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2 China's other bull is solid
gold By Adam Hamilton
Two years ago, many American investors
would have unanimously scoffed at the notion that
the world would soon look to China's stock markets
for guidance rather than the US's. Yet here we are
today. Over the past two years the Shanghai Stock
Exchange Composite Index has soared a breathtaking
328%, capturing the world's attention.
At
best at the end of May, the SSEC was up 62% this
year alone! Such gains are clearly unsustainably
parabolic, which places the
Chinese stock markets deep
into classic bubble territory. And the amazing
stories coming out of China these days reflect
mania extremes. From an accelerating day-trading
craze, to record numbers of new stock-trading
accounts being opened, to even lowly Chinese
laborers giving stock tips, China is caught up in
the throes of a textbook stock mania.
While stock manias are certainly fun as
American tech investors can attest to, they always
eventually end badly. Large rates of gain simply
cannot be sustained mathematically because soon
all the capital in the world would be sucked into
the mania market's exponential growth. So sooner
or later all stock manias fail, typically with a
sharp crash.
From May 29 to June 4, just
four trading days, the SSEC plunged a brutal 15%
on a closing basis. In some ways this looks like
the start of a collapse technically, but bubble
tops are notoriously tricky to navigate as
Shanghai's fleeting late February swoon showed.
Only time will tell whether this is the beginning
of the end of this mania or just another hiccup on
the way higher. Either way, the end is inevitable
at some point here.
While the stock mania
in China is fascinating to study, stocks are not
the only market for capital in China. Just like
the rest of the world, Chinese investors have
investment alternatives. One in particular, gold,
is exceptionally interesting at this moment in
time. In Western stock-market history when stock
manias collapse, gold tends to soar as stock
investors flee the imploding bubble. Will the East
mimic this behavior?
Believe it or not,
buying gold is not a problem in China. The Chinese
have a millennia-old cultural affinity for gold
and have long bought physical gold from local
shops, whether it happened to be legal at the time
or not. And the Chinese central bank recently gave
preliminary approval for the Shanghai Gold
Exchange to launch gold futures trading. So
Chinese investors' conduits for investing in gold
are growing.
Stock market issues aside,
gold trading in China is thriving. In January, the
Shanghai Gold Exchange reported its gold trading
volume soared 73% year over year. On February 18,
Chinese New Year, the Year of the Golden Pig
dawned. While a normal Year of the Pig hits every
12 years on the Chinese calendar, a Golden Pig is
far rarer. This is the first one in either 60
years or 600 years, depending on which Chinese
calendar expert is consulted. A Golden Pig year is
believed to offer extremely good fortune, and
during one the Chinese buy gold to celebrate.
Thus gold investment demand in China is
very healthy and growing totally independently of
the stock market situation. But when Chinese
stocks start relentlessly grinding lower, will
some Chinese stock traders move capital into gold
for protection like we do in the West? I really
think they will, given the ages-old Chinese love
for gold.
This raises the questions, "Are
the gold technicals looking bullish in China? Is
now a good time for Chinese investors to plow
capital into gold whether or not the stock slide
accelerates? If I was in China would I buy gold
today?
In order to explore these
questions, I had to see today's secular gold bull
charted in Chinese currency. It is formally known
as the renminbi ("people's currency") but more
commonly in the West as the yuan, its principal
unit. Yuan is a one-syllable Chinese word that
literally means "round", a reference to the round
coins from China's history that went by the same
name. So renminbi and yuan are interchangeable in
the vernacular today.
Now, unfortunately,
getting historical gold-price data from China is
not easy. For the early years of our secular gold
bull, there was no official gold exchange or
national price quotation available. Gold prices
could vary considerably regionally based on local
supply and demand, and I haven't seen any
historical data series capturing any of them. And
not being able to read Chinese like a typical
provincial American, I couldn't dig deep enough on
the Web to piece together real historical Chinese
gold-price data.
Thankfully there is a
curious peculiarity of the gold market that
renders this point moot. Since the US dollar has
been the world's reserve currency for decades now,
the dollar gold price still dominates world gold
trading for the time being. Everywhere on the
planet, the local gold price is still a function
of the dollar gold price and the exchange rate
between the local currency and the dollar. With
the Fed working overtime to inflate the dollar
into oblivion this situation won't last forever,
but it still works today.
Thus we can use
the yuan/dollar exchange rate along with the
benchmark US dollar gold price to infer the
Chinese gold price. This forex-implied local gold
price is not perfect, but in my experience it is
pretty darn close. Every time I have checked it
over the past six years by periodically digging up
a true local-currency quote from a local exchange,
I have found that the implied gold price is well
within 1% of the actual local price.
Bull
to date at best, yuan gold has powered 172% higher
from April 2001 to May 2006. Although such gains
are nothing compared to a parabolic stock market,
gold's rise has been slow and methodical. It is
based on global supply and demand and not local
euphoria. Chinese investors with capital invested
in gold have done quite well while bearing just a
minuscule fraction of the risk that stock traders
have borne.
Interestingly, the May 2006
gold highs, 5,764 yuan an ounce, were actually
all-time highs for China. Back in the early 1980s
when the all-time US gold highs were carved, the
Chinese yuan was much more valuable relative to
the dollar, lowering that yuan-gold high. Back
then one yuan cost about $0.57 in dollar terms
compared with just $0.13 today. So in one sense
the China gold bull is already breaking new ground
in nominal terms, something that has yet to happen
in the States.
Now you sharp-eyed students
of the markets have no doubt noted that the China
gold bull looks an awful lot like the US gold
bull. Indeed. This is largely due to the yuan
currency peg, which existed for the decade ending
July, 2005. The Chinese currency was dead flat for
the first four years of this gold bull. It was
hard-pegged at 8.28 yuan to one US dollar, or a
little over $0.12.
So up until the
People's Bank of China started the process of
decoupling the yuan from the dollar in July, 2005,
the China gold
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