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Posts Tagged ‘China inflation’

28
Jan

WHAT RESOLUTION FOR THE CHINESE SYNDROME?

   Posted by: Mr. Gold    in Uncategorized

What a mournful January it has been for gold bugs. The misery of this seasonally slow period has been compounded by the crass underperformance of XAUEUR. Gold in Euro terms has lost 11.36%. While the robust Euro, bolstered by hawkish ECB comments and record interest in bailout EFSF bonds registered record gains over high growth proxies (such as AUD), gold, which usually benefits from strong EURUSD performance, has languished, elbowed away from the pedestal by the ever more radical ETF redemptions.

Much of the real (as opposed to nominal) gold losses can be attributed to the newfound optimism concerning the interest rate trajectory and a possible reduction in liquidity injections in the West. But while the transatlantic hawk/dove rhetorical discrepancy has reached 1987 levels (by itself hardly a bullish signal for the raging stock markets), few gold market observers have paid attention to the travails of PBOC in Beijing. There, the regulator, frustrated by the ineffectiveness of lending quotas, slapped an initially yawn-inducing seventh increase in reserve requirement ratio.

This poorly timed, pre-holiday tightening has created liquidity havoc at a time where most Chinese withdraw cash in order to purchase gifts for the family and train tickets to head home for a week of bonding and home food feasting. Remarkably, after repo rates rocketed, the central bank had to conduct reverse repos and briefly disengage from open market bill selling. Instead of addressing the underlying problems of inflation, the actions rocked the money market. But why did PBOC act in such an untimely fashion?

The answer lies in the system’s deepening inability to deal with structural inflation. With minimum wage increases rising more than 20% in the main cities, China’s low marginal costs and its output gap are now unlikely to protect the country against price pressures. Nowhere is it more evident than in the food sector, where spare capacity has been the slimmest to start with. For several months now the system has exhibited two basic characteristics of overheating: rising overconfidence and booming credit.

China is experiencing a massive discrepancy between asset appreciation and hitherto suppressed inflation of goods and services and the resolution of this tension can only occur in a binary fashion. Either asset (including home prices) deflate or goods and services increase in price. Which path will China choose and what it will mean for gold?

In the US, where the focus of the monetary authorities is exclusively on core inflation, it was the asset price deflation that closed this gap, with huge costs. Although most banks survived, the country is now saddled with a broken housing market, structural unemployment and severe political polarization. In China – asset deflation would mean a significant loss of wealth for realtors and other clients of the communist party officialdom. High inflation could potentially mean social unrest.

Beijing will only act when all other options to kick the can down the road have been exhausted. In a normal world they should pick the former (i.e. asset deflation) and then offset a resulting NPL crisis by injecting capital (including from overseas – similar to the floating of Ag Bank last year). But the authorities have been vacillating to act on interest rates because too much personal wealth of decision makers has been tied up in property and because with higher interest rates the sterilization costs would make their foreign reserve management very costly. So instead, Beijing is resorting to raft of new ‘anti-inflationary’ measures: generous statistical inventiveness, soviet style price controls, ban on usage of corn for ethanol (in case feedstock prices affect negatively pork supply) and periodic release of commodities from “strategic” inventories. All this is being combined with an even stronger grip on dissent (the government spends $78bn on ‘weiwen’ stability maintenance, which is smaller only than the official military budget of $81bn). An almost perfect control of electronic media thus precludes a Tunisian-style scenario.

A serious asset price deflation would deliver a shock which would be deeply commodity-unfriendly. Although industrial metals and steel would suffer most, gold would not be spared in the sell-off. A clean-up would offer another gold buying opportunity as the impact of the burst bubble would most likely slow down the interest rate cycle in the developed economies dealing most of which have to grapple with their own refinancing woes in 2012-2014.

But contrary to a widely held opinion, possibly based on an optimistic reading of Engel’s Law, a rising inflation of goods and services does not bode well for gold, and particularly so in the emerging countries. Should inflation really accelerate, the economies particularly sensitive to food prices (like China) or energy prices (like India) may not yet be wealthy enough to offset cost increases if they advance faster than the growth in disposable incomes. Gold’s performance has benefited hugely from M2 explosion in the developed economies and more recently in China. An onset of liquidity revenge may not be its best friend.

