5 August 2009

China Building Yuan Strength

China has massive savings and massive trade surpluses and is capable of tremendous growth on the back of rural and regional development. Strategies such as yuan loans to the third world in return for access to resources might work and levering up at this point in China's development, if it is based on stimulating manufacturing and Chinese access to resources rather than property prices in Shanghai, might successfully run for a long while...

Some new economic paradigm is in the works; something along the lines of cuban advisors trained in community based urban agriculture enabled by access to cheap finance for building materials and, say, alternate energy infrastructure made in and financed by China will likely sweep through the third world and lay the basis for the next step in human economic progress.

Thats my guess but its a bit early to be sure....but I don't buy doomsday post fossil fuels, thats for sure.

This is a great article on Chinese technicals....


I hear her heart beating, loud as thunder
Saw the stars crashing
China Girl (David Bowie)

Last week a subscriber asked me to comment on the Chinese market.

My feeling about the subject reminds me somewhat of Willie Sutton’s response when asked why he robbed banks: “That’s where the money is.”

Asking me to comment on China is like asking an economist to analyze a potential time/price harmonic with Kaiser Soze pattern following a Rule of 4 Breakout. Well, you get the point. Other than my economics class in college and my stint at Drexel Burnham in Beverly Hills, I have no formal fundamental economic training--and frankly, that may have been a blessing. I am not carrying a lot of the preconceived baggage regarding the financial markets that many educations have shoved down the throats of those hungry to matriculate.

In all seriousness, there is a lot of magical thinking and a lot of statistical significance imbued in both the "science" of economics and the "art" of reading the technical picture of the financial markets--neither of which will yield a high degree of certainty. If you are looking for certainty in the fundamentals of economics or the technical’s of the stock market, you won’t find it either place. Prowling the bowels of economic theory will offer little clarity: put 10 economists in a room and you will get 11 opinions. Nor are charts the compass of certainty when it comes to the stock market: there are many ships at the bottom of the ocean and I am quite certain they all had chart rooms.

This is a game of probabilities, not certainties. Nothing always works. What we are looking for is an edge. Many edges, ideally. I won’t make you do this again, promise, but read that again: this is a game of probabilities, not certainties. Nothing always works.

That is why the secret to stock market profits is two-fold: use a stop, and decide where that stop is beforeyou initiate a position. Trying to figure out how to get out of trouble after you’ve gotten into it doesn’t work well. Oh, and from my experience, a third prong to success is that after identifying an edge (set-up) and getting stopped out, consider taking that set-up the second time around if it retriggers. The stock market likes to bait participants. The second mouse usually gets the cheese. And if stopped out the second time, consider taking a perfectly good set-up the third time if it triggers yet again. There is a reason why the cliché, ‘the third time is a charm’ is so well-worn.

None of this has anything to do with China. The recent eclipse that was the tightest in the last 100 years and the next 100 years cut a swath directly over the country and may have nothing to do with China either. But it is interesting in light of the cycles regarding the Federal Reverse offered in this space in past months and the challenge that some in Congress are giving to the Fed. This is interesting in view of the idea that the amount of greenbacks that we owe cannot be supported by demographics, i.e. we can’t earn our way out of the debt leaving three choices: default, remodification, or monetization.

The symbiotic relationship between the U.S. and China seems to be reaching a point of critical mass. Last week a high level Chinese delegation came to Washington. After they left, the US dollar made a 10 month low late in the week and gold exploded. Did the Chinese ask for something they didn’t get and in response is the US getting slapped in the face? Trying to decipher the delicate relationship is a job for Jake.

According to recent reports, China is rapidly accelerating efforts to internationalize its currency with a series of maneuvers that could see the Yuan become one of the top three monetary units in the world. Some analysts expect that by 2012 as much as $2 trillion worth of trade flows may be settled using the ‘redback’ as China shifts its commercial tentacles throughout the commodity producing world. The red octopus is holding hands with the emerging markets of Asia, South America and the Mid-East. Will it become a choke hold on the US? It is worth considering that with all their wealth versus the great wealth destruction in the West in the last year, the US is bogged down militarily while China is not.

Currently, Chinese dreams of a major role in international currency transactions are impeded by Chinese government policy which restricts the yuan from trading freely around the world and being fully convertible. But that could change quickly. China has already inked a series of agreements with Argentina, Malaysia and Indonesia to allow their central banks to acquire yuan for use in trade with China.

The radical shift in attitude may arise from a desire to protect China from what it may perceive as a ‘dollar trap’. This problem emerges when a country, through its trade, amasses a huge surplus of dollars, which it is effectively forced to reinvest in dollar assets. This is why China is the US’s largest creditor. It has as much to do with necessity as desirability. China’s US dollar assets have in the past been vulnerable to the whims of Washington. But the greenback is losing some of its hue. Moreover, the specter of a US consumer without the same tools to spend wildly should be making China nervous about the export of goods/import of US Treasuries double helix.

Not all is peachy-keen for China. They may have a few economic curve balls of their own to duck: during the first part of the year China came in with a much heavier stimulus than took place in the US. However, the export market in China which relied heavily on a now devastated American consumer must rely on domestic, organic growth. Because the domestic economy in China is 25% the size of the US, all that money sloshing around could cause a very serious inflation problem in China. Can the Chinese consumer replace the American consumer--quickly? That’s a big transformation which may entail China having to deal with a bubble of its own. Will China be forced to raise interest rates?

At the same time some analysts say China is not ready to take reforms needed to allow the yuan to be an true international contender. In making the yuan a freely traded currency would mean losing control by Chinese policy makers over its value and flows of capital in and out of the country. China’s government loves control and ruthless competition and may be fearful about protecting China’s domestic financial sector from seismic shifts in the global economy.

Another interesting issue is that at the same time the Chinese population is big buyers of gold as in the past they have been forced to turn in their gold for paper currency that turned worthless.

Speaking of gold, just as it appeared to be breaking down early last week, the metal reversed offsetting the stab down and recaptured its 50 day moving average. Last week left an outside up week in gold and any extension this week looks as if it will trigger a move out of a bullish Cup & Handle pattern.

This pattern exists within the pattern of a short-term inverse head and shoulders pattern as well as a larger inverse head and shoulders pattern. Last week’s turnaround in gold sets up a potential move over resistance in the way of a long declining 3 point trendline. A breakout over triple tops will trigger a Rule of 4 Breakout which has a strong likelihood of follow through. As many of you know panicky moves often times culminate at/near the 49th period of a move.

The crashes of 1929 and 1987 being good examples as the crash in both instances occurred 49 to 55 days from the high day. Looking at the weekly chart of gold, we see how the two most important peaks on the chart occurred 49 weeks apart. October will mark 49 weeks from the last important swing low. Will it be a spike high if gold breaks out?

While gold is poised to break out, the stock market is coming off the July Jolt. Despite the seeming bullishness of the outside up month of the S&P, the market has entered into the time period where a reversal could occur.

I don’t know what the catalyst for a reversal would be anymore than I knew what the catalyst would be at the March low. I still don’t think anyone can point to anything other than hope in a heavily oversold market that turned stocks around in the spring. The reason why any downside reversal must be respected is that it could be larger than most participants expect: bull and bear trends often play out in three’s---I don’t see 3 drives to a low on the monthly chart of the S&P which raises risk on any turndown in the Monthly Swing Chart in August.

Because of many cycles and patterns including 1979, 1929, 1990, and 1999 (the DJIA topped in August and double topped in January the next year) which I will flesh out further tomorrow, I believe that the July Jolt will lead to August Angst and a September Surprise... to the downside

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