Yesterday, China’s stock collapse triggered a panic sell-off all over the world. What does it mean for the global economy and the gold market?
After Beijing did not announce the expected policy support over the weekend, the Shanghai Composite Index plunged 8.5 percent in the biggest sell-off since 2007. The collapse spread bloodletting across Asia (e.g. Japan’s Nikkei slumped over 4 percent), Europe (e.g. London’s FTSE 100 Index dropped 4.67 percent, suffering its biggest tumble in over six years) and the U.S. The US stock market has suffered its biggest sell-off in four years, as the Dow Jones declined 3.5 percent, while the S&P 500 lost around 3.9 percent. Although today we saw some rebound in the global equity markets, the China's main stock exchange plunged for a second day by 7.6 percent.
The sell-off should not be surprising, since all bubbles have to burst, eventually. As we wrote in July, “unless the government closes the stock market exchange, we can expect further declines”. The stock valuations were significantly inflated, so the repricing of the equity markets all over the world, although unpleasant, is not very strange. In such an environment, combined with weak economic growth, and expectations of the Fed’s interest rate hike and the following unwinding of the carry trade, even a small sparkle could kindle a fire. The devaluation of the yuan and the following concerns about China’s economy together with ineffective government measures to support the stock market became the sparkles this time.
It is definitely too early to judge properly the recent developments, however, there are some disturbing similarities to the 1997 Asian financial crisis. In short, then and now a low interest rates environment led to money inflows, domestic misallocation and debt build-up, while the correction came after the rise in the U.S. real interest rates, the appreciation of the greenback and the slowdown in a big Asian economy (then in Japan, now in China).
What does it all mean for the gold market? Well, the next possible financial crisis should be positive for the price of gold, as it would spur the safe-haven demand. However, the upswing may be initially limited by fire sales of gold, as some market participants are selling the shiny metal in order to raise cash to meet liquidity needs as a consequence of plunges in other markets. Other potential headwinds are deflationary concerns and the appreciation of the U.S. dollar. The strengthening of the greenback was the very reason why the price of gold was not rising after the outbreak of the 1997 Asian financial crisis. However, the U.S. economy is now growing much slower than in the 1990s. This means that the probability of recession is much higher, which is good news for the gold market.
To sum up, China’s stock collapse triggered panic selling all over the world, which may be the beginning of the next financial crisis or at least an important correction. This should be supportive for the gold market, however, investors should remember that stock market bubbles often deflate in waves, with many ‘dead cat bounces’ on the way. The gold should gain as a safe haven and because it seems that the September Fed’s hike is now unlikely to happen.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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