The Chinese Stock Market Crash; Gold Demand Continues

The Chinese Stock Market Crash; Gold Demand Continues

Jim Clark

8/2/15

The Chinese Stock Market Crash
Since peaking in June, Chinese stock market indexes are down roughly 30%. As reported on CNBC today, Chinese farmer/investor has lost his and his family’s life savings and then some. Because of margin calls, Yang Cheng owes his brokerage firm $1 million, the amount of his original investment.  Yang said, “I don’t know what to do… I trusted the government too much.”

If you think that the financial fall out from China’s stock market crash is isolated to China, think again. Ignoring for the moment that China is the largest supplier of goods to us here in the USA, the parallels of the catastrophically overvalued Chinese stock market to the overvalued US markets are stark and ominous.

As we know, the US Federal Reserve has been providing liquidity to support US Markets through its near zero interest rate policy for the Wall Street banks, aka money printing. Margin debt in the US is at historical highs not seen since the crash of 1929. See the chart below:

 

Note the timing of previous peaks: 1. Just before the dot com crash in 2001 and 2. Just before the 2008 failure of Lehman Bros. and the financial crisis of 2008 from which we have not yet recovered.  Economic conditions in the US are far worse than they were in 2008. Even if you are not trading on margin, the flood of selling to meet margin calls will affect your stock valuations sharply.


 

Low Priced Gold Drives Gold Sales
The latest gold sales numbers from the US Mint show that so far in July, the mint has sold 285,500 ounces of gold coins, by far the greatest monthly sales this year. Compare this to June, the second highest total for 2015 at 163,000 total ounces sold.  Clearly, despite what you may hear or read in the mainstream press, the safe haven demand for physical gold is up significantly, worldwide and here in the US as well. The Shanghai Gold Exchange has delivered the second highest tonnage of gold in its history so far in July.

If you bought gold at higher prices, now is the time to dollar cost average and reduce your cost basis for your gold holdings. A lower average cost means greater appreciation in your assets. At today’s spot (paper) price, you can literally buy physical gold for less than most mines can get it out of the ground.  Miners are cutting back marginal production and there are early signs in the market of a developing shortage of physical gold. Ultimately, this must drive prices higher.

The Advantages of owning physical gold:

  • No counter party risk- The market cannot be shut down, nor selling prevented by the stock exchange.
  • No margin calls- You own gold outright and control your possession directly.
  • Gold is money.

 

Gold Price Volatility
We begin this writing with a simple question, “If you went into a car dealer to buy a car, would you talk the price up or would you talk the price down?”  The mainstream press including the Wall Street Journal, the Washington Post and Bloomberg have recently pronounced the death of gold. For generations of professional investors and traders, this kind of negative press has been used a contrarian indicator- a buy signal.

At the same time, demand for physical gold is surging toward historic highs. From UBS, “There are indications of physical demand for gold starting to develop and support the market… Meanwhile, U.S. Mint gold-coin sales are the highest in more than two years, even though July is a historically a slow month, UBS points out. “As it currently stands, U.S. Mint gold coin sales in July are nearly four times as much as the historical average,” UBS says.”

So, who is forcing prices of paper gold down, while demand for physical gold and silver is up significantly? Put another way, Who is talking down the price of paper gold and silver, buyers or sellers of physical metals? Remember, 90% of all the gold ever mined is held by central banks.


Gold and Interest Rates
There is much talk about the Fed move toward an interest rate hike in September this year. Some analysts conjecture that the rate hike will not come until 2016 but an increase is coming. Any rate hike will have a negative effect on equity and bond markets worldwide, causing a flight to safe haven investments.  Current increasing demand for physical gold may be a harbinger of the future as the mainstream press continues to misdirect the true picture of demand for physical gold. With an eye toward the systemic risk of cash in bank deposits as we have written about recently, let’s look at what happened to the price of gold the last time we were in a zero interest rate environment with subsequent rate hikes:

 


Dollar Cost Averaging (DCA)
During this period of gold and silver market price volatility, the dollar cost averaging investment strategy is particularly effective in improving returns for long term investors. Dollar cost averaging is a wealth building strategy that works to reduce the average cost of an investment so as to improve the long term return on investment. Utilizing this strategy frees an investor from feeling the need to pick market tops and bottoms, the tyranny of trying to time the market and the fear of “buying too high”. This discipline will prevent you from “chasing” overvalued markets.

For maximum success, the DCA strategy requires some investor discipline to ensure that investment buying is executed on a regular basis with a consistent amount of capital, regardless of market direction. Most investors are familiar with this strategy through their regular systematic contributions to 401k and IRA plans. These investments are made systematically, over time, without regard to market conditions and the results are without exception, superior.

When prices are up, dollars will purchase fewer ounces. When the cost per ounce for gold and silver is down, as now with both metals’ spot price below average cost of production; investors can purchase more ounces per dollar. You have greater buying leverage. The DCA strategy takes advantage of price fluctuations over time to give you a lower average cost per ounce of your metals holdings. The graph below illustrates the point:

 

If you dollar cost average, you need never be right about the short term market direction- only reliable to yourself.


London Metals Exchange Now Accepts the YUAN as Collateral
China continues to expand its penetration and influence in world financial markets. In conjunction with the acceptance of the Peoples Bank of China as a member in the London Bullion Market Association (LBMA), the London Metals Exchange (LME) will now accept the YUAN as a collateral currency for trading metals. The LME is the world’s largest venue for trading metals, over $15 trillion in metals traded last year on the LME. This is another major inroad for China’s influence in world financial markets. The YUAN is now the fifth most used currency for international payments.

From Zero Hedge, “A Bank of England survey on Monday showed that trading in yuan rose 25% in London in the six months to April this year, even as trading volumes in other currencies fell by 8% on average over the same period.

This acceptance represents a further erosion in the USD status as the world’s reserve currency and foreshadows the day when the US Fed will no longer have the luxury of printing dollars without the pressure of significant inflationary consequences. What happens to our equity markets when the Fed supplied liquidity dries up?

China as we know is both the largest buyer and producer of gold in the world. What will happen to the price of gold when it suits China’s purpose for prices to rise in support of the value of the YUAN as an international reserve currency?


 

Final Note on Silver
The US Mint is once again shipping Silver American Eagles. For now. After reopening sales of the SAE, 2.55 million coins were shipped in two days! This represents roughly 60% of global production for the two days. Silver is becoming increasingly scarce.


Contact your Account Executive at RME to learn more. Demand has been very high and investors have taken advantage of the current prices in both gold and silver.  If you currently own metals that you purchased higher than today’s prices, dollar cost averaging can allow you to own more metals at a lower overall average cost. If you are an investor that missed the boat in 201o, your opportunity to invest is here right now.

“I’ll be keeping a sharp eye on the market and I encourage you to do the same!”
jim-sign