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Stock Market Charges Ahead, but Is Gold Sensing Danger?
Gordon Chang: Blowup w/ China or North Korea Could Change Almost Everything Overnight
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Happy New Year and welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.
Coming up we’ll hear a wonderfully insightful interview with Asian expert Gordon Chang. Gordon shares his views on Donald Trump’s much-hyped Tweet about the size of his nuclear button, gives his very studied view on the state of the Chinese economy and what the state of all of the Asian geopolitics will mean for the global markets. Be sure to stick around for my very interesting conversation with Gordon Chang, coming up after this week’s market update.
Precious metals markets are off to a strong start in the New Year.
The gold market shows a 1.2% gain this week to bring spot prices to $1,319 an ounce. The first key technical level to watch going forward from here is $1,350 – gold’s high mark for 2017. After that, the $1,375 and $1,400 levels will come into play. A breakout above $1,400 would represent a multi-year high and likely induce some strong momentum buying for the first time in years. But for now the yellow metal still remains mired in a long-term basing pattern.
Turning to silver, prices currently come in at $17.24 per ounce and are higher by 1.5% for this first week of 2018. Platinum was the laggard in the PM space in 2017 but is a leader in the first few trading days of 2018 – posting a gain of 4.0% this week to trade at $970. Its sister metal palladium made a new all-time high on the heels of a 3.0% weekly advance and currently trades at $1,095 an ounce as of this Friday morning recording.
On Wednesday, the Federal Reserve released the minutes from its December meeting. Metals initially sold off as the dollar strengthened, but those market reactions both reversed on Thursday.
Policymakers raised the Federal funds rate by a quarter point this past December. But as the meeting notes reveal, opinion is divided over whether to continue raising rates at a gradual pace this year. The consensus forecast is for the central bank to push through three rate hikes in 2018. Traders are now putting the odds of a March hike at close to 70%.
The GOP’s tax cut passage may tilt the Fed slightly more hawkish. Fed economists now project modestly higher GDP growth thanks to the tax cut stimulus.
The fiscal stimulus should help push inflation rates up toward the Fed’s 2% target by the end of the year – and perhaps beyond. In recent weeks, inflation-correlated assets such crude oil, precious metals, and resource stocks have perked up while interest rate sensitive assets such as bonds have struggled.
The stock market, of course, keeps chugging ahead – where it finally stops, no one knows. Momentum chasers keep buying, which pushes prices higher, which creates more momentum to chase. The stock market has long past the point of being a place for value investors – at least when it comes to the major averages such as the Nasdaq and S&P 500. Valuations are now in bubble territory.
Investors may look back on 2018 as the opportunity of a lifetime to switch from overvalued stocks to undervalued precious metals.
The supply and demand fundamentals for precious metals are set to improve in 2018. Low gold and silver prices over the past few years have severely hurt the mining industry. It has continued to operate existing mines – sometimes at losses – even as it has slashed exploration and development of new projects. That will mean years of stagnating or even declining output ahead.
Metals Focus projects mining output of gold in 2018 will show a slight decrease from 2017. Analysts expect a more significant drop could occur in 2019.
A similar pattern is expected to play out in silver, though it’s more difficult to forecast since few primary silver miners exist. Demand for silver is also more variable, with investment demand being the biggest wild card.
Commodity markets analysts at TD Securities believe silver may be the metal to own in 2018. They forecast silver prices will hit $20 this year. That would be an important technical level to hit. Yet $20 per ounce silver would still be less than half of its all-time high. You can’t say that about gold or most any other commodity or asset class on the planet right now.
From a value perspective, silver looks compelling. Stacking more silver may be a great new year’s resolution for investors to keep in 2018.
Well now, without further delay, let’s get right to this week’s exclusive interview.
Mike Gleason: It is my privilege now to welcome in Gordon Chang, author, television pundit, and columnist at the Daily Beast. Gordon is a frequent guest on Fox News, CNBC, and CNN, among others, and is one of the foremost experts on Asian economics and geopolitics, having written books on the subject and it's great to have him back on with us.
Gordon, it's a real honor to have you on again, and thanks so much for your time today. I know it's been a busy week for you given all of your media appearances, and we're grateful that you could join us today. How are you?
Gordon Chang: I'm fine, thank you, and thank you so much, Mike. I really appreciate the opportunity.
Mike Gleason: Well, there are many things to cover here given all that's going on right now. We certainly appreciate your expertise, particularly when it comes to the developments in Asia. There's a lot going on in that part of the world with big implications for investors. Let's start with North Korea. That's obviously been at the forefront of the news this week with tensions getting ratcheted up again.
