"To the deep pocketed and level-headed, volatility is not a risk but an opportunity. To the leveraged, undercapitalized, manipulated retail investor, it is a cancer. I've made money playing volatility against investors. Cooking settlements to test speculators' resolve on the floor. Banks successfully did the same to me as a marketmaker for 20 years. Central Banks are at the top of the heap. Central Banks manipulate by definition. And China is just learning the tactical game."
How China Manipulates It's Citizen Investors
Yesterday, we outlined the pattern in China's investment activities for Precious and Base Metals. Essentially they buy before they weaken their own currency. And when they weaken their own currency, the Chinese public panics, putting the markets already loaded up on by their government in overdrive. The cycle is typically:
- China sells dollars by buying physical commodities
- China then devalues the Yuan
- Chinese retail panics in the devaluation and chase the markets already in rally mode
- China puts on the brakes through restrictions
- markets tumble as retail sells, and (likely) China buys from them
- markets return to normative behavior
Sound Familiar? Ever get a margin call on Gold when you were profitable because the exchange raised margins?
The Chinese even admit it.
China “Owns Gold [Silver, Copper, Iron, Rebar] Through its People"
That is a direct quote from a Chinese banking official. What does that even mean? It means that China has directed its citizens to be buyers of Gold as well as base metals via its co-opted investment industry. Every swoon in Chinese stocks brings more Chinese gold buying.Every time the Yuan weakens, retail investors flock like sheep to what China has already bought PRE-devaluation. The Yuan's inclusion in the IMF SDR and China's subsequent pitching an SDR bond to its people is also a potential Gold play. China is using its companies, exchanges, banks and people as piggy banks for when it needs its Gold, Silver, and base metals. Then it will likely confiscate it "for the good of the country" if it cannot get the public to sell via newly minted anti-speculation rules. Who will be there buying the dip as their people puke positions bought at the top of markets? China.
The U.S. is No Different
Do you think western investors are any different in the eyes of their government? China is ham-fisted in its manipulations now. But the West is expert in getting what it wants by manipulation and regulation, and finally force if need be.
Trading China Patterns
April Surge on new listings, July surge on Brexit, November on Trump. When metals spike, China reacts.
Bloomberg has a story today entitled:
Iron Ore Gets Its Groundhog Day Moment as Tumble Follows Surge
The article is spot on in telling you what happened. What we are back to describe again is the why and how it happens. Frankly, the pattern only became obvious to us post Brexit. Apparently, the Chinese government shifts its de-dollarization plans into overdrive when it fears an event like Brexit (or more recently Trump's Election) could jeopardize their export trade agreements.
From Bloomberg
Iron ore is having a Groundhog Day moment. Prices that were pumped up on speculative enthusiasm just capped the biggest weekly drop in six months, echoing a sharp rise and tumble seen in April and May that was driven by a surge and fade in trading in China, the largest buyer.
This is accurate. The point we are trying to make is these events are simply accelerations in Chinese trading patterns: Sell dollars via purchase of base and precious metals, devalue the Yuan, sell finished goods to the west- repeat.
In July during Brexit, it was Gold and Silver that enjoyed the spike-buying followed by the aggressive Yuan debasement. During the Brexit vote, note Iron -ore also jumped in the chart above.
In April and May, it was the base metals taking off on the back of newly opened markets to Chinese retail. In the end the retail gets killed by China's salesmen advising them to buy because the Yuan is weak. But the public buys after the government has already bought and then weakened the Yuan. Finally, after the public has piled in, Chinese regulators seek to "put a stop to the speculation".
Iron ore is retreating from the highest since 2014 as authorities in China raised trading charges to quell the spike in speculation in commodities, including iron, steel and coking coal. -Bloomberg
"The Base and Precious metals markets in China are a wild west of binge-and-purge behavior forced on the newly minted middle class there. They will be left holding the bag just like the public is here."
China is a Student of Western Manipulation
Sound familiar? Not unlike an exchange raising margins. What is worse is that the Chinese government starts teh rally by loading up, then weakening its currency. China is no more guilty of manipulating its markets than any Central Banks does. However, they can afford to be more transparent about it, as they don't need to keep up the facade that their markets are free.
One Executive from Fortescue stated on the rally in Iron: “The Trump victory is only a factor to the extent of the psychological impact.” We agree. Trump's win was a catalyst of further debasement of the Yuan to make its exports competitive. And thus, a catalyst for retail investors to buy physical assets, only after the government already did. Manipulation is psychological. Manufactured volatility is how deep pocketed players shake out undercapitalized ones.
