'Bubble-Mania' in Shanghai Spreads to Global Markets

The S&P-500 Index, a global bellwether for the world stock markets, extended its best five-month winning streak since 1938, by advancing through the psychological 1,000-level, and is up nearly 50% from its 12-year low set on March 10th. The S&P-500 gained 7.4% in July, its best monthly performance since 1997, even as average earnings per-share tumbled -32% and sales slid -16% from a year ago.

Industrial commodities, often viewed as barometers for global economic trends, have also moved sharply higher. So far this year, copper has soared by +96%, nickel is up 62%, and zinc is +50% higher. China, which buys two-thirds of the world’s seaborne iron ore shipments, boosted imports 30% in the first seven-months of this year to 353-million tons, lifting its spot price to $91 /ton, up from $60 per ton in February. Crude oil rose above $71 /barrel this week, doubling in value since December.

In hindsight, while the “Group of Seven” (G-7) economies in North America, Europe, and Japan, were experiencing the most severe economic contractions since the Great Depression of the 1930’s, coupled with unemployment rates ratcheting upward to multi-decade highs, the emerging economic giant - China - was demonstrating its prowess, with the most ambitious stimulus plan the world has ever seen, to rescue its juggernaut economy from the brink of social disaster and unrest.

In a little more than nine months, the pendulum of investor sentiment in Asia has swung from the extreme of terrifying panic and fear, to the opposite side of the emotional spectrum - hope and unbridled greed. The Shanghai stock market index has surged +90% this year, owing its good fortune to 1.2-trillion of bank loans clandestinely funneled into the stock market by brokerage firms, leaving it awash with yuan and lifting share prices above what economic reality can support.

China’s ruling Politburo is demonstrating to the world its command and control over its stock market and economy. Over the past few years, Beijing has proven its ability to either massively deflate a stock market bubble, as seen in 2008, and the wizardry to re-inflate a stock market bubble this year. Beijing is following the Greenspan – Bernanke blueprints, - turning to massive money printing to re-inflate bubbles in asset markets, in order to jump start an economy from the doldrums, or in this latest case, from the grip of the Great Recession.



A relatively healthy banking system enabled the Chinese central bank to work its magic. China’s M2 money supply is growing at a record +28.5% annualized rate, and the money supply surge is coinciding with big rallies in stocks and property, spilling over into neighboring Hong Kong. State-controlled Chinese banks extended 7.4-trillion yuan ($1.2-trillion) of new loans in the first half of this year, equal to 25% of China’s entire economy - helping to fuel a powerful Shanghai red-chip rally.

One of the beneficiaries of the explosive growth of the Chinese money supply is the Shanghai gold market, which is trading near 6,600-yuan /ounce, and is also tracking powerful rallies in industrial commodities. China is poised to overtake India as the world’s top gold consumer this year, and there is speculation that Beijing will quietly buy the gold which the IMF wants to sell in the years ahead.

China, the world’s biggest gold mining nation, is seeking to boost gold output by 3% to 290-tons this year, far less than the 400-tons it consumed last year. Thus, China could become an even bigger importer of the yellow metal in the months ahead, helping to cushion inevitable corrections in the gold market. Given the trade-off between expanding growth and fighting asset-price inflation, Shanghai traders are betting that Beijing will opt to blow even bigger bubbles in asset markets.

Industrial Commodities Eyeing Shanghai

China’s super-easy monetary policy is designed to offset the damage to its export-dependent regions, which are suffering from the collapse in global trade. Beijing is also spending 4-trillion yuan on infrastructure projects, equal to roughly 15% of its economic output per year, to create jobs and stoke economic growth. So it was of great interest to global traders, when the Shanghai red-chips suddenly plunged -5% on July 29th, the biggest daily loss in eight-months, on rumors that Beijing would curb bank lending in the second half of this year.



The Shanghai index is prone to sudden shake-outs, with the index trading at 35-times earnings, and Shenzhen’s small-cap shares trading at 45-times earnings. The Shanghai red-chip index has evolved into the locomotive for key industrial commodities, such as crude oil, base metals, and rubber. Industrial commodities rebounded from a nasty one-day shake-out on July 29th, after the People’s Bank of China wasted little time in denying rumors swirling in the media that it was considering the idea of enforcing quotas on bank loans.

The prospects for Chinese corporate earnings growth are of critical importance, with the Shanghai stock index flying higher in bubble territory. Large-scale industrial companies in 22 Chinese provinces saw their profits decline -21.2% in the first half to 894.14 billion yuan, but the decline rate was less from the first quarter’s 32% slide, and nowadays, “less bad,” means signs of recovery.