Kim Jong-Un and President Trump are both bragging about their nuclear arsenals. The over the top posturing on both sides makes it hard to gauge just how seriously the threat of nuclear exchange should be taken. The market seems to have stopped paying attention for the most part. Please give us your thoughts on the matter. Is there any likelihood the disagreement over North Korea's nuclear weapons program will escalate beyond words, Gordon, or is this war only going to be fought on Twitter?
Gordon Chang: If you look at Twitter, this certainly is a matter of concern, but I think the reality is much different. Right now, Kim Jong-Un, the ruler of North Korea, is feeling sanctions. We saw a hint of that in his New Year's address where he referenced it, at least indirectly, and at one point he actually called the sanctions an existential threat.
What he's trying to do right now with his overture to South Korea is to get the South Koreans to shovel money into his regime. What he would like in return for sending two figure skates to the winter Olympics in South Korea next month would be for South Korea to lift sanctions to resume inter-Korean projects, like the Kaesong Industrial Complex, and also for more North and South Korean aid.
I don't think that those expectations are realistic. Some of what he wants would be a violation of UN sanctions, and President Trump's policy has been to cut off the flow of money to Pyongyang so it can't launch missiles or detonate nukes. This is going into, I think, a very crucial period, because if you look back in history, and I'm talking seven decades, we have seen North Korea engage in military provocations shortly after making peace overtures. And this whole concept of the Olympics and his opening of dialog with South Korea, that's a peace overture.
Mike Gleason: We've got two huge wild cards at the forefront of all this with President Trump and Kim Jong-Un being rather unpredictable, to say the least. Is Trump's tit-for-tat responses to his adversary here going to make diplomacy harder to achieve as our allies might have a hard time joining in full force to combat the North Korean threat?
Gordon Chang: I think on Tuesday, the second of his two tweets certainly made diplomacy harder. I think it was a setback for the American position. You've got to remember that in the morning, the first tweet was actually quite constructive. In the first tweet, President Trump talked about how sanctions were biting the North Korean regime.
What Trump needs to do, and this is not just among friends, but also neutral countries and potential adversaries like Russia and China, the backers of North Korea, what he needs to do is to get them to cut off the flow of money to the North. Any time that he talk about sanctions, that's important. That's good for us, but Tuesday evening in that exchange of messages, we saw President Trump with his tweet about button size. This was a setback in the sense that we're no longer talking about what's important for diplomacy, which are sanctions. We're now talking about infantile behavior on the part of the American president. That's not a good thing.
Mike Gleason: Now, let's talk about North Korea's much larger neighbor for a bit. Chinese officials just held the Communist Party's National Congress, a gathering held once every five years to formalize the party leadership. Some think the event may be significant in that it will mark a turning point, the theory being that officials there worked hard to prevent a slowdown in the Chinese economy until after Congress has concluded, and now that it is done, a much-needed correction could be underway. Do you see National Congress as meaningful, Gordon, and what are you expecting for the Chinese economy in the year ahead? Because as we know, what happens in China has far-reaching effects on markets globally.
Gordon Chang: The Congress was important I think because Xi Jinping outlined a very expansive notion of Chinese power. That's going to be I think an overstretch. I think that their commitments now are far bigger than their resources. This has implications, of course, for the economy and the strains on it. This year, this whole issue is going to be deleveraging. Chinese officials have been talking about deleveraging for years. They haven't been able to accomplish it. And that's largely because they are not willing to undertake structural reforms. They're not willing to see the economy go into a recession.
In 2016, the last year where we really had good numbers, the World Bank thinks that the Chinese economy grew not at the 6.7% pace that the official national bureau statistics claimed. They actually released a chart in the middle of 2017 and with a little arithmetic, you can see that the World Bank thinks that the Chinese economy grew by 1.2%. Also, that 1.2%, although it might be shockingly low to many people, is consistent with the most reliable indicator of Chinese economic activity. That's the overall consumption of energy.
In 2016, overall energy consumption increased, but only by 1.4%. So, we're talking an economy that is growing maybe now a little bit better than 2016. Maybe we're talking 2%. I don't know. But the point is that they're accumulating debt at a pace which is about six, seven, maybe eight times faster than they are producing output. They can do that for a little while because they control the banks, they control the big state enterprises, they control the markets, but they can't do that forever.
