What is China up to?


US markets took more kindly to news of ‘Chinese stimulus’ than the Aussie market did yesterday. Wall Street was up around 1% overnight, providing positive momentum for Aussie stocks today.

I’m not sure what all the excitement is about though. More than likely this is just standard market volatility, with the newsflow being used as an excuse for the market rally.

As I explained yesterday, a cut to China’s reserve requirement ratio is not overt policy stimulus. It’s in part a way to offset an outflow of capital, which is occurring because of the slowdown in China’s economy.

The biggest risk is that it frees up capital for lending to stock investors, thus giving the already heated Chinese stock market another blast of cheap money. Lending against land values is low risk compared to lending against equity values, which is what appears to be happening now.

Whatever the reality, the market decided to like the stimulus story overnight, and higher it went. After all, upwards is the path of least resistance for stocks right now. Most global equity markets are in an upward trend and this is likely to continue until a catalyst — like an exit of Greece from the Eurozone — occurs.

But that will never happen, right?

The news of China’s stimulus measures, announced Sunday, overshadowed the default of a Chinese property developer, Kaisa Group Holdings Ltd, which occurred on Monday.

It is quite possible that news of the impending default forced the People’s Bank of China’s hand. Much better to have stimulus laden headlines than news of a default by a property developer.

According to Bloomberg, this is the first ever default by a Chinese property developer on dollar-denominated bonds. The company missed a US$52 million payment, but the story didn’t reveal the size of the default.

You’re going to keep hearing about defaults in China in the coming years. And there will be more cuts to bank reserve requirements to try and plug the liquidity gaps caused by these defaults.

But there is a bigger story going on in China, playing out behind the scenes. It’s about a soft challenge to the US’ global dominance in trade and financial markets.

China is already laying the groundwork for this. I’ve been researching the topic for the past few weeks, especially on the trade side of things. I’m putting the pieces of the puzzle together and will publish a report on the topic for my subscribers tomorrow.

Let’s just say that the long term implications are massive. China is directly undermining the US dollar centric financial system. And who can blame them? The system only works for the US and, more specifically, the global elite who create the rules and run the system to their benefit.

China’s strategy won’t have immediate implications. This is a long term plan. But if you’re a US strategic planner, you should be worried.

Another Bloomberg story today hints at a different, but complementary angle, to China’s strategy.

China’s push to challenge U.S. dominance in global trade and finance may involve gold — a lot of gold.

While the metal is no longer used to back paper money, it remains a big chunk of central bank reserves in the U.S. and Europe. China became the world’s second-largest economy in 2010 and has stepped up efforts to make the yuan a viable competitor to the dollar. That’s led to speculation the government has stockpiled gold as part of a plan to diversify $3.7 trillion in foreign-exchange reserves.

China may be preparing to update its disclosed holdings because policy makers are pressing to add the yuan to the International Monetary Fund’s currency basket, known as the Special Drawing Right, which includes the dollar, euro, yen and British pound. The tally may come before the IMF’s meetings on the SDR next month or in October, Nomura Holdings Inc. said in an April 8 report.

China doesn’t want the yuan to be the global reserve currency. It may be a benefit in the short term, but in the long term it’s a curse, as the US will discover soon enough.

But they know a solid amount of gold reserves will buy a seat at the table when it comes to designing the next (non US dollar based) global monetary system.

Despite this, gold in US dollar terms continues to languish near its lows. It’s not trending higher like global equity markets, so Western traders (with a very short term mindset) continue to ignore it.

And so do most Aussie investors, despite the fact that gold in Aussie dollars is in a healthy upward trend, a trend that started late in 2014.

Aussie gold producers are making healthy margins at current prices, a fact made evident in some of the March quarterly reports that have just been released. These good results encouraged me to add another gold stock to the Sound Money. Sound Investments. portfolio last week…and there will be more to come.

Yesterday, Evolution Mining [ASX:EVN] announced the purchase of private company La Mancha’s Australian assets, which will make them Australia’s second largest gold producer behind Newcrest.

Experienced gold players see good value in this market. Most other investors just keep buying the banks or Sydney property. You make money in the long term by going against the crowd…and then waiting for them to see what you saw previously. That will happen with gold again. Now is the time to buy.

Greg Canavan+,
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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