Gold down BIG ... as China is put on the hot seat!

Click here to view this issue in PDF format.

Commentators today are writing about one of two things: gold or China.

I figure I’ll write about both.

In fact, Jack and I have spilled a lot of ink on China in the last month or so ... right here in the pages of Currency Currents. The country’s rapidly expanding shadow banking system is rapidly garnering attention.

Should investors be concerned?

It’s certainly something to worry about in the longer-term, as China’s Banking Regulatory Commission chief recently warned. But it’s not yet the type of development that’s going to break the back of the Chinese economy.

Actually, many Chinese officials are supportive of the growth in wealth management products and off-balance-sheet lending – these unconventional practices help to support growth at a time when official credit policies are somewhat restricted. Check out this video from Reuters for an idea of the dynamic playing out.

Now lump on the fact that China’s first quarter GDP numbers were just reported. The 7.7% annual rate was a disappointment on expectations of 7.9%. Some other numbers are also factoring into investors’ nervous reaction to start the week.

Surely, though, a 7.7% rate of growth is nothing to shake a stick at ... but China’s economy is supposed to have stabilized so that it may level off at a necessary and sufficient 8%.

US and European Policymakers dream of a 7.7% print in their respective economies. But Chinese officials acknowledge that managing the economy (read: its citizens) becomes increasingly difficult the further a GDP number falls below 8%.

It also becomes increasingly difficult as credit growth exceeds generally-accepted levels of sustainability.

This blurb leads into a Reuters’ article put out over the weekend:

Financial leaders of the world's 20 biggest economies will consider next week in Washington a proposal to cut their public debt over the longer term to well below 90 percent of gross domestic product, a document prepared for the meeting showed.

That number – 90 percent – I assume has some basis in the Reinhart, Reinhart and Rogoff analysis put forth in April 2012 regarding the sustainability of national debt levels. You can find some excellent analysis, done by Hoisington Investment Management Company in 2Q12, by clicking here.

One final note on this: the International Monetary Fund, in recent issues of its World Economic Outlook and Global Financial Stability reports, remarks that rising debt-to-GDP poses a risk for respective emerging economies sooner, at lower levels, than it does for developing economies.

Unofficial estimates put Chinese debt-to-GDP at levels in the neighborhood of problem countries in the Eurozone. Are we soon to see a point where taking on more debt doesn’t generate the economic growth China needs and in fact jeopardizes the economy?

As you ponder that question, here is another asked by Yahoo Finance:

“Is the Era of Gold Over?” 

I’m not going to answer that – in reports written earlier this month, Societe Generale effectively said ‘Yes’ and Goldman Sachs concurred. (Their respective 2013 gold price targets have practically been achieved already.)

The gold era may indeed be over. But one must wonder what freshly and overtly bearish rhetoric means for gold in the near-term ...

As of writing, gold has fallen more than $140 today (more than 9%) and is trading well below $1,400 an ounce. Popular gold analyst, Dennis Gartman, has said he’s “never seen anything like” what’s happening to gold right now (and he means it).

I’ll wager the gold bugs will be out tomorrow with headlines containing two words: buying opportunity.

Let’s not forget that a “buying opportunity” has been staring us in the face since at least $300 ago! But perhaps the bugs will at least have some technical basis for this buying opportunity ...

We received some timely analysis from our friend Bob Brogan at Brogan Group Research on Friday that put a rough target on gold at $1,410. Well played! The research they put out is based on proprietary money flow oscillators and ATR bands ... among other things.

My technical analysis is far more elementary, but here is what it suggested:


A 100% Fibonacci extension put a third-wave downside target at $1,392, which has today been surpassed. An extension of 168% would take gold to about $1,150 an ounce. But I doubt it’s going to achieve that with the velocity of the last two days’ decline.

In fact, I thought gold was due for a small corrective bounce about $150 ago! Now I definitely think it is due for a bounce.

Jack warns buying here is the same diving underneath a falling knife ... or trying to break up a dog fight. He notes other support levels don’t come into play until $1,307 (swing-low chart support) and then $1,257 (138% Fib extension) ... and gold may just extend to those levels before a bounce happens.

Tough to say ... but the faster the rush to call the end of the gold era, the sooner the bounce will happen regardless of whether the forecasts are correct.

I’ll wrap up with a final suggestion one could deduce from gold’s plunge:

The era of central bank monetary accommodation expectations as market driver is over.

Sorry – that was a mouthful.  So to clarify, here is what I wrote 10 days ago after the policy announcement from the Bank of Japan:

Do central banks have anything left in the toolbox the people can’t ignore?

I certainly don’t want to underestimate the potential central banks will concoct some sort of new and unprecedented strategy. Like I said of the BOJ above – I think policymakers (and politicians) have become desperate.

Of course, if the influence of central banks has truly run its course, then the market may have the opportunity to take over.

Is the gold price an indication the market is taking over?

Gold prices do especially well during phases of low interest rates and high money printing. If the investing public believes the central banks’ stimulative policies are a) exhausted, b) ineffective, or c) both, then gold could lose its appeal for longer than many are likely to expect.

Central banks have notably been buying gold at an impressive clip. Some take that to be bullish while others correctly note central banks have a pathetic track record as it concerns timing the gold market. So I ask ...

Have these central bank purchases been aimed at propping up gold prices (and the status quo mentality) so that central banks may conceal their failure to truly reverse the deflationary forces still at work in global economies?


JR Crooks