Mike Gleason: You haven't been terribly optimistic about the Chinese economy, and for good reason. However, from a certain point of view, there is a massive amount of central economic planning going on everywhere. You just alluded to that. Obviously, there's a lot of that going on here in the U.S., of course. We've seen some extraordinary maneuvers from the U.S. Federal Reserve over the past decade, and the truth is that we almost certainly don't know the full extent of what our central bank has been doing to intervene in markets. If history is a guide, all of the tampering could lead to serious trouble.
It probably isn't fashionable to ask since most are talking about strength in the U.S. economy, but it is at least possible that there are bubbles waiting to pop in both the US and China. Admittedly, there are lots of differences between the two nations, and the potential for central bank policy errors is just one piece of the equation. What are your thoughts? Is the risk of a bubble bursting lower here than in China?
Gordon Chang: Well, I don't know if it's lower. In China, there's going to be a bubble bursting. It could be a lot later than I think, but it will burst. Of course, in the United States, when you have a run up in the economy, you're going to have a rundown at some point. But whether it's going to be a 2008 style burst, I just don't think so.
In any event, from the Chinese perspective, they look at the U.S. economy. They're extraordinarily dependent on us. For instance, in 2016, the last year for which we have complete figures, a full 68% of China's merchandise trade surplus related to sales to the U.S. When the U.S. is doing well, Chinese exporters do well, but there's a real risk in the U.S. doing well, which I think people don't talk about. And that is, the Chinese are able to hang on because they've been able to control the renminbi, but with the Federal Reserve tightening, that is putting pressure on the Chinese currency. It makes it much more difficult for Chinese technocrats to manage in a difficult environment already.
If you talk to the American citizen, they might even not know what the Federal Reserve is. They certainly don't follow what's going on in terms of interest rates for the most part, but if you go to China, many housewives can tell you a lot about what the Fed is doing because it affects their pocketbook in a very immediate way.
China has been able to staunch the outflow of currency. In 2015, it was about $1 trillion according to Bloomberg. 2016, probably a little bit more than that. Last year, a lot less because of extraordinary capital controls, some of them announced, some of them not. With the Fed tightening, that makes it very difficult for China to maintain those controls, which are difficult even under the best of circumstances. I think it's going to be a very difficult environment for Beijing this coming year, much more difficult than it was in 2017 or 2016.
Mike Gleason: If we recall back to late summer of 2015 when the Chinese stock market had a sharp and deep correction, it had major implications for markets around the world, including the U.S., so they certainly are interconnected. If the Chinese markets were to be the first to falter, you would have to think that U.S. investors would feel that, as well, just like it did two and a half years ago.
Speak to that and then also comment about the likelihood that the Chinese and thus the world will be able to right the ship this time, like they did last go around, when they were able to prevent that snowball from really getting going.
Gordon Chang: Well, of course, any major downturn, especially a sharp one in China, is going to ripple through global markets. It will be felt here, but we're relatively, I think, in good shape because China is less important to the global economy than people think. Yes, there's a lot of growth there, but China has been taking growth away from other countries through predatory trade practices.
So, if it were to disappear down a dark hole, yes, we'd all be shot, but I think in six months, we'd realize, "Hey, this wasn't so bad," because when you have Chinese producers not able to flood the global markets as they have been, producers in other countries will take up that slack and there will be, I think, better conditions elsewhere, including the United States. So, I think that the effect of China's problems really, I think are just exaggerated in people's conceptions.
With regard to the second question, I think that central banks are not in as good a position today as they were in 2008, 2009 to take up the slack. And so I see things better of course in many, many, many ways than the last decade, but I don't think that we're going to get the relief efforts from central authorities that we did last time. But I think the economies are better than they were before, so I'm a relative optimist about the rest of the world, but we've got to remember, though, that geopolitical problems in North Asia could actually be the one thing that takes all of our assumptions and makes them incorrect.
Mike Gleason: Getting back to capital controls, Chinese citizens have certainly had a big appetite for cryptocurrencies like Bitcoin and others as they look to flee the local currency. Any developments there to update us on when it comes to the government cracking down and trying to prevent people from diversifying with cryptos?
Gordon Chang: I don't think there's been really very much in the way of developments in the last week or so. The most important thing is that the Chinese authorities are very suspicious of crypto-currencies. They are going to continue to try to attack Bitcoin and others. They may let up every once in a while, but I don't think that they have given up in any event, because this is where Chinese technocrats view the last stand. They've got to protect the renminbi. If they don't, it's all over, and not only for the Chinese economy and financial system, but also for the political system. So, they're going to do everything possible to make sure that currency doesn't leave China.
