The Chinese Stock Market Crash and its Impact Down Under

“New Zealand is one of the world’s largest dairy-producing countries. Dairy products like milk and butter make up 21% of New Zealand’s exports.

Like with other food commodities, dairy prices have fallen hard. Dairy products, on average, are 37% cheaper than they were in July 2014.

Bloomberg reports that New Zealand’s economy is “under pressure from the weakest raw-material prices in 13 years.” It added that “New Zealand is suffering from zero inflation after a plunge in whole milk powder prices to the lowest since July 2009.”

“Central banks often cut interest rates to stimulate the economy. Lower rates make it cheaper to borrow money… which generally helps a country’s businesses and its stock market.

But low interest rates are generally bad for a country’s currency. “

“A declining currency is bad for its country’s citizens. It makes everyday items cost more. And it makes people’s bank accounts worth less.

This is exactly why we recommend owning physical gold and silver. Governments are constantly making paper money worth less. If you keep all your wealth in US dollars, there’s nothing you can do when the government decides to debase them.”

If the Fed does raise rates in September, it will be for the first time since 2006.
Conventional wisdom says that rising rates are bad for gold. The argument goes that gold doesn’t generate income. So when interest rates rise, people prefer to own bonds and dividend-paying stocks instead of gold.But it turns out that’s dead wrong. The price of gold actually goes up when the Fed raises rates.

HSBC’s Global Research team found that the price of gold has actually risen the last four times rate hikes began. A recent article by The Reformed Broker explained…

This is an important finding. Most investors assume that higher rates will hurt gold. But the data shows that rate hikes have actually been good for gold in the recent past.
We borrowed this chart from HSBC to show what happened the last time the Fed began a rate hike cycle in 2004. As the Fed raised rates (represented by the red line), the gold price went up (black line):”

However we’re still not convinced the Fed will raise rates anytime soon. We’ve posted an article this week that outlines some reasons why they may not:

Gold’s Down. What’s up With That? 

We also read a good flipside to this argument this week from Chris Sayce in Australia. He argued that the Fed can’t kick off another money printing round while the US Stock market is near its record high.

So he reckons the Feds aim is actually to “push the market over the edge”…

“A small unassisted drop won’t help, because the market will assume the Fed will prevent a plunge.

So, the Fed has to assist…it has to engineer a crash. Hence, the Fed’s determination to raise interest rates this year.

The timing couldn’t be better. After this week’s meeting, the Fed next meets on 16–17 September. Barely two weeks later, US companies will begin releasing third-quarter earnings results.

If, as we expect, those results are disappointing, it will be a bad October for stocks.
Look, we know it’s an ‘out-there’ idea. There’s every chance we’re wrong. But after spending the past six years telling you to ignore each and every fake crisis as it came (and being right to do so), this is the first time since 2008 that we have genuine worries about the market.

Even if we’re half right on this, the time to prepare for it is now and over the next two to three weeks.”

The other consideration about raising interest rates from here is that they are at record lows. Much lower than where previous rate rises have started from.So a few 0.25% increases from the current 0.13% is a much bigger proportionate increase than a 0.75% increase from say 2.50% or 3.00%.

This could increase the government’s short term borrowing costs by a decent chunk.

Chris Makes the point that:

“…interest rates are at record lows. Also remember that a lot of what central banks are doing today is trial-and-error.

No one (including them) really knows the impact of years of low interest rates on the markets and the economy. But, while we don’t know for sure, we can make a good educated guess.

You may see a short-term boost in stock prices from an interest rate increase, as a natural knee-jerk reaction. After all, that’s what has happened to stocks before.
But remember, every previous interest rate rise has led to a recession. This will be no different.

The only difference is that the lag between the rate rise and the beginning of the recession will be much shorter than in the past.”

Therefore if the US Central Bank does increase rates we’ll likely see a slow down fairly fast.

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We’ve mentioned in a couple of recent articles how gold dropped by about 50% in the mid 70’s. And how this current correction bears some similarity.

Well here’s some VERY exact numbers from the National Inflation Association:

“Between January 1970 and December 1974, gold rose 456.6% from $35.08 per oz to $195.25 per oz, which was followed by a 47% decline to a low in August 1976 of $103.50 per oz. Afterwards, gold rose 721.3% to a high in January 1980 of $850 per oz.

Between April 2001 and September 2011, gold rose 630.4% from $259.45 per oz to a high of $1,895 per oz. Since gold’s peak, it has declined by 43.1% to a current price of $1,078.50 per oz. Just like in the 1970s, gold has been experiencing a medium-term decline, as part of a secular bull market.

Too many people were bullish on gold at $1,895 per oz. For gold to rise to $2,000 and beyond, we needed to first see a decline that turns everybody into bears – even the so-called “gold bugs”.China’s recent announcement of their latest central bank gold reserves disappointed many of the “gold bugs”, who were expecting China to announce an even larger increase than it did – that would trigger a massive gold rally. With their one last hope for gold $2,000 now gone and no further short-term catalysts in sight, the “gold bugs” are finally throwing their hands in the air and giving up on gold, which means true capitulation is almost here.