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2
Dec

BETWEEN THE STEADY DRIVERS AND THE SOLID FLOOR

   Posted by: Mr. Gold    in Uncategorized

As a currency, gold is known to be difficult to adulterate as its supply is fairly price-inelastic. But as a commodity, gold is plentiful – even though many stocks cannot be easily mobilized into flows. This huge, quasi-available inventory means that the price of the metal is as dependent on physical flows as it is on the sentiment surrounding the sustainability of these flows in near future.

The driver of the gold price has for many years been set by Comex futures trading – easily swayed by the perception of changes to the interest rate environment, liquidity conditions and currency swings. The currency myopia of many observers leads to underestimation of the impact that FX market has on the level of gold prices on a given day.

But any significant movement on the futures market is ultimately not sustainable without the robust physical flow underneath. It is here – in the markets of India, Europe, Middle East, US and East Asia that the rules of supply and demand reappear – regardless whether gold is purchased and sold for investment or adornment purposes.

What is unique in the current environment is that many of the short-term and mid-term determinants of both the paper and physical market point north. We are seeing as many as eight factors impacting on the gold price over the next 2 months.

First, let us look at the drivers of the gold price. Currently the attention of this fast-paced market is focused on the troubles of European banking system. Yesterday’s successful bond auction in Portugal may have stemmed somewhat the hemorrhage and Euro has stopped sliding. But much depends on the ECB’s next move. The immediate reaction to the delay in the withdrawal of emergency liquidity has been bearish Euro and positive for gold, accentuating further the periodic breakdown of the negative USD/gold correlation.

Secondly, we have the stellar manufacturing data. From Sweden and Switzerland to US and China – the data are nothing short of impressive, coming against the backdrop of positive surprises in economies as different as UK and India. This generates positive momentum in global stock markets and broader commodity markets. Yet for as long as the extraordinary monetary policies remain in place, any such data flow also raises a specter of inflation. And when the economy reflates, no asset rises faster from the starting block than gold. Except that this might have already taken place.

Third, there is the sentiment surrounding the ‘wall of demand’ for gold ETFs coming out of China. Although the first approval for a Chinese fund to invest in gold ETFs overseas is constrained by the tethers of the QDII system, which limits PRC investors’ rights to deploy capital overseas, the news conjure the image of millions of greedy buyers in search of golden security, wherever it is available. As usual, the actual impact will be mitigated, but it is the sentiment that counts.

And finally, we have the WikiLeaks with all the manipulatory, slanderous, self-serving nonsense which delights journalists the world over. Any sophisticated observer of the world’s affairs knows of South Korean disdain for the Chinese “negotiators”, Saudi fears of Iran or mafia’s power in Russia. But because we are touching upon overblown egos, nuclear non-proliferation and major geopolitical faultlines, the barrage of news does contribute to the level of overall market uncertainty.

Then we have the physical market which provides the floor under the gold prices. It currently tells us that any pullbacks in gold against a basket of currencies will be limited. First we have the central bank and IMF sales. The World Gold Council has just announced that the new selling quota since September has been largely used up by the well-documented IMF sales. As of end of October, IMF had 32.7t left to sell and is probably now finalizing the program. This is very constructive for the physical gold market.

Secondly, we have the import tariff jumping phenomenon in India. In the last 3 years, New Delhi’s budget steadily increased the tax imposed on gold imports. Rumors that another increase is in the offing for next February may have contributed to the unusual pace of purchases in the country. In fact, the budgetary round may further exacerbate the seasonal patterns of demand on the Subcontinent – an issue discussed on these pages previously.

The third physical issue is the investment demand inside China. Unlike the expectations of ETF purchase overseas, the current gold flows reflect something of an inflation panic. China’s official banking system has found it difficult to stick to the RMB 7.4 trillion lending quota this year and the tolerated, though largely unregulated minjian jeidai lending system may have increased the money supply by another RMB 4 trillion. As a result, food prices run in double digits and gold imports have increased fivefold.

And finally, we have the miners’ hedging issue. Although the hedges left AngloGold’s balance sheet a while ago, it is interesting to note how well supported the prices were in the subsequent weeks. A similar phenomenon took place after Barrick’s announcement in 2009.

On balance, the comparison of the factors that dominate the macroeconomic newsflow with the gold-specific flow determinants yields a picture in which further price gains may lose some of the recent momentum, but in which pullbacks will be very shallow. Barring a sudden deflationary shock, such as caused by a major default, this scenario is bound to stay with us for several weeks. Anyone hoping for a significant correction any time soon will be disappointed.

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