As we saw in 2017, they were really determined. Now, they're going to pay a big price, or actually many big prices, for their currency controls. What they did was they solved their immediate problem. These guys are looking at the short-term. They don't look at the long-term. So, you can expect for them to go after Bitcoin, go after the crypto-currencies, go after any other conceivable way to get money out of China. The Chinese authorities are going to attack it. So, any sort of optimism short-term about Beijing changing its views I think is just misguided.
Mike Gleason: China recently launched an oil futures contract, which is denominated in yuan but convertible into gold. This looks to us like another assault on the supremacy of the Petrodollar, what we'll see if the gold backing is enough to lure some of the energy trade away from the established markets. If you've been following that development, please give us your comments. Is the yuan a significant threat to the dollar here, Gordon?
Gordon Chang: No. If we're talking 50 years, 60 years, 70 years down the road, yeah, it could very well be a threat to the dollar, but not now. Renminbi usage around the world over the last couple years has been in decline, and it will remain in decline as long as China has those capital controls announced and unannounced. By the way, having unannounced capital controls makes China look like a Banana Republic.
So, as much as they're going to try to encourage use of the renminbi, it's just not going to have significant success until they're willing to open up their capital account. And I don't see that (happening) any time soon because there's just too much pressure on the currency for them to do that. So, they can devise whatever instrument they want. They might make a little bit of in road here and there, but long-term, renminbi usage probably will continue to fall. That's just because if you can't get the money out, you're just not going to want to use that as a medium of exchange.
Mike Gleason: We often talk about how the Asian world is full of very strong hands as it relates to gold and that much of the precious metals that leave the West and head East don't come back. Any thoughts there about what that might mean for the western world if we do have a big rush into precious metals as a safe haven investment during an economic and market downturn, given that so much gold has left western in recent years and gone over to China?
Gordon Chang: What leaves will come back. The U.S. has a strong economy. It's relatively stable. Asia right now is a place of geopolitical danger, and I think that there's going to be a long-term reversal. Right now, there's just too many hot spots along the periphery of China. One of those situations is going to go wrong. I can't tell you which one. It could be India. It could be South China Sea. It could be East China Sea. It could be North Korea. We don't know, but if you're looking at safe havens, Asia is not it.
Mike Gleason: Well, as we're getting close here, Gordon, any final comments that you want to leave us with? Maybe give us an idea of what you're watching most closely here over the coming weeks and months in terms of the geopolitical theater in Asia, and then the impact that it's likely to have on U.S. investors.
Gordon Chang: The most important thing will be the attitude of the Trump administration towards China. There are a number of items on the agenda which could derail relations. For instance, the section 301 investigation into China's intellectual property theft and a number of other investigations. There's going to be continuing friction between the United States and China, not only over North Korea, but other matters. This is not going to be good for the markets. I can understand markets not discounting this now, but when things happen, I think that we will see sharp reversals. This is just the thing to keep in mind in terms of geopolitical risk, because it's the one thing that could change almost everything, or even everything overnight.
When it comes to geopolitical risk, I think that there's a mis-perception of things. The one thing that really concerns me is war talk in the United States. There's an assumption in Washington among many people that the United States can strike North Korea without consequences. That could very well be true, but we've got to remember that in August of 2017, the Chinese said that if the United States were to strike North Korea first, it would come in and aid North Korea.
While although there could be no consequences to an American attack on North Korea's missile and nuke sites, we could very well end up in an exchange of nuclear weapons, not only with the North Koreans, but with the Chinese and perhaps the Russians, as well. So, all of these scenarios are there. Of course, the extreme scenarios, the extremely good ones and the extremely bad ones usually don't come to pass, but we're at a time where it resembles in many ways the prelude to the Cuban Missile Crisis of 1962.
There are extraordinarily large number of ways that all of this can go wrong. I'm not saying it will, but I don't think people have started to think about the consequences of some of the courses of action that they're recommending. The United States can peacefully disarm North Korea, not use force in doing that, but there's no political will in the United States to do that – which is essentially to impose cost on North Korea's backers, primarily Russia and China. It is easier to start a chain of actions that could lead to global conflict than it is to go after North Korea's backers. That's a very dangerous situation.
Mike Gleason: Well, very good summary there to close us out. Gordon, it's been a truly fascinating conversation. I really enjoyed it. It was great to have you on. Once again, I'm really glad you were able to find time for us this week with everything going on. Continued success to you in the new year, and I would love to have you on again in the future as this all unfolds. Thanks again and have a great weekend.
Gordon Chang: Thank you so much, Mike.