China's 3 Step Commodity Playbook
We note that China has a history of binge-buying before devaluing the Yuan. This makes sense given the smart move is that when a country knows it must weaken it's own currency's purchasing power, it should buy (and spend dollars) before weakening its own currency. In a macro sense it is quite simple really
Buy Raw Materials, Devalue, Export Finished Goods
Given a country like China that is long USD, keeps its Yuan in a range vs the USD and is dependent on exports to drive its economy still; the mechanics of trade would go like this. Also note, what would you do if you knew your country was about to devalue its currency in the next few days?
- Buy raw materials with a strong Yuan
- Debase the Yuan
- Export finished goods better via a weaker currency
The Reasons
The simple fact is China wants to slowly de-dollarize its economy and entice domestic consumerism. But every time a crisis jeopardizes their trade export position like Brexit, they realize Yuan depreciation must accelerate. And the 3 steps listed above are in play, only faster. Then after th epublic buys in apanic, they put the brakes on so the Gov't can buy more.
Brexit as Example of Fast Motion Chinese Playbook
Why was Brexit a crisis for them? Because the UK is their primary tie to the EU as trade partner. No UK, no EU buying to generalize. Note that they weakened the Yuan considerably after buying Silver, Gold, and rebar. And then those markets retrace rallies. Same thing is likely here from our analysis.
Chinese Market Structure is a License to Manipulate (Gold Example)
- China owns the PBOC
- The PBOC owns the SGE
- All Gold in and out of China must pass through the SGE
- The overwhelming majority of Gold in China is stored in SGE vaults
- China created an interbank Gold market expressly so its free standing banks can act as agents for the PBOC in buying more Gold
- The SGE: because of its stored Gold and its designated status as the intermediary for China's interbank Gold market is the only Bullion market in China
- China's free standing banks are under the PBOC thumb both commercially and legally.
- China has encouraged its citizenship to buy Gold, even going so far as to pitch the first IMF bond issue that includes the Yuan as part of the currency basket. "To buy the Yuan is to own Gold" we imagine is their motto
- If the PBOC wants to own all the Gold in the SGE vaults, it merely has to tell those banks to buy it, and they will comply.
- More deviously, the PBOC can simply seize that gold as it owns the SGE, its assets and its vault
The structure above lends itself to easy confiscation if China ever needed to. It can confiscate all the gold held at the Shanghai Gold Exchange (SGE)and Hong Kong markets. And the same template goes for any other natural resource the Chinese government "stores" with its citizenry.
No other government is different. The Chinese are just not as good as manufacturing consent through rhetoric. They do not have to be.
The Trade
This is our opinion. But truly, what is anything in the markets these days if not conjecture based on empirical evidence. So until we see evidence to the contrary we will rely on Bayesian Probability and remember that "if it walks like a duck..." etc.
The trade is, when metals spike preferably on an event, short the yuan. If you miss that, buy the USD. Then short the metals. The metals will back off and into the hands of China's proxy buyers after its public pukes. April, July, and November were give-aways that China panicked a bit on fear of trade issues. Keeping in mind the risks, and your own personal financial situation, trade accordingly.
The Investment- Just be long things
Your Government Will Default. You will be its Piggy Banks
This trade works just as well if you just buy base metals and dont sell for 5 years. Because they are going up. Copper now. Then Silver. Then Gold when the world realizes the Fed has no good way to keep inflation in check. Gold lags in a real inflationary environment (1970's). How can they fathom stopping the pendulum swinging towards the inflation side when it took 10 years to stop it on the deflationary side? These people have no concept of "dynamic equilibrium", much less simple physics.
Japan: 2006-2016 Missed it by that much.
The only trend then will be Fed chasing inflation and being (secretly) happy they don't catch up. Why? Because they want negative real rates as they inflate to keep stocks moving higher even as they slowly default on sovereign debt. Stagflation will not be tolerated because dogmatic academics cannot ever admit they are wrong. The phrase "put more on you moron" comes to mind.
We are the Academic Bankers' Hedge
Thing is, they can do that, because they have no skin in the game. All the risk is ours.
The US public will bear the burden of the Dollar's debasement while the Treasury slowly defaults on its own debt. The Dollar will be the last to circle the drain after the emerging markets have loaded up on it. US citizens will not be able to exit dollars then.
Next chapter will be "Buy American" based on the fact that the greenback wont be able to buy anything else. We will be trapped financially. Next US manufacturers will have license to make inferior products because the consumer is locked into domestic purchases via a weaker dollar and electronic money. Why do you think companies like Apple are considering reopening factories here again? Because the consumer will be trapped in part after the incentives to open the plants have kicked in.
Years, not months from now this will happen. But it must happen to clear the markets. Government intervention only works in the direction of the trend. Markets must clear themselves.
Good Luck
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