The most optimistic scenario calls for Chinese industrial profits to rebound to an annualized growth rate of +30% in the fourth quarter, due to the government’s massive stimulus. China’s Bank of Communications predicts the economy’s growth rate will accelerate to a pace of +9% in the third-quarter and +9.8% in the fourth-quarter. China’s crude steel output would surely top 500-million tons this year, equaling 40% of the world’s total production.

Korea Joins Alignment of B-R-I-C-K

Upbeat markets in China are helping underpin the BRIC nations, including Brazil, India, and Russia, which have the four best performing stock markets this year. Brazil’s Bovespa Index is up 79%, India’s Sensex Index is up 63%, and Russia’s RTS Index has gained 62-percent. The S&P-500 Index by comparison, is up 9.4% this year, while Japan’s Nikkei-225 index is up 7.5-percent.

One could add Korea to the alignment of B-R-I-C-K stars, since the Kospi Index has rebounded by 72% above its November low, emerging as the most favored market among global investors. With growing appetites for risky assets, global investors have rushed to snatch up Korean Kospi shares, particularly those in the information technology (IT) and the auto sectors. Foreigners were net buyers of $4.7 of Korean stocks in July, much larger than net-purchases of $2.6-billion of stocks in Taiwan, $1.9-billion shares in India, and $1.29 billion shares in South Africa.



“Money has no motherland, financiers are without patriotism and without decency, - their sole object is gain,” observed Napoleon Bonaparte. Highlighting the fickle nature of speculators, - foreigners bought a record $18-billion of Korean securities in the second-quarter of this year, or 24-times more than $750 million the previous quarter. In the third and fourth quarters of 2008, foreigners sold $17.9-billion and $17.4-billion, respectively, at the height of the global financial turmoil.

Foreign buying of Korean equities knocked the US-dollar 28% lower against the Korean-won, and the Japanese yen has tumbled 20% to 12.8-won, since March 10th, when global stock markets bottomed out. “Carry traders” are active in Seoul, and profiting from a stronger won. In a world where G-7 central banks are pegging rates at record low levels, it does not take much imagination to envision the Federal Reserve, the ECB, and the Bank of Japan underwriting rallies in the emerging currencies of Brazil, Russia, India, and Korea, just as Tokyo pumped massive liquidity straight into New Zealand and Australian dollars during its flirtation with the hallucinogenic drug - “Quantitative Easing” (QE) between 2001 and 2006.

Virtuous Cycle Swings in the Kremlin’s Favor

The resilience of China’s economy has rekindled the de-coupling debate, which hinges on the premise that the emerging economies in Brazil, Russia, India, China, (BRIC) can grow in spite of a declining G-7 economies. The so-called BRIC countries accounted for half of global growth in 2008 - China alone accounted for a quarter, and Brazil, India, and Russia combined equaled another quarter. Furthermore, the IMF notes that BRIC “accounted for more than 90% of the rise in consumption of energy products and metals, and 80% of grains since 2002.”



The virtuous cycle of events are now swinging back in the Kremlin’s favor, as global speculators flock back into hard-hit resource shares trading in Moscow. Russia’s central bank cut its main interest rates for the fourth time in less than three-months, after Moscow said the local economy contracted an annual 10.2% in the January-May period. Bank Rossii lowered the refinancing rate a half-point to 11% following on initial reduction on April 24th and two further cuts on May 13th and June 5th.

The Russian rouble has rebounded 16% against the US-dollar, since the first quarter, as Urals blend crude oil rebounded towards $70 a barrel, and base metals surged higher, boosting demand for Russia’s currency, a world leader in commodity exports. Russia is the world’s second-largest oil exporter behind Saudi Arabia, and supplies a quarter of Europe’s natural gas needs. Russia is also the world’s largest nickel and palladium miner, the second largest platinum miner, and the fourth-largest iron ore miner, behind Brazil, Australia, and India.



After reaching a record high of $597-billion last August, Moscow’s foreign currency reserves were dramatically depleted in the second-half of 2008, as the central bank spent more than $200-billion supporting the Russian rouble and bolstering the capital position of domestic banks. This year’s rebound in Urals blend crude oil has improved the Kremlin’s coffers, to the tune of $404-billion today. China, the world’s second-largest oil guzzler, imported 3.83-million barrels per day in July, or 25% more than a year earlier, the fastest pace in nearly two-years.

The BRIC nations are rethinking how their US-dollar currency reserves are managed, underlining a power shift from the United States, which spawned the global financial crisis. Russian chief Dmitry Medvedev has repeatedly questioned the US-dollar’s future as a global reserve currency. China is allowing companies in its southern provinces of Yunnan and Guangxi to use yuan to settle cross-border trade with Hong Kong and Southeast Asia to reduce exposure to the US-dollar.

