Before
the first week of the new year is in the books, the Chinese stock
market has lost more than 14% and triggered circuit breakers that
have led to the shortest trading day in the stock market's 25-year
history.
As
far as stocks are concerned, the Chinese market made huge gains –
up over 100% - from early 2014 into early 2015. Then we had the
selloff in the summer and the market came back again. Given the
massive gains, it's not surprising that there's going to be a
significant correction, circuit breakers or not.
The
circuit breakers, which kick in if the market falls 7% during
trading, will only slow the correction, not alleviate it. A 30%
correction in the Chinese market still leaves it up 70% over the past
two years.
The
real issues aren't Chinese stocks. These are the 3 main issues as I
see them:
- The massive devaluation of the Chinese yuan against the dollar.
- The effect this is going to have on Chinese dependent companies like Apple that are over represented in all US financial indexes.
- The ultimate reckoning this will all have in the energy and transport sectors in the US, which will certainly send the financial sector reeling.
Each
of these deserves its own space, so here I will talk broadly about
the implications of this entire 3-part scenario playing out before I
drill down into each part.
A
Cheaper Yuan
Here's
how the transmission mechanism works: The Chinese have begun to
devalue the yuan against the dollar. That announcement from the
Chinese central bank on Thursday is what set off the second massive
selloff on the week.
The
implications are that the Chinese economy is weaker than it appears
and the move is to stimulate growth; and that Chinese businesses and
citizens are now holding money that is worth less every day and most
can do little about it because the yuan is not yet an openly traded
currency.
The
US Stock Connection
What
that also means is companies like Apple
(NASDAQ: AAPL)
and Qualcomm
(NASDAQ: QCOM)
and GM
(NYSE: GM)
and everyone else looking to China as their main engine of growth are
going to earn less money in China on the goods they sell, which will
hurt earnings for the company as a whole. Plus, a weaker Chinese
economy means less spending and economic expansion.
The
slower economic expansion means less need for energy and commodities.
That's why oil is down to 12-year lows again and dropping.
US
Energy and Banking Problems
This
will be another blow to the US energy sector, which needs higher
prices than most of its global competition to produce oil profitably.
And one area where we can see the problem clearly is in rail
transportation numbers, since much of the oil from US shale fields is
moved by rail.
Bank
of America analyst Ken Hoexter has found that rail loads have fallen
5% year over year for 11 successive weeks, something not seen since
2009.
And
the 3 largest drops by sector: coal, metals and ores, and oil, which
are are all down by at least 26% year over year.
This
is why the Dow Jones Transportation Index was off 20% in 2015 even
with record low energy prices. If you're not moving goods, it doesn't
matter how cheap the fuel is.
The
other shoe to drop here is when the banks have to cover the losses of
the US energy companies that go under. The banks have underwritten
loans, junk bonds and any manner of investment vehicles into this
sector of the years and now they're as exposed as they were during
the mortgage debacle 8 years ago.
And
in all this doom and gloom: One piece of good news is that gold hit a
9-week high last week. And silver is moving proportionally stronger than gold.
The
Coming Hard Assets Rally
The
flight to safety is on and gold should see a very good 2016. And as
I've discussed in previous articles, silver is a leveraged play on
the return to hard assets.
Given
the fact that the Chinese prefer hard assets and that most
individuals can't trade in the foreign exchange market, there will be
a significant increase in gold demand in coming days and weeks.
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