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The China Debt Downgrade Could Fuel “Gold Fever” in China
Please note: This is our last twice-monthly NavellierGold market update. In the future, we will be covering the gold market about once every six weeks in Louis Navellier’s MarketMail. As our thanks for your loyalty to these NavellierGold updates, you will automatically receive MarketMail every Tuesday.
As of June 15, 2017, gold us up almost 10% in the first 5-1/2 months of the year, rising from $1,150 to $1,255. Gold’s latest surge was related to a credit downgrade in China. On May 24, Moody’s Investors Service cut China’s credit rating for the first time in almost 30 years. The reason, says Moody, was China’s rapidly-escalating debt level. China is the world’s second largest economy, behind only the U.S., so a credit downgrade of the world’s second largest economy is big news, reminiscent of the gold boom created by the U.S. Treasury credit downgrade by Standard & Poor’s in the first week of August, 2011.
In late July and early August of 2011, there was a showdown at the highest levels of the U.S. government over a debt ceiling debate. On Friday, August 5, partly in response to this debt standoff in Congress and the White House, Standard & Poor’s cut the U.S. Treasury’s credit rating a notch below its long-time peak of AAA. The U.S. had held this AAA rating since before American entered World War II in 1941. The 2011 credit downgrade was expected to cost U.S. tax payers tens (maybe hundreds) of billions per year in extra interest costs on the national debt, so gold soared rapidly in August and September, 2011.
Gold spikes are essentially misleading market signals. Any rapid rise fuels greed and the quick purchase of more gold – pushing the price up faster. That is a recipe for disaster. “Bubbles” are never sustainable. But if you level out its spiky price peaks, gold’s long-term gain remains impressive. In the last 40 years, for instance, gold has risen from a low of $104 in late 1976 to a recent price of $1,265, up over 1,100%.
Here is a chart isolating the 1980 and 2011 gold price spikes, using data supplied from Bloomberg:
In this chart, the 2011 spike looks to more extreme than 1980, but the percentage rise and fall in 1980 was far sharper than the 2011 spike. In essence, gold shot more than doubled in less than two months of late 1979 and early 1980, followed by a sharp (-38%) fall in the following two months. At the time, the U.S. was in a high-inflation, high-unemployment recession with interest rates spiking at 20%, but the specific cause of the January 1980 gold price rise came after Russia invaded Afghanistan on December 27, 1979.
Here are some of the specific month-by-month increases surrounding gold’s spiky summit
From September 1976 to January 1980, gold rose eight-fold in less than 3-1/2 years, then gold was dormant for 20 years. The next bull market came from 2001 to 2011, when gold gained rose seven-fold in 10 years – a much slower and more stable bull market than in the late 1970s. Like 1980, the spike in 2011 ended a bull market. Sometimes a spike is the gold investor’s worst enemy, causing a general exodus from the metal after it stops rising. That’s clearly what happened in the years from 2011 to late 2015.
The 2011 gold spike came after S&P downgraded U.S. Treasury debt to AA+. In the weekend news shows on August 7, Treasury Secretary Tim Geithner lashed out at S&P: “S&P has shown really terrible judgment and they’ve handled themselves very poorly… they’ve shown a stunning lack of knowledge about basic U.S. fiscal budget math. And I think they drew exactly the wrong conclusion …”
The next day, investors said the trusted S&P’s math more than Mr. Geithner: In the days after the Friday S&P debt downgrade, the Dow Jones index fell 634.76 points on Monday, August 8. Then it rose 430 points on Tuesday, then fell nearly 520 points on Wednesday in a stomach-churning roller-coaster ride.
While stocks were careening mostly downward, gold enjoyed three straight days of 2% or greater gains:
In the first three weeks of August 2011, gold rose $255 (+15.7%) while the Dow Jones index fell 11%.
Gold eventually peaked at around $1,920 in the futures market and $1,895 on the London pm fix as of September 6, 2011. Then, stocks began to recover and gold tailed off from its spiky “bubble” peak.
After rising 28% in less than 10 weeks, gold fell sharply (-15%) in the month after its September 5 peak:
China May Experience a “Gold Rush” Similar to the U.S. in 2011
China’s debt downgrade may fuel a round of “gold fever” in China. Like American investors in 2011, Chinese investors may be suspicious of their rigged and volatile stock market. Like the U.S. in 2011, the Chinese are now disappointed by the recent rise and fall of real estate prices. Meanwhile, China’s yuan is in danger of falling or even being devalued for trade advantages, reducing the value of their cash savings in gold or dollar terms, so Chinese investors may look at gold as their safest investment option available.
As Ivan Martchev has long warned in his “Global Mail” segment of Louis Navellier’s MarketMail, China’s debt load has entered dangerous ground in the last decade. Their economy has exploded but their debt load has grown even faster, as Beijing has fueled rapid growth with a vast expansion of credit.
On November 14, 2016, Bloomberg dramatized this debt increase in an article entitled, “Will China’s Financial Bust Ever Come?” They used the Bank of International Settlements indicator pictured below:
At the time, Bloomberg explained this credit-to-gross domestic product (GDP) “gap” as “the amount of credit provided to households and businesses as a share of gross domestic product.” The chart (above) shows how the 2008-09 crisis caused China to undertake a credit stimulus package which quickly pushed that nation above the “danger level” in early 2010. Since then, the credit to GDP ratio is, in the words of Bloomberg, “blowing out – suggesting a credit boom and the risk of trouble brewing.”
The following chart underlines the fact that China’s credit binge really began to take off in early 2009, when China’s debt-to-GDP ratio began exploding from about 125% in 2008 to 214% in 2016.
In a similar way, the U.S. was over-extending its credit in 2011, leading to the S&P downgrade. The Obama administration presided over four straight trillion-dollar annual budget deficits from 2009 to 2012. The U.S. government was forced to undertake some necessary cuts in 2013 and a crisis was averted, but the Chinese government has shown no indication of limiting its credit expansion, resulting in Moody’s downgrade last Wednesday, May 24. We’ll see if this causes a run toward gold in mainland China.
China is the world’s #1 gold producer and #1 gold consumer and there are active free markets in gold bullion and futures in Shanghai and Hong Kong, so there are plenty of Chinese investors and plenty of gold to go around there, but gold is a small-capitalization market compared to currencies, stocks, real estate, bonds or any other major investment category, so just a small increase in the amount of gold demand in China could send gold up sharply in yuan terms, and up for U.S. and global investors too.