US.. In other words, a move by China to substantially cut forex reserves would not only be a disaster for the developed world but for China itself.

Are recent events a tipping point?
If you agree that China’s current economic model is unsustainable and that any transition away from it will be difficult, the question then becomes when a more serious downturn may occur. The short answer is that no-one really knows. But recent events are beginning to show severe stresses in the economy. Perhaps a sign of things to come.

First, it’s clear that China is trying to keep the investment boom going to aid GDP growth. Though overall credit growth has slowed somewhat, it’s still likely to be up 20% in 2013. That’s much higher than nominal GDP.

The continuing credit binge is why property prices in China have remained strong, even though many have seen a bubble in this space for several years.

The problem is that the credit boom is resulting is less bang for the proverbial buck (or yuan in this case). Recent manufacturing surveys have showed a slowdown.

The consumer price index and producer price index have also slowed. The latter indicates excess industrial capacity ie. too many produced goods chasing too little demand.

In addition, there are warning signs of serious stresses in the banking system. Two episodes of spiking inter-bank rates (where banks lend to each other) over the past six months suggest a very fragile credit system. With both, the central bank had to inject money to keep credit flowing, otherwise it would have risked skyrocketing inter-bank rates, resulting in a wave of defaults across the country. There is only so long bad debts from bad investments can be rolled over and covered up though.

Also, there has been widespread corporate credit distress. Coal miner, Liansheng Resources Group, has made recent headlines, ending up in court owing almost US$5 billion. China Everbright Bank has also belatedly admitted to a US$1 billion default on a loan back in June (coinciding with the first spike in inter-bank rates). There are many other rumours of corporates in trouble. This is hardly surprising with debt/income among corporates at 5x and total corporate debt to GDP being 125%.

In sum, you have still abundant credit-driven investment, but slowing economic output, softening inflation, inter-bank system ructions and corporate debt troubles. Hardly signs of a healthy economy.

Best ways to bet against China
If you agree that China’s economy is in serious trouble, the next question is which markets, sectors or companies are most vulnerable to such an event? The fall-out from a China downturn would be enormous and widespread, but here is a list of things which appear most susceptible were this to happen (our favourite shorts in order of preference):

1) Australian banks. Mining contributed 50% of Australian GDP growth in 2012 and that’s set to slow sharply. A China downturn would send that contribution into negative figures and that’s a big deal when mining contributes about 9% to GDP. The Aussie banks are exposed to this slowdown, are among the most expensive banks in the developed world and have huge exposure to a mammoth property bubble which has ironically been driven by Chinese buyers of late.  Commonwealth Bank (ASX: CBA) is the most expensive bank in Australia and probably the most short-able.

2) China property developers. Given the risks to the bursting of the investment bubble, the good times for property developers are unlikely to last. State-owned China Resources Land (HK: 1109) appears one of the most at risk.

3) The Chinese yuan (vs USD). This will surprise many people given the yuan strength in 2013. However, the yuan is overvalued in my view and highly vulnerable to a downturn in the economy. Moreover, there’s the added issue of yen depreciation which has to provoke a reaction from other prominent exporters, such as China, at some point.

4) Fortescue Metals. This Australian iron-ore miner is near 52-week highs as the price of iron ore has recovered nicely. But iron ore and steel are highly vulnerable to a China downturn in investment. Fortescue (ASX: FMG) isn’t cheap, has high leverage and is therefore probably the best short in the iron ore space.

5) The Aussie dollar. Yes, the Aussie has pulled back a long way already. This could well be a market signal of trouble in China, by the way. But whichever metric you use, the Aussie remains overvalued and would end up much lower should a China downturn eventuate. The Australian central bank talking down the currency is an additional negative factor.

You’ll probably notice that the list doesn’t include large parts of the Chinese stock market. Keep in mind though that this market (Shanghai Composite) is already down more than 60% from their 2007 peak. This market has signaled trouble in China ever since 2008, but too few have paid attention. Put simply, much is now priced into Chinese stocks. There may be a strong case for the potential inclusion of some of China’s second tier banks though as they’re the most vulnerable in the financial sector to a downturn.

AC Speed Read

– There are many signs that China’s economy is in serious trouble.

– The signs include still booming credit growth but lower output growth, softening inflation, spiking inter-bank rates indicating stresses in the financial system, as well as large corporate defaults and bankruptcies.

– These things combined have increased the odds of a more severe China economic downturn this year.

– The best ways to bet on a China crash include shorting the following: Australian banks, China property stocks, the Chinese yuan and iron ore miners such as Fortescue Metals.

This post was originally published at Asia Confidential:
http://asiaconf.com/2014/01/05/betting-against-china-in-2014/

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/crq6px13zd0/story01.htm Asia Confidential