Gold and silver continue to consolidate - with a moderate bias to the downside - in a continuation of sideways trading that has characterized this week's price action. U.S. equities have similarly stalled as market participants wait for some updated guidance regarding policymakers' solutions for the U.S. fiscal cliff and ongoing Greek debt concerns. Platinum and palladium have been the exceptions this week, performing admirably after Johnson Matthey Plc made a statement forecasting that this year we will witness the largest shortage of these two metals in over a decade.
The platinum/palladium story will be the topic of another article. The crux of today's piece is to consider two economic developments that have been eclipsed by the ongoing Greek and fiscal cliff dramas. Japan and China both released economic data recently that is noteworthy for a few reasons. The revelatory news coming out of Japan is specifically relevant to precious metals while the Chinese economic data release is more important to consider because of its context within the nation's economic blueprint going forward.
Japan's Cabinet Office revealed on Sunday that the nation's third quarter GDP contracted by an annualized rate of 3.5%. However, the news was not met with a dramatic response in financial markets as better-than-expected October export figures coming out of China served to mitigate the full depressive effects of the disappointing Japanese data.
In Japan, the 3.5% annualized contraction in third quarter GDP represents the largest economic contraction in the country since the earthquake and tsunami in 2011. A bulk of this disappointing revelation is being attributed to slumping exports and weak domestic consumption in Japan. Should this dynamic of economic contraction bleed into Japan's fourth quarter performance, it would represent the nation's third technical recession since 2008. A weak domestic picture in Japan is important to precious metals for two major reasons.
First, as Japan's economy slides inexorably closer to its "third textbook-definition recession since 2008," the nation's policymakers and central bank will be increasingly responsive to weak-dollar policies. An accommodative stance by the Fed directly influences the yen's valuation - a weak U.S. dollar generally means a stronger yen and vice versa. With an export-dependent economy, a strong domestic currency compromises the competitiveness of Japan's exporters. Considering this, and the yen's sensitivity to monetary policy in the U.S., we can increasingly expect the Bank of Japan (BOJ) to implement policies that mirror the Fed's as the BOJ acts to limit yen appreciation. For as long as the Fed maintains its easy money policies, it is safe to assume the BOJ will adopt similar measures. This latest installment of the global "currency wars," and race-to-the-bottom mentality, all serve to underpin prices of intrinsically valuable assets like precious metals.
Second, a weak domestic economy in Japan means that policymakers will be less likely to adopt the measures needed to realign fiscal policy on a more sustainable trajectory. Japanese Prime Minister Yoshihiko Noda pushed through the nation's first sales-tax rise in 10 years. The goal of this measure is to increase tax revenues in an effort to begin reducing Japan's substantial debt load - with a debt to GDP ratio that is above 200%, Japan is the world's most indebted country in relation to its total economic size. However, economic contraction and the prospects of Japan's economy slipping into another recession could force Prime Minister Noda to shelve attempts to increase tax receipts as such policies would inevitably depress domestic consumption further.
If the Japanese hold off on a sales-tax hike (the tax rate is slated to double from 5% to 10% by 2015), and shelve additional measures aimed at raising tax receipts and reducing the nation's debts, the yen's status as a "safe haven" will be increasingly called into question. Any doubts regarding the safety of the currencies perceived as riskless (i.e. Swiss franc, U.S. dollar, Japanese yen, etc.) will invariably benefit precious metals as these inherently valuable assets are immune to the third-party concerns that continue to plague the world's fiat currencies (i.e. currencies that are not backed by anything tangible; the value is derived from the "full faith and credit" of the issuing government).
To recap, Japan's disappointing third quarter data solidifies expectations of further quantitative easing (i.e. money printing) from the BOJ, while it also hampers the nation's ability to raise tax receipts and cut its debt load. As the yen's safe haven status is eroded by fiscal miasma and bleak prospects of a short-to-medium term reduction of the country's unprecedented debt burden, much of the cash currently allocated in yen for "safe" parking will be increasingly reallocated towards alternative options - among which we can include precious metals.
