Chinese Gold

The Shanghai Composite Index crashed again today - dropping about 8% from the open, for its largest drop since the crash in 2007.  Markets around the world followed it down.  At the same time, the price of Gold also fell; in fact, the price of Gold has been collapsing all  month.  A number of things are happening at once, none of which suggest a bright future for the world's economy.

The Chinese Purchasing Managers Index - a gauge for Chinese economic activity - signalled contraction when released last Friday.  This has sent commodity prices, notable for copper, plunging.  China absorbs about half the world's supply of copper.  If China's economy stalls or reverses, commodity prices will collapse, likely to price levels not seen in decades.  All recent evidence suggests that China is at least stalling.  The clear implication is that the world's economy may soon follow.

But why is the price of Gold falling?

In bad times, the price of Gold usually rises as a hedge against declining asset prices, especially in equities, and rising inflation.  It's recent decline would normally signal that all is well, and getting better.  And yet, the price of Gold has been falling as the Chinese stock markets have started to collapse.

Gold prices collapsed in the recent recession as well.  The reasons may have included that with equities falling and margin debt being called in, investors dumped all the Gold they had in order to stay afloat and satisfy creditors.

The Chinese have been allowed to buy Gold for some years now.  At one point, the government was actually encouraging citizens to buy the stuff, and for the past few years Chinese investors have been buying record amounts of Gold.  Many Chinese probably still have substantial profits, as they were buying as early as 2009 when the price of Gold was as low as just over $800 an ounce.

It seems that as their equities markets stumble, Chinese investors are either taking profits in Gold, or they are scrambling for cash or both, and as they sell the price of Gold is pulling back.  The fact that Gold production has expanded in recent years to meet Chinese demand, and that mining companies keep producing Gold at a mad rate, hasn't helped things.

There are now a record number of short positions in Gold, suggesting that the "smart money" thinks the price will keep falling.  We are in uncharted waters here - no one knows what Chinese investors will do in the coming weeks and months, not even Chinese investors themselves.  It is very possible that these investors, having burned in equities and to some extent in real estate as well, could turn on a dime and flock right back into Gold as a traditional safe haven.  For now, the price just keeps dropping, but short sellers need to take care - the short term for this market is now mostly unpredictable.

The price of Gold is the latest "canary in the coal mine" to become ill and threaten to collapse.  The drop in price is not, as some US news outlets have implied, a sign that all is well with the world's economy - quite the opposite; just look at copper.  Gold's recent price decline is part of a slowly spreading investor panic, that is staring to take hold in China, and that is almost guaranteed to spread.