The stock market in China has tumbled almost 30 percent since mid-June. Is it the beginning of the global financial crisis? How could it affect the gold market?

We have focused recently on Greek debt-crisis, but it is possible that we looked in the wrong place for a global financial crisis. In China, the stock market bubble has finally burst. We are hardly surprised, since it was a classic unsustainable boom triggered by the easy monetary policy, which had come to a sad end. In just one year before crash, the combined market capitalization of the Shanghai and Shenzhen exchanges rose more than 140 percent. In line with the greater fool theory, since May more than 5 million new investors, most of them ordinary Chinese (including farmers), have entered the market. In a few last weeks, individual investors were responsible for 85-90 percent of the volume. Since the mid-June, the market has tumbled almost by 30 percent, wiping out more than $2 trillion (which equates roughly to Brazil’s GDP).

What are the implications for the gold market? The China’s stock market crash should be supportive for the gold prices (however, not necessarily in the short-term, as, inter alia, Chinese government introduced some stimulus measures) for two reasons. First, investors may turn into gold now. At the beginning ordinary Chinese invested in the booming real estate sector. After the housing market collapsed, they turned to equities. Now, the stock market is crashing and the economy is slowing down, so precious metals seem to be the best choice under these conditions. Second, the collapse of the Chinese stock market will be probably a strong deflationary force, as the bubble was debt-fueled. Margin financing raised the risk of a liquidity crunch, which could imply worldwide consequences. The commodities are already falling. Industrial metals fell to the lowest in almost six years and crude oil had the biggest decline in five months after turmoil in Greece and China. The further decline in commodities could be lethal for Australia, Canada and Russia. The deflationary pressure could also impact the Fed’s decision on interest rate hiking.

Summing up, the second largest stock market in the world is collapsing. The consequences may be far-reaching. The last time the Shanghai Composite Index crashed was in 2007-2008, just before the last financial crisis. The lack of sound investment opportunities and the liquidity crunch exerting downward pressure for inflation should support the gold prices in the long run.

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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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