China's Problems Intensify

The great economic miracle called China is slowly coming unwound.  Beset by a host of converging economic and financial problems, Beijing is about to face the ultimate test.

Front and center is the housing bubble and an economy that is rapidly overheating.

The problems in China’s housing market are thought to be more severe than those in the U.S. before the financial crisis.  They combine the potential housing bubble with the risk of social discontent, according to an adviser to the Chinese central bank.  In the last 12 months, property prices have appreciated by 11.7%.

China initiated limitations on property speculation recently as economic growth accelerated to 11.9%  in the first quarter from the same period last year.  The State Council said anyone buying a second home would be required to put up a 50% deposit, up from 40%, while the mortgage rate for second homes was also raised. The downpayment for first homes bigger than 90 square meters was increased to a minimum of 30%.

The economy expanded at its fastest rate in nearly 3 years and more quickly than economists had expected, putting new pressure on the financial authorities to consider tougher tightening measures, including an appreciation of the exchange rate and interest rates.

Despite rising fears of overheating, consumer price's dipped to an annualized 2.4% in April from 2.7% in February, according to recently published data.  Inflation at the factory level continued to accelerate, increasing half a percentage point to 5.9%.

Asia’s soaring factory output appeared to have slowed this morning as production data from China, Taiwan, South Korea and Australia showed a decrease in the pace of growth in output in May.

The official Purchasing Managers’ Index (PMI), compiled by the China Federation of Logistics and Purchasing, fell to 53.9 in May from 55.7 in April.  Concurrently, the unofficial but closely watched HSBC China Manufacturing PMI fell to 52.7 from 55.2.  An index reading above 50 indicates an increase in output.

Beijing has been the main driver of commodity prices in the past year, but the markets have been hit in recent weeks by concerns that measures to cool growth will temper the country’s appetite for raw materials.  As a result, oil prices have stalled.

Add to that China's exposure to the dismantling of the Euro-Zone and belligerent neighbor North Korea to the south and the ingredients are in place for an early termination of the China miracle.  As a result, investors need to be careful about taking on too much exposure to Chinese interests.

Marko's Take

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Rising Chinese Inflation Augurs Well For Gold

The Chinese economy is growing at double-digit rates, yet, instead of rejoicing, the Chinese leadership is worried.  Beijing has slowly begun to take steps to begin to cool its economy and an increase in interest rates is thought to be coming sooner rather than later.  The various stimulus plans appeared to have done their job, but now comes the inevitable effect on prices.

Recently released data indicates that the Chinese economy is overheating and that prices are beginning an upward creep.  Consumer prices in China rose 2.8%  in April from the same month a year earlier, the fastest pace in 18 months - but below Beijing’s full-year target of 3% , data released on Tuesday showed.

Adding to fears of potential overheating, Chinese property prices jumped 12.8% in April from a year earlier, the biggest increase since records began in 2005, although sales volumes have already fallen substantially in many big cities in reaction to a string of government measures to cool the market.

More disturbing was the news that Producer prices rose 6.8% in April, up from March’s 5.9% rise, indicating that consumer prices are likely to increase faster in the coming months.

Food prices make up about a third of China’s consumer price index and were the main driver of higher inflation in April, rising 5.9% from a year earlier, while non-food prices rose a mere 1.3%.

With the benchmark one-year bank deposit interest rate at 2.25% , Chinese savers are already faced with negative real interest rates, making investments in the booming property market more attractive.

The fear of Chinese policy tightening has dogged commodities markets in recent weeks, with base metals well off their mid-April peaks.

This morning,  copper for delivery in three months fell 2.1% to $6,970 a tonne on the London Metal Exchange.  Aluminium was off 2.9% at $2,075 a tonne, while lead – particularly exposed to moves in Chinese demand as it is used in car and electric bike batteries – dropped 3.7% to $2,022 a tonne.

As inflation creeps up in China, as well as the rest of the Asian-bloc, it will undoubtedly spill-over into the rest of the world.  Just as Chinese infation is rearing its head, so should that in the United States.  Washington has also enacted substantial stimulus programs and the accompanying inflation is inevitable.

Especially in a low interest rate environment, this can only be bullish for Gold.  It's no surprise that the yellow metal has taken center stage, broken out to new all-time highs and will undoubtedly explode higher as the world scrambles for the only bona-fide infation hedge.  Investors would be wise to jump on board before its too late.

Marko's Take

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