India Weathers the “Great Recession”

Reserve Bank of India chief Duvvuri Subbarao says India’s modest dependence on exports will help Asia’s third largest economy, to weather the “Great Recession” and even stage a modest recovery later this year. Even during the depths of the October massacre in the Bombay Sensex Index, India managed to maintain a 5.3% growth rate in the fourth quarter, and India’s banking system had virtually no exposure to any kind of toxic asset, manufactured in the United States.

India’s factory output contracted by a slim 0.25% in January, the first decline this decade, and export earnings had fallen for six straight months. In January exports were 16% lower from a year earlier tumbling to $12.3-billion. So the Reserve Bank of India (RBI) scrambled to rescue the Bombay stock market, by slashing its lending rates six times from September thru April, by a total of 425-basis points.

click to enlarge



The Indian Sensex index began to decouple from Wall Street and Tokyo in early May, after it rallied 14% for its biggest weekly gain since 1992, when Indian Prime Minister Manmohan Singh won a second term. Bombay stocks soared with enthusiasm at the prospect that Singh’s new government, shorn of Communists, would privatize up to $20-billion of state-owned assets, increase foreign investment in highly profitable crown jewel companies, begin deregulation of banking and financial services, and gut restrictions on the closing of factories.

India’s factory sector, measured by the Purchasing Mgr’s Index, held strongly at a reading of 55.3 in July, or 2-points higher than China’s, signaling a strong industrial recovery in the second half of this year. If the decoupling of China, India, Russia, and Brazil becomes a reality, it could be good for the developed G-7 nations, as growing wealth in BRIC nations could, in theory, increase demand for goods made in battered nations like Japan, Germany, and the United States.

A decoupling between the emerging BRICK nations and the more developed G-7 economies would mean a huge shift in the global financial markets, away from the traditional pattern of emerging markets dancing to the tune of G-7 economies, which still account for 60% of global GDP. Instead, increasing independence could lead to a greater sphere of influence of the emerging giants, led by Beijing.



In the United States, Fed chief Bernanke is pumping a “bailout bubble” for Wall Street, similar to the policies of his mentor “Easy” Al Greenspan, who inflated the housing bubble, the sub-prime debt bubble, and the high-tech bubble. It’s a never ending cycle of boom-and-busts of bubbles, engineered by central banks. The revival of the “Commodity Super Cycle,” might already be in motion, and if a global economic recovery gains traction, soaring input costs would begin to crimp the profit margins of the giant Asian industrialists.

All the liquidity that’s been unleashed into the global banking system would play havoc with accelerating inflation. History shows that central banks won’t pre-empt inflation by withdrawing liquidity early. Instead, the money printers tend to inflate bubbles to dangerous proportions. Add to the mix, the vast leverage of the US-dollar and Japanese yen carry trades, it’s going to be a wild ride for the US Treasury bond market, which is increasingly dependent upon the whims of BRICK.

Comments

[Fighting Yoda:]

China is trying to inflate – playing straight out of the US playbook. Yes they do have the money to do it but it is overheating the economy- they have huge surplus capacity and they are adding more- their own social pressures. China is simply playing the ‘beggar-thy-neighbor’ game – it is holding its currency down against the dollar. It might actually let its currency fall. Chinese currency has gotten hugely overvalued against the neighboring Asian currencies – that is a major problem for China.

China has managed relatively well, but it certainly is very export dependent to the West – which is in a Great Recession. Chinese exports are doing very poorly – down 30-40%. But for some reason – its imports of commodities are hugely up – that is simply a commodity bubble – that will burst very soon.

Overall there is no end in sight for the global recession – today’s job loss and ISM numbers is a clear and glaring reminder. So watch out both for commodities and equities – they have priced in a V-shaped recovery.

Aug 05 03:33 PM

[whidbey:]

"History shows that central banks won’t pre-empt inflation by withdrawing liquidity early. Instead, the money printers tend to inflate bubbles to dangerous proportions". We will see no moderation of liquidity - the race is on between industrial and Emerging markets.

It is leading to the crossroads: either default or inflation out of control. The Commodities will do well - for a while.

Aug 05 03:45 PM

[Alphameister:]

Take a look at what the leaders of the two countries have done in the past ten years regarding economics and then tell me where you'd rather place your bets! Getting it "right" is not an absoute; I'm betting that China will get it less wrong than the US.


On Aug 05 02:29 PM TD747 wrote:

> The same folks who complain every day that Washington misallocates
> resources and capital somehow have blind faith that Beijing, a communist
> regime, can get it right on a much larger scale. Really?

