Why Gold Could Be China’s Safe Haven

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Aussie stocks should get a reprieve from the recent selling after Wall Street rose overnight. But how long it will last is anyone’s guess. The recent selling is a result of a more risk-averse market following the Fed’s decision to ‘taper’ its purchases of assets. Emerging markets have been hardest hit.

The Fed began a two day meeting overnight and no doubt many in the market will be hoping for some soothing words. But with the S&P500 just over 3% from its all-time highs, it’s unlikely the Fed is going to change course on its tapering plans. More than likely you’ll get some reassuring words like ‘we’re keeping a close on eye on things’.

In reality, the Fed will be very nervous about what they have started. To keep going with the tapering plans means emerging markets will remain fragile. But to push back will give another green light to the hedge funds to go nuts on the speculation front.

Softly is the best they can do. After all, it’s Ben Bernanke’s last meeting before he heads back off to the Ivory Towers of academia. He’s not going to change course now. He’s thinking of his legacy…

In a year or two, when the system is imploding, someone will ask him what went wrong. (By this time the Fed will be universally scorned.) And he’ll be able to answer…somewhat truthfully:

‘I have no idea. When I left the place we were in the process of getting interest rates back to normal. The economy was improving and employment was growing. It must have been Janet, I knew she’d screw things up as soon as I left. Go and ask her.’

And then that same someone will go and track Janet down. They’ll find her in a nondescript town, trying to forget. She’ll stare into the distance, muttering ‘unintended consequences’ over and over.

It’s as good an answer as any. Why did the world blow up…again? ‘Unintended consequences’. Exactly.

You see, this next stage of the crisis, which is surely coming, is not about the Fed’s tapering. It’s about the Fed’s QE policy that preceded it. When you manage the world’s reserve currency, you have an obligation to manage it in the best interests of the world, not just for domestic economic purposes.

The Fed, with a focus on domestic employment, ran monetary policy for the US and the US only. But the liquidity they created post 2008 leaked into the rest of the world and set-off booms in emerging markets, notably in China.

Now, liquidity and capital is flowing the other way. It’s coming back out of emerging markets, sending currencies crashing and interest rates soaring. But it’s early days. This emerging markets crisis looks like it’s just warming up.

Check out what’s going on in Turkey. In an attempt to slow foreign capital outflows, which is hurting the Turkish lira and sending market interest rates higher, Turkey’s central bank has just increased its overnight lending rate to 12%…from 7.75%! 

That’s quite a hike. While it will restore some confidence in the currency and help to keep inflation under control (estimated to be around 6.6% at year-end) it will bring about an economic slowdown.

Now if you multiply this scenario across the emerging market economies, you have to expect a decent economic slowdown to take place over the first half of 2014. Not that all economies are going to hike rates by as much as Turkey. But they are all suffering capital outflows to varying degrees, which represents a monetary tightening. Slower growth will follow.

It might take a few more months, but eventually even developed country stock markets will realise that slower growth in the emerging markets bloc will impact the profits of the large multinationals. Their safe haven status may come under question.

What, or where, is the safe haven in a world of tighter global liquidity? There doesn’t seem to be one. ‘Cheap assets’ is the only answer we can come up with. But with seemingly every asset having inflated over the past five years, there’s not a lot of cheapness around.

In a report to subscribers at the end of last year, we ventured that commodities and gold were the cheapest assets around. We also guessed that they might become cheaper still should the emerging markets rout pick up pace. But at that point, adding some of these beaten up assets to your portfolio might make sense.

Perhaps we should ask China about safe havens? In 2013, according to Reuters:

China imported about 1,158.162 tonnes from Hong Kong, compared with 557.478 tonnes in 2012, overtaking India to become the world’s biggest gold buyer.

Is it because of the credit boom that China is buying so much gold…or is it because of the fear of what comes after the boom?

We don’t know. It’s probably a bit of both. Credit booms lead to an explosion in the money supply. In China, if you’re a recipient of a large wad of new money you can either conspicuously consume it, put it into a bank or a wealth management product promising high (but risky) returns, or borrow against it to buy property.

Or you can put a bit into a time tested ‘safe haven’, like gold. After all, the West is selling heavily so it’s available at a good price. News of such robust Chinese demand is nothing new. They’re simply soaking up what the West is selling. Gold is coming out of the vaults in London, being melted down and recast into smaller bars that fit the preferences of the Asian markets, and moving into China and elsewhere.

The China demand story is important, but it’s not necessarily the thing that will kick off a new bull market in precious metals. That will happen when the West regains its appetite for gold. Because at that point, the supply of gold will be severely constrained. China isn’t giving any back. Not at these prices. It will require much higher prices to get the gold flowing again.

So when will the West regain its appetite for gold, you ask? We don’t know. Probably around the time when you hear Janet Yellen repeatedly muttering ‘unintended consequences’ through a thousand yard stare…

Regards,

Greg Canavan+
for The Daily Reckoning Australia

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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11 Comments on "Why Gold Could Be China’s Safe Haven"

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George
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‘China imported about 1,158.162 tonnes from Hong Kong, compared with 557.478 tonnes in 2012, overtaking India to become the world’s biggest gold buyer.’

Careful Greg when quoting around Reuters figures, your credibility may get burned easily.

George
Guest

‘China imported about 1,158.162 tonnes from Hong Kong, compared with 557.478 tonnes in 2012, overtaking India to become the world’s biggest gold buyer.’

Careful Greg when quoting around Reuters figures, your credibility may get burned easily.

Justin King
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“you have an obligation to manage it in the best interests of the WORLD ”

THE big mistake – American xenophobia & “exceptionalism” caused this kind of behavior, and is now starting to wreak it’s HAVOC.

Justin King
Guest

“you have an obligation to manage it in the best interests of the WORLD ”

THE big mistake – American xenophobia & “exceptionalism” caused this kind of behavior, and is now starting to wreak it’s HAVOC.

slewie the pi-rat
Guest

could you speed up the slow-down, please?

slewie the pi-rat
Guest

could you speed up the slow-down, please?

Harquebus
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I blame Alan Greenspan. He started it.

Harquebus
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I blame Alan Greenspan. He started it.

Jason
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China will need the gold to maintain its finances, which are now going to come under the effects of demography. China and the rest of East Asia now have the lowest fertility rates in the world and the rest of Asia is sliding towards the same fate. As Asia ages and the effects of long term subreplacement fertility hit, the aging Asian nations, including China will have to rebalance their economic priorities, and that includes the means to fund pensions and aged care for the increasing number of elderly, and all the while enduring the shrinking of their younger population.… Read more »
Jason
Guest
China will need the gold to maintain its finances, which are now going to come under the effects of demography. China and the rest of East Asia now have the lowest fertility rates in the world and the rest of Asia is sliding towards the same fate. As Asia ages and the effects of long term subreplacement fertility hit, the aging Asian nations, including China will have to rebalance their economic priorities, and that includes the means to fund pensions and aged care for the increasing number of elderly, and all the while enduring the shrinking of their younger population.… Read more »
John
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When the US greenback and the fiat currency fails and a new currency introduced by the IMF,and a reintroduction of the gold standard we will then see the flow of gold flowing again it will have to change from a commodity to a currency,and only then we will see which countries have it and which do not, we will then see the flow of gold between countries, and I hope it stops the manipulation of gold prices when it also changes over to selling and buying physical gold not paper gold.

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