And now we have the classic ‘dead cat bounce’.
Yesterday, Chinese stocks climbed 5.8%. Last night, the iron ore price bounced 9%, recovering nearly all of the prior evening’s historic losses.
Don’t be lulled into thinking this is a bottom though. This is simply a bounce from panicked and oversold conditions. You’re going to see lower prices in the weeks ahead.
So how far can this bounce take us?
Let’s have a look at a chart of the Shanghai Composite Index. After increasing nearly 160% in the year to June, the index crashed by around 35%. This sent panic through the markets and the halls of power in China.
Officials attempted to stem the selling and restore confidence by announcing a number of policy changes. Given the oversold nature of the market (see top panel in the chart below) it’s been enough to entice buyers back into the market.
When bubbles are in the process of popping, you generally see panic selling followed by panic buying. It’s an emotional time.
So let’s take a step back and see where this rally could go before turning back down. The green lines above represent an area of resistance. Don’t be surprised to see the index rally back into that region before heading lower again.
Of course the selling could start back up at any time. The point you should note, however, is not to get too carried away with any recovery talk. Given the flimsy nature of the rally (fuelled by buying on margin) and the extreme overvaluation of many companies still, this looks like a classic equity bubble bust.
Check out the table below. It comes from JP Morgan via FT Alphaville. The right hand column shows the trailing price-earnings ratios for a number of companies. In most cases they are in the hundreds, which is insane level of overvaluation.
This is a rally akin to the NASDAQ tech bubble in 1999/2000. The buying was mindless and completely divorced from fundamentals. A big bust and lower prices seems inevitable. But not before a hope fuelled rally.
That means there might be some respite for commodities too. As I mentioned yesterday, commodities were one of the victims of the Chinese authorities’ decision to ban trading across a whole swathe of the market.
In China, commodities act as collateral for financing, in the same way US Treasuries act as collateral in more mature capital markets. In other words, commodities are ‘monetised’ in China and are a source of liquidity.
With more than half of the Chinese market frozen and illiquid, commodities become the obvious source of liquidity and have been sold off sharply over the past few days.
But with selling pressure set to ease in China, it could provide some respite for commodities too.
Speaking of commodities, what is up with gold?
Despite Greece rocking the Eurozone to the core, and the China stock market crash, gold remains friendless. In US dollar terms, it’s trading around $1,160 an ounce. It’s very close to making a new bear market low.
This signifies that big money still sees governments and central banks as being in control. Even with Greece coming close to exiting the Eurozone, global capital has seen it for what it is. That is, political manoeuvring to get a better deal to stay in the Eurozone.
And so far, this big money view has been correct. The latest on Greece is that Prime Minister Alexis Tsipras has just submitted a proposal for a three-year, €53.5 billion bail-out plan that comes very close to the one submitted last month.
So much for the Greek people rejecting austerity in the referendum. This sounds like a way to relieve pressure on the banks for a while before angling for the more important concession of debt restructuring.
The creditors will vote on the proposal on Sunday so you’ll no doubt awake to a fresh set of Greek headlines on Monday morning. Unless Greece gets a significant debt reduction though, it’s all just another round of can-kicking.
But the point is, for all the drama, both sides want to do what they can to keep the Eurozone intact. Gold knows this. That’s why you haven’t seen a genuine safe haven spike in the precious metal.
On top of this, you still have the US Fed Reserve leaning toward a rate hike at some point in the not too distant future. That’s helping the US dollar and keeping gold under pressure.
But for Aussie investors, is the price of gold bad news? The media always quotes the gold price in US dollars. Fair enough, it’s the benchmark price. But gold is just a piece of metal. One ounce is one ounce. To get a ‘price’ for that ounce, you need to express it in currency terms.
So while the price of gold is $1,160 US dollars, in Aussie dollars it is around $1,550. The difference is due to the weakness of the Aussie dollar against the US dollar.
If your earnings and costs are denominated in Aussie dollars, it’s the Aussie dollar gold price that matters to you — not the US dollar price.
It’s like going to the pub and seeing a pint of beer priced in US dollars. It’s irrelevant. You want to know what it costs in Aussie dollars, because that’s what you have in your wallet.
The good news is that at $1,550 an ounce, Aussie gold miners’ profits are healthy. As the Australian reports:
‘Gold producers are continuing to build their cash balances, something the rest of the resources industry is struggling to achieve in the face of collapsed commodity prices.
‘Aided by the dollar’s weakness and the benefit of starting early on cost-cutting in response to the 2013 gold price shock, the gold producers are currently enjoying margins of more than $500 an ounce on average.’
Yet the market doesn’t realise this. They see a US dollar gold price in a grinding bear market and think gold stocks are hopeless. One of the gold stocks in the Sound Money. Sound Investments portfolio trades on a price earnings multiple of just five times 2016 forecast earnings.
There is significant value in the sector. It’s just a matter of waiting for a catalyst to realise that value. A rising US dollar gold price would certainly help. That may come about from a Fed Reserve who finally gives up on raising interest rates, as Jim Rickards of Strategic Intelligence believes will happen.
By the way, if you haven’t done so already, check out and ‘like’ The Daily Reckoning Facebook page here. Today at noon, Strategic Intelligence editor Tim Dohrmann, who works closely with Jim Rickards, will host a live Q&A session on the Facebook page. So head over there and ask some questions.
For The Daily Reckoning, Australia