Aug 05 06:31 PM

[Jade Bond:]

What the heck difference does it make what your balance sheet is when you dilute your equity? Dilution is dilution. China gets away with it because they don't have free-floating exchange rates. Someone should compare China to the U.S. in the 50s and 60s - fixed exchange rates and balance of payment surpluses.

On Aug 05 11:32 AM djj420 wrote:

> The author said:
>
> "Beijing is following the Greenspan – Bernanke blueprints, - turning
> to massive money printing to re-inflate bubbles in asset markets,
> in order to jump start an economy from the doldrums, or in this latest
> case, from the grip of the Great Recession."
>
> It's two very different dynamics when a net creditor prints money
> and when a net debtor does.

Aug 06 02:06 AM

[Jade Bond:]

Well, I hear the Chinese like to do everything bigger than life. Why not economic stimulus, too?


On Aug 05 12:22 PM Teutonic Knight wrote:

> Graham, concur with your view - the Chinese Bubble is the Ultimate
> Bubble of the Bubbles.
>
> TK

Aug 06 02:11 AM

[I am not a ...:]

What is not mentioned is that of tuesday last, China has finished loading it's iron ore stock pile for the year.
Something to consider .

Aug 06 09:17 AM

[WD216:]

I couldn't help but chuckle at doubleshortetf's analysis of China. It is scary, especially number one, only because it sounds so similar to the USA. Funny thing is that doubleshortetf's and most of the American public don't even realize it.

His statement- "China is a communist country ruled by 1 party with iron grip. Party bosses pick the politicians and many private company managements since many private companies are ex-SOE (communist state owned enterprises)."

Hmm, isn't the USA now ruled by one party? Obama and the Dems are pushing through whatever they want, aren't they? So indirectly it's a one party rule and no one can stop them.

Then his statement about the Chinese:
"Party Bosses pick politicians and many private company managements."

Too funny, has doubleshortetf looked at GM, Fannie Mae, Freddie Mac, AIG, C, and a whole slew of other companies now controlled by the government. Oh but we are the USA....land of the free. Ha.

Face it, these are government run companies now. They now control the autos, banks, insurance and soon heath care companies. And you all think you are better off then Communist China? Why?

He goes on to say, "judges are appointed by...political bosses". Too funny, isn't that what is done in the USA?

Then doubleshortetf says, "No one except pea size brains trusts the communist government's statistics which are MANIPULATED."
LMAO, he actually think the USA's statistics aren't?

He must be living in a box. The US pumps numbers up like the rest of the world, you really think the US government is different than others? Note how often old figures are revised. Also note that you are unable to dig deep and really drill down into the statistics. Why don't they give a complete breakdown of them? Where so they get these statistics? What exactly are the sources? Americans are blind bats, you have to love them. See no evil and hear no evil.

For those of you who think there is no corruption (political deals) in the USA? Are you all that ignorant or just naive?

Finally, his statement:
"Chinese....commodity appreciation have lot to do
with communists pumping money to the economy by directing the banks to make loans. This kind of stimulus cannot go on.

FYI, first the USA is pumping money into the system much faster than the Chinese, it's not comparable. Second the devaluing US dollar and speculation that this will continue is most of the cause of soaring commodities prices. And why shouldn't they speculate? It's a no brainer the dollar will continue to devalue. Obama is spending like a drunken sailor and the US continues printing money 24/7. So blame the USA for higher commodities prices. Stop pointing fingers like cry babies do. Wake up and grow up. Stop ragging on other countries and clean your own house.

Aug 06 09:18 AM

[Graham and ...:]

Dear TK:

I refer you to my article on Prussia and the "minimum wage."


On Aug 06 02:11 AM Jade Bond wrote:

> Well, I hear the Chinese like to do everything bigger than life.
> Why not economic stimulus, too?

Aug 06 10:08 AM

[nakedjaybird:]

doubleshortetf - you sure you were not describing the USA business practices????

Aug 06 12:51 PM

[nakedjaybird:]

PS - and the last time I checked, in the US, business includes the Government!!!!!

Aug 06 12:53 PM

[Harry L:]

Imagine what inflation would look like right now if we were not importing a massive amount of our products from China. There is just no way the US can compete with the far eastern labor markets. We had a similar situation in the 70's and 80's after we gave our electronics and auto industries to Japan. Took about 25 years for the Japanese to get wealthy and now they are suffering along with the rest of the world. Only difference between Japan and China is that Japan had very few people to share in the growth of wealth. Compared to Japan, China and India have an endless supply of laborers, and I should add educated workforce.

We survived the 90's on hi