Taal selectie

Hong Kong Umbrella Movement

The Genie is Out of the Bottle

Pascal Blackburne & Luc Synaeghel 2019-09-01

Right now, from China’s perspective, intensifying Hong Kong protests arguably pose a greater problem than the trade dispute with the US. A repeat of the Tiananmen events, three decades ago, is to be avoided at all cost – for the sake not just of the Chinese, but also the global economy.

Although no longer THE gateway to China, having been supplanted in recent years by Shanghai – alongside a number of other east coast harbours – Hong Kong nonetheless remains a major business and financial centre. Its implosion would have severe economic repercussions, meaning that the conflictive situation requires careful management. And it is not just a matter of replacing the governor or repealing the extradition bill that sparked the protests. The unrest has since taken on an ideological turn, pertaining to the very independence of the city. Arresting leading activists was certainly no “spur of the moment” decision, given how China’s leadership usually functions, but it has clearly upped the stakes. Two scenarios could develop from here: violence escalates, providing the Chinese military with an “excuse” to intervene, or the protests gradually lose momentum. Us Westerners can only watch from a distance, hoping for the latter outcome. Hoping, that is to say, that the Chinese authorities will find a way to back down without losing face, and then accept to sit out the situation through 2047, when Hong Kong automatically integrates into China.

On the trade front, meanwhile, the dispute continues, with China having recently started to really show its teeth. We talk here not of alleged “underwater” renminbi depreciation, but rather of the publicly announced retaliatory tariffs (on US cars and, more surprisingly, crude oil) as well as the halting of US soybean purchases. Angering President Trump is perhaps seen by China as the only remaining way to achieve a deal. But while US and Chinese negotiators should eventually find common ground, we do not expect a formal agreement until the fall of 2020. Donald Trump will want his “moment of glory” for obvious reasons as close to the Presidential election as possible.

Over the next months, investors will have to bear with more sabre-rattling – and find solace in the odd pacifying tweet (the US President also being intent on avoiding a stock market collapse).

Amidst all this, and to continue on the subject of geopolitics, the G7 meeting proved positive, mainly in that there was no (public) quarrelling. It also saw some smooth manoeuvring by French President Macron, whose stunt may have paved the way for US/Iran discussions.

Brexit, however, remains murkier than ever, with Boris Johnson’s decision to suspend the UK Parliament widely seen as an act against democracy. A “no-deal” Brexit, a vote of no confidence triggering UK general elections, or the holding of a second referendum: nobody knows what will happen.

From an investment viewpoint, with uncertainty so rife, we can only reiterate to be very prudent. Prefere (asset backed) equities over long term bonds – to the extent that the former offer the possibility of protecting purchasing power whilst the latter, owing to spreading negative rates, involve a foreseeable loss of capital. As for gold, it remains our portfolio insurance: its price might stall somewhat after the hefty year-to-date gains, but we would be buyers on a pullback. Goldmines however have become expensive after their recent rally.

Gold Remains the Ultimate Hedge

goldGraph(Source : Bloomberg)

Central bank buying (mostly in emerging markets) and surging investor inflows into gold ETFs have been the main drivers of the yellow metal’s substantial appreciation this year.

Some central banks purchases involve maintaining their gold base as they ramp up the money printing press. Others have sought to boost their gold reserves because of mounting global uncertainties. The latter reasoning also holds for private investor flocking to gold ETFs, alongside the fact that the opportunity cost of holding gold has effectively disappeared in a world of negative rates. With the German Bund yielding -0.5%, what you pay for storage and management on gold ETFs is virtually equivalent to what you pay (no longer what you earn) for holding safe government paper.

From USD 1,282 /ounce at the onset of 2019, gold proceeded to gain ca. 10% and reach USD 1,410 by the end of June – breaking through the USD 1,350 resistance that had held for the past five years. This triggered additional speculative (aka hedge funds) buying via derivative contracts that now cover more than 35 million ounces (a historical high), many of which have a strike price of USD 1,500. As such, whenever the gold price trades above this level, speculators will be tempted to take profits.

This speculative buying then pushed the price of gold further upwards to USD 1,523 on August 15 (a year-to-date gain of nearly 20%) – after which the aforementioned profit taking began, resulting in a pullback towards the USD 1,500 level. Then another upswing towards USD 1,542 was triggered after China announced retaliative tariffs on 75 bln dollar worth of US imports on August 23, followed by an outburst of president Trump tweeting he would increase already existing import taxes on Chinese goods and impose the rest of Chines imports as well. Next to that he “ordered” American companies to leave China as soon as possible and to bring back their production to the US… Then again profit taking appeared (see graph).

Considering the 35 million ounces overhang, it is very unlikely that the price of gold can move much higher in the short term. On the contrary, if speculators lose their nerve and begin to sell in earnest, a sharp correction (towards USD 1,350) is not unrealistic. Particularly given that buying of bullion and jewellery by Chinese and Indian private investors (the major purchasers of physical gold) has virtually come to a standstill at the current price level – further heightened by local currency depreciation.

That said, it is only really the speculators that are liable to exit gold. Chinese and Indian private investors rarely sell their holdings (gold being a form of savings for them), central banks should remain buyers and inflows into ETFs will likely continue – with accommodative monetary policies here to stay and little sign of geopolitical abatement. We thus retain a fundamentally positive long-term view on gold and would take advantage of a correction to add to positions. Note, however, that this constructive outlook does not extend to gold mining companies, whose valuations now appear quite high in our eyes.

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