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China currency crisis drives gold

Advice herein is provided for the general information of readers and does not have regard to any particular person's investment objectives, financial situation or needs. Accordingly, no reader should act on the basis of any information contained herein without first having consulted a suitably qualified financial advisor.

By Colin Twiggs
March 21st, 2016 2:00 a.m. EDT (5:00 p.m. AEDT)

China's looming currency crisis

The Yuan strengthened against the Dollar, breaking support at 6.50 (USDCNY) as Chinese authorities attempt to squeeze short-sellers. But the primary trend is unchanged and warns of further weakness. USDCNY From Anne Stevenson-Yang and Kevin Dougherty at WSJ:

After initial declines in the Chinese market to start the year, the past few weeks have seen signs of what some would call a rebound. Lending in China rose by 67% in January, iron-ore prices initially rallied by 64% and housing sales in the top four markets surged.....

Chinese authorities have been trying to bring back the old, quasisuperstitious belief in Beijing's omnipotence. But the political desperation behind these efforts betrays a different story: that an impending currency crisis is a signal of the dream's undoing. That's why in China getting money out of the country is now the major preoccupation of both families and corporations.

One way to stem the crisis would be through depreciation. That would be sound policy for the people of China, but it's a dreaded last resort for a leadership that wants, more than jobs for its people, to bolster buying power and save political face overseas. Yet history shows that holding the line on the currency is a losing strategy. Tightened liquidity causes more pain to the economy and simply delays the inevitable.

In other countries, currency crises usually followed a sudden and irreversible loss of confidence. The Asian Tigers were booming and then fell apart rapidly. Same in Russia. China faces the added difficulty of having little institutional memory and few tools to manage the economy in a time of capital scarcity. And there is no sign that capital-outflow pressure will ease.

From David Llewellyn-Smith at Macrobusiness:

The macro logic here is impeccable and Ms Ms. Stevenson-Yang knows China better than most. I actually think that Chinese officials already understand this and the current back and forth on yuan policy is them searching for a way to do it in a manageable glide slope rather than crash.

China faces a currency crisis. I lived through one in South Africa in the 1980s and recognize the signs: purchase of offshore homes, local companies bidding for offshore acquisitions, over-invoicing, local residents using ingenious methods to avoid capital controls.....

This graph of the US Dollar/South African Rand exchange rate from Wikipedia covers the early alarm in the 1980s, when the Rand fell from parity to 2:1 against the greenback, through to the current "Zuma-gate" when the Rand hit 15 to the Dollar in late 2015:

USDZAR 1995 to 2015

Capital controls are too late. The horse has bolted. Trying to prevent Chinese residents from moving their capital to a safer climate is as effective as herding cats. The only way depreciation can work is "shock and awe": a massive once-off devaluation of the Yuan. Gradual weakening of the currency will simply reinforce the panic.

I shudder to imagine the effects a dramatic fall in the Yuan would have on global capital markets. Chinese companies would be forced to default of USD-denominated debt. Trading partners, including the US and Europe, forced to respond with competing devaluations to avoid the contagion. I hope that Chinese officials have been persuaded this is not an option.

....Which leaves capital controls, and eating through China's $3 trillion plus of foreign reserves to support the Yuan, as the least-worst option. Or is that simply kicking the can down the road?

Hat tip to David Llewellyn-Smith at Macrobusiness.

Crude

Nymex Light Crude futures (June 2016) are testing resistance at $43/barrel. Penetration of the descending trendline indicates that a bottom is forming. Respect of resistance would warn of a decline to test primary support at $30 to $32/barrel. The primary trend remains down but a higher trough would suggest a reversal.

Nymex WTI Light Crude March 2016 Futures

Gold pauses

Long-term interest rates remain weak, with 10-year Treasury yields reversal below 1.90 percent warning of another test of primary support at 1.5 to 1.65 percent. Fed softening of their tightening bias reinforces this. Declining 13-week Twiggs Momentum warns of further weakness.

10-year Treasury Yields

The Dollar Index is trending lower, headed for a test of primary support at 93. Declining 13-week Twiggs Momentum, below zero, warns of a primary down-trend.

Dollar Index

Dollar weakness is being driven by China's sell-off of foreign reserves, primarily Dollars, to support the Yuan. This is likely to continue for as long as China maintains its Dollar peg.

China: Foreign Reserves

Gold is now a China play, driven by expectations of a depreciating Yuan. Low interest rates and inflation are now secondary influences. Consolidation between $1200 and $1280 is likely to continue for as long as the Yuan strengthens against the Dollar. Any weakness of the Yuan would be likely to drive gold through resistance at $1300/ounce, signaling another advance.

Spot Gold

* Target calculation: 1200 + ( 1200 - 1100 ) = 1300



All that is gold does not glitter,
Not all those who wander are lost;
The old that is strong does not wither,
Deep roots are not reached by the frost.

~ J.R.R. Tolkien: The Fellowship of the Ring

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