Yesterday, the Shanghai Stock Exchange Composite Index plunged by 8.48%, its biggest one-day drop since February 2007 and second biggest crash in history. What does it mean for the global economy and the gold market?
As we wrote three weeks ago, the stock market bubble in China had burst. In response, the government intervened heavily to prevent the further plunge. The unconventional measures included banning major shareholders, corporate executives, directors from selling stock for 6 months, freezing majority listed companies from trading, halting IPOs, reducing margin requirements and threatening short sellers with arrests. These steps resulted in three weeks of relative calm, but the inevitable sell-off has finally come. It should not be a surprise, since policy interventions have only short-lived effects and create some unintended consequences, often contrary to the objectives. Taken steps reduced liquidity, so when investors decided to take profits after a rebound and after the partial unwinding of supporting measures, the stock market plunged. Additionally, investors feared that the government would withdraw supporting measures from the market after the IMF urged it to normalize its relentless market intervention.
What are the implications for the gold market? The China’s stock market crash should be generally supportive for the gold prices in the long term (investors may turn to gold and the plunge may lead to a decline in commodities and some deflationary pressure, which could deter the Fed from hiking interest rates), however, as it should be clear after the previous plunge, the gold price’s reactions will depend heavily on the investors’ perception. The gold price will react strongly only if investors expect that the violent swing in the Chinese stock exchange market will spill over into global economy. China's stock exchanges are relatively isolated from the rest of the world, because only Chinese residents are allowed to trade, however, the collapse may change the way investors look at the country. And the economy is slowing down, which may hit global trade and pull down commodity prices and countries producing raw materials.
Summing up, the second largest stock market in the world is collapsing again. The Shanghai Composite Index plunged about 8.5 percent. Unless the government closes the stock market exchange, we can expect further declines. Investor should remember that all bubbles must eventually burst, but bubbles often deflate in waves, with many ‘dead cat bounces’ on the way. If investors expect that the Chinese turmoil has global consequences, they will turn to gold as a safe-haven, which will be supportive for its price.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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