While this news out of Japan is certainly disheartening, financial markets did not respond accordingly because seemingly upbeat data from China seemed to dilute the blow to broader confidence that one might have naturally expected.
In China, October exports beat analyst estimates with outbound shipments growing 11.6% last month. On the other side of trade data, China's October imports grew 2.4% - the same rate as September. The low and unchanged rate of import growth speaks to China's well established export-oriented economic model.
However, China's recent import data also provides insight into a stark reality that policymakers are not adopting the measures aimed at promoting domestic consumption that they have popularly espoused in the recent past. As the wealth gap in China continues to widen, the general populace will become increasingly cognizant of a glaring disparity between the political lip service that advocates a policy shift towards domestic consumption and the observable lack of measures aimed at actually achieving those results.
While China may have enjoyed robust export growth in recent months -a nice reprieve from the 1% and 2.7% rates of export growth in July and August - the global demand picture remains nebulous. The likelihood of a global consumer renaissance precipitating a rise in the world's consumer demand to pre-crisis levels is highly suspect. As such, China's obstinate approach to economic growth solely on the back of exports is unsustainable going forward. With China's lending measures almost exclusively geared towards providing financing to the nation's behemoth state-owned enterprises (SOEs) and other massive, export-oriented industries, policymakers in China are effectively starving the small and medium sized private businesses of desperately needed capital. Instead, these companies are forced to tap the unfavorable terms of China's notorious shadow-banking system.
Many of these smaller, private companies are domestically oriented and could engender sustainable growth in jobs which in turn benefits domestic wealth. However, the massive SOEs and export industry leaders that are commandeering the lion's share of available financing continue to build unsustainable debt loads to build out productive capacities that do, and will continue to, outstrip global demand. All this will occur while anemic domestic consumption is consistently stymied by China's export-oriented policies. As such, slowing global demand combined with weak domestic consumption will put these huge corporations with massive debt loads in a dangerous position as their revenues will fail to grow at rates needed to make servicing their rising debt levels possible.
This dynamic will be exacerbated should China be forced to hike interest rates as inflationary pressures reemerge due to the easy money policies maintained the industrialized world. Deteriorating borrower profiles of major Chinese corporations and the associated delinquent loans will mar Chinese banks' balance sheets and complicate the inevitable future reorientation of China's growth model towards domestic consumption. While interest rates will need to rise if China wants to adopt a more consumer conscientious approach to its economic management, the associated financing risks could be mitigated if China adopted a similar, consumer-oriented lending bias now and going forward. Unfortunately, this does not seem likely.
Ultimately, the weak-yuan policies that the People's Bank of China (PBOC) has maintained to sustain its export dominance has and will continue to drive precious metals demand in mainland China. Besides an undervalued currency and a cultural affinity for precious metals, the lack of investment options for Chinese citizens ensures the nation has robust demand for precious metals.
With low interest rates offered for deposits, concerns of a housing bubble, and the fact that the Shanghai stock exchange is down more than 60% over the last five years, Chinese investors are understandably attracted to precious metals. While third quarter demand for gold in China was down from past quarters, the fact remains that the nation is the world's largest producer of gold yet doesn't export an ounce. Not only does Chinese gold demand consume every ounce produced in the country, China is currently the second largest importer of gold and is slated to surpass India to become the largest gold importer in the near future. For as long as China maintains the status quo economic model, we can expect Chinese citizens will continue to have a healthy appetite for precious metals.
While China's economic policies could be discussed at great length, the takeaway from the nation's recent "positive" economic data is that it evidences a policy skew that is not only unsustainable, but detrimental to the global economy. If China actually adopted policies aimed at bolstering domestic consumption, as so many of the nation's political leadership claim as their intent, the resulting boom in Chinese demand would be a boon for industrialized nations that export many of the finished and refined products and services that an increasingly wealthy Chinese population would demand.
However, for as long as there is a disconnect between China's proposed interest in domestic consumption and the prevailing policy reality, positive export data will not always represent a legitimate cause for confidence as is the current market response. As the continuity of robust export growth is observably untenable, it is rising imports and greater overall domestic consumption in China that should cheer markets going forward.