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China Is a Red Herring

If you’re going to live in fear, at least fear the right monster. And China ain’t that monster.

Maybe you heard this week that stocks fell out of bed. The S&P 500 officially started the year in the worst fashion ever, down 5% in just the first four days. China, everyone pointed to, was to blame! Chinese equity markets crumbled over the course of last week, prompting Chinese regulators to step in and halt trading several times, in turn prompting global Wall Street to soil itself in panic.

Never mind that the Chinese equity market reflects the Chinese economy about as accurately as a basketball reflects the game of golf. China’s equity markets are a dog track — though that’s unfair to dog tracks, because at least dog tracks operate under a certain set of rules. The typical investor in Hong Kong resembles the typical investor in the U.S. — and those typical U.S. investors, thus, extrapolate that Chinese investors resemble Hong Kong investors and presume that the typical Chinese investor makes the same (somewhat) rational and (somewhat) sane and (somewhat) logical decisions when buying and selling stocks. This is flawed Western thinking.

The investors pushing and pulling at equity prices on mainland stock exchanges are gamblers, your basic punter taking a flyer on with money earmarked for financial entertainment. If they want to invest, they buy real estate. If they want to gamble, they throw a few yuan at the stock exchange.

So, the fact that Chinese share prices tumbled and recovered and then tumbled again says precisely bupkis about the state of the Chinese economy.

If you want a real indication of the health of China, look to the Chinese consumer as reflected by the service-sector component of China’s GDP. Over the last four quarters, it grew at nearly 12%. That’s twelve percent, not 1.2% — 12%!

Yes, other portions of the Chinese economy are growing at a much slower pace, particularly manufacturing. But as I’ve explained before, China’s manufacturing economy is intimately tied to the direction of the U.S. dollar. Until recently, China pegged the yuan to the dollar so that as the buck rose, so, too, did the yuan. But that just means that a stronger yuan shrinks demand for Chinese products globally because they become increasingly expensive in terms of other currencies. And as demand for Chinese goods slows, Chinese manufacturing slows, which means Chinese demand slows for the raw commodities those manufacturers use … which means all the commodity economies in the world take it in the shorts.

All because our Federal Reserve has managed the post-financial-crisis economy about as well as an alcoholic manages an all-you-can-drink kegger. Had the Fed not promised for years that U.S. interest rates would rise soon — even as the rest of the world’s central banks were cutting rates — global investors would not have snapped up dollars, thereby pushing the buck higher and pinching the Chinese economy, commodity markets and commodity currencies the world over.

Ifs and buts and hickory nuts at this point…

But that does point to the real monster to fear: U.S. recession.

The Atlanta Federal Reserve Bank reported last week that the U.S. economy in the fourth quarter probably grew at a whopping (he said with great sarcasm) 0.7% annualized rate. So much for Yellen’s assurance that the U.S. economy can handle the rate hike the Fed plated up for an impatient Wall Street in December.

Even as the economy once again sputters, we have U.S. manufacturing in a recession. The latest reading shows back-to-back months for contraction and the weakest showing since 2009, in the aftermath of the global crisis.

We are most assuredly not moving toward a strong American economy. We’re moving toward the great likelihood that the Federal Reserve, after raising rates for the first time in nearly a decade — and telling global Wall Street that it envisions four more quarter-point hikes in 2016 — will cut rates as its next move.

The Fed, of course, will look schizophrenic and will have been shown to have made a boneheaded decision in December. But if the economy is now slowing so sharply, and with manufacturing recessions routinely presaging economic recessions, the Fed will have little choice but to backtrack. It certainly has no room to raise rates again anytime soon; doing so would cause a world of hurt on the American economy — and no Federal Reserve governor wants to be the deciding factor in a presidential election year.

So it is, then, that the coming recession is the monster to fear. Not China.

But, then again, this is modern America, where we’ve learned to deflect attention from our own self-inflicted woes and cast aspersions upon others whom we blame for our own weaknesses. And if it’s not those pesky Russians or the shady Iranians … well, by God, it must be the Chinese!

Don’t buy it.

Don’t buy the claptrap about a healthy American economy.

Don’t buy the temporary excitement about the jobs numbers that tickled markets on Friday. I looked at those 292,000 new jobs, and nearly 206,000 were in low-wage jobs — including social services, hotel and food services, administrative services, nursing-home care, couriers and messengers, and various retail sales jobs. Nearly half the professional jobs were temporary help. Adding a lot of low-wage, low-skill and temporary jobs does not breed the kind of “healthy” we Americans associate with our economy.

Soon enough the headlines will tell you that the real monster is at the door … the next American recession.

The dollar will weaken. U.S. stocks will weaken. Bond prices will rise (a good time to own a high-grade muni-bond fund). Gold will rise (all the more reason to buy bullion, as I regularly recommend).

So, that’s the way we begin 2016.  Gonna be real interesting to see how we end it…

In the Sovereign Investor portfolio … On the topic of gold, our precious-metal positions were a bright spot this week as investors rushed into safe-haven investments. Gabriel Resources (Canada: GBU, buy up to C$1.25), our gold-exploration company that is currently going through a legal dispute with the Romanian government (which it will likely win, generating a nice profit for shareholders), surged 25% this week.

Our other, more conservative precious-metal plays, such as Goldcorp (NYSE: GG, buy up to $20), NovaGold (Canada: NG, hold) and Silver Wheaton (NYSE: SLW, buy up to $21.59), were positive for the start of 2016 — all while the S&P 500 finished the week down more than 5%. Traders are showing us where to invest in 2016, and that’s in the precious-metal sector. If you haven’t added exposure yet, now is a great opportunity to add to our positions that remain in the buy zone.

Until next week, stay Sovereign…

Jeff D. Opdyke
Editor, Sovereign Investor
January 10, 2016