During gold’s 1974-1976 decline of 47%, it had two false bottoms at $128.75 per oz and $124.60 per oz, before true capitulation occurred with gold eventually bottoming at $103.50 per oz. During gold’s current decline of 43.1%, it has already experienced two false bottoms: one in June 2013 at $1,192 per oz and another in November 2014 at $1,142 per oz. The fact that these two bottoms didn’t hold, has totally frustrated the most loyal “gold bugs” – who will likely end up selling at the exact bottom. If history repeats itself, we could see gold ultimately settle at $1,004.35 per oz(down 47% from its medium-term peak), followed by a move to $8,248.73 per oz (up 721.3% from its medium-term bottom).”

As alluded to above we could well be close to the point of “true capitulation”.

Another positive sign is that hedge funds are now holding a ‘net short’ position in gold for the first time since 2006.

Why might this be a good thing?

Well back in 2011, around the time gold peaked near $1,921, hedge funds were at an extreme net long position.

So when they reach extremes maybe it makes sense to do the opposite?

Greg Canavan from whom we snatched the above chart notes:

“You’re seeing an increase in bearish articles on gold. You’re seeing bearish bets on the metal increase to record levels. That tells you this market is getting close to a bottom.

It doesn’t matter what market you’re talking about, whether it’s coffee beans or soybeans or stocks in Apple. Whenever anything seems so obvious that it’s a sure bet, a turning point is close.

I don’t know if this is the bottom for gold or whether it will first breach the $1,000 mark, as nearly everyone seems to expect. You could see another decent rally from here before the final, gut wrenching sell-off. But’s it’s getting close.

Gold benefited from some ‘short-covering’ in US trade on Friday on the back of renewed uncertainty about Greece. Short covering occurs when traders buy back the gold they had previously sold in order to ‘cover’ their position. This saw gold rally from just under $1,080 to around $1,100 an ounce.

Still, gold is in a nasty downtrend. The path of least resistance is down. My guess is that you’ll want to see something like a $50 an ounce short-covering rally to gain confidence that the market might be turning.”

So keep an eye out for those $50 per oz rises.

We’ve seen a few negative stories on China’s lack of buying following the recent gold plunge like this one, unlike what occurred in 2013.

However China’s increased demand has had little impact on pushing prices higher in the past couple of years. As for now the price is still set in the western futures markets.

So perhaps lower demand in China might also not have as much impact as some might think?

“China and India are the world’s top gold consumers. Physical demand there has not picked up strongly despite a sell-off last week that knocked global prices to 5-1/2 year lows.

That contrasts to the explosion in physical demand seen after gold prices dropped sharply in the second quarter of 2013.”
Source.

This is a key paragraph in the article. We noted back in 2013 after the large plunge when there was a surge in buying globally that we doubted that was the bottom in gold.So this is likely a good sign that the latest fall hasn’t been met with the significant buying that it did in 2013.

We can’t say the bottom is in but there are certainly growing signs pointing to it being closer than ever.

This Washington Post article that the NZ Herald featured on Monday is another one of them.

Titled “Here’s why gold is doomed”, it is rather disparaging of “Gold Bugs” and how wrong they have been.

We think the smugness of this writer will likely come back to bite him down the track when his article proves to have come at pretty close to the bottom in gold.

Actually there’s been a veritable feast of negative gold and silver articles in recent days. We’re spoilt for choice! Here’s a couple of other dismissals:

This one sounds remarkably like Warren Buffett’s arguments against gold.

A Societe Generale analyst says “Gold is out of fashion like flared trousers: no one wants it,” 

While Germany’s Deutsche Bank analysts say “Gold would need to fall towards $750 per ounce to bring prices in real terms back towards long-run historical averages.”

“[Even after] this substantial correction…the long-term record shows gold literally spent decades trading below $400.” Source.

This one takes the cake though. Adrian Ash reports:

“Get ready for $350 gold,” says a MarketWatch headline…quoting an academic who apparently forecast the plunge in prices back in 2012.

Only, he didn’t. Read the paper which MarketWatch cites, and what the 2012 research actually said was that gold might go down…or it might go up.

A proper two-handed economist then…

…right up until the downtrend in gold has already lopped 40% off the price…and calling it lower becomes all the rage.”

So just remember when everyone is shouting about lower prices ahead (which there could be in the short term) the odds favour us being much much closer to a bottom than a top.We’ll repeat our thoughts from last week. Unless you’re incredibly lucky you won’t pick the bottom. Instead consider the full amount you want to remove from paper wealth into gold or silver and break this up into say 4 or 5 chunks and buy regularly over the coming weeks and months.

This was you’ll not only get a decent overall price, but psychologically you’ll likely feel better. If the price falls you’ll have funds to buy some more. If it goes up you’ll already have some at lower prices.

As always let us know if you have any questions.

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