China's stock markets.....well, we can't say we weren't warned

Tuesday 7th July 2015

China's stock markets.....well, we can't say we weren't warned

"Calling time on China's credit and stock market party" , The Financial Times 6/7/15, Opinion, p.11

We flagged up the danger of China's soaring stock markets having all the hallmarks of being bubbles about to burst more than once, but what with being offline for a while and Greece dominating all the headlines we haven't had a chance to talk about them now that it's actually happened .... or not, depending on your point of view.

To recap :

China's two main stock markets in Shanghai and Shenzen more than doubled their value in the 12 months to June, and in doing so they put the kind of stratospheric valuations on companies not seen since the dot-com boom. It's widely acknowledged that the frenzied rise was engineered by the Chinese authorities. Worried by the economic slowdown and rising levels of debt, they sought to inject an asset price boost to the economy and to encourage corporates to swap expensive loans for equity financing.  A number of methods were employed : the Shanghai - Hong Kong Connect scheme allowed easier access to Chinese shares, and the People's Bank of China lowered both interest rates and reserve requirements and offered cheap funding to banks. Above all though, the move was fuelled by "leverage" in the form of margin debt, whereby investors borrow to finance larger purchases. Margin debt has increased by 700% in eighteen months, and is very much a double-edged sword. Of course it increases profits in the good times, but has the same effect on losses when things go wrong and in fact downside moves tend to be deeper and quicker as everyone scrambles to get out at the same time. 

Which brings us to the present ..... the two exchanges have fallen approximately 30% in three weeks, wiping more than $3.2 trillion off the value of Chinese-listed shares ..... yes, that's $3.2 trillion. The efforts of Beijing' and the market authorities to stop the rot have yet to prove effective though you can't fault them for their determination. Huge liquidity injections, more rate cuts, lower trading fees, a suspension of new issues, allowing state pension funds to buy stocks, pledges by brokers and fund managers to support the markets, prosecution of short-sellers ..... you get the picture, no holds barred.

The problem is that so far it ain't working, and at the time of writing this morning Chinese stocks are lower again by more than 2%. If all this fails to turn things around, a lack of confidence in the authorities' ability to control the market will become the biggest deterrent of all to investors. We'll know soon enough whether this is an overdue correction in an feverishly overbought market , or the real thing. Cross your fingers, and everything else.

Some extra bits :

How the Eurozone's other 18 line up over Greece.....

"Taking sides : how rest of Europe sees the negotiations" , The Times , p.8/9

Just thought it was worth a look to see how the Eurozone members are positioning themselves as they meet to discuss whether to offer Greece yet more help. The only surprises are that Portugal and Ireland are put in the mediator role. Both these countries have been through the wringer themselves and have voiced their opposition to letting Greece off the hook, so to speak. The Times's assessment however is that they have enough sympathy to at least play the honest broker role. Anyway.....

Hardliners : Germany, Netherlands, Finland, Spain, Slovenia, Slovakia, Estonia, Latvia, Lithuania,

Mediators  : Portugal, Belgium, Austria, Luxembourg, Ireland

Sympathisers  : Malta, Italy, France, Cyprus

China ?? Greece ?? So why's gold so weak ??

It all used to be so simple ..... in times of trouble, you bought gold. It was the ultimate safe haven refuge. What's going on in China and Greece at present would in the past have provoked a headlong rush into the yellow metal ...... no longer. The market seems to believes that either any contagion can be contained, or that gold has lost its safe-haven allure. Both are true in part. The simple truth is that gold is trading on supply/demand fundamentals that reflect the current price of approx. $1170 per oz . Crucially, it is also a US dollar-denominated commodity and its price naturally comes under pressure as the US$ strengthens on the back of Greek / China turmoil. And finally, gold probably maintains its status as an effective hedge against inflation but we know that there's precious little of that around. In fact, one of the largest drivers in measures of inflation, the price of oil, is on the slide again. Which brings us nicely to ......

OK, why's oil so weak ?

Brent crude below $57 per barrel again  (at the time of writing) ? And they told us this market had stabilised ....... This really is a supply/demand equation, or at least one of future supply/demand. Simply, Iraq is raising production beyond expectations, US shale producers are increasing the number of rigs in operation at a time when many thought that lower price levels would keep them out of the market , and as talks on Iran's nuclear programme progress that nation stands ready to open the taps. If you add in China and Greece, and the danger they represent to global growth and therefore demand, the oil slump makes sense. The irony is that even for oil-consumer nations its a mixed blessing, or at least for their finance ministers and central bankers. In itself, cheap oil might be welcome but the deflationary pressures it brings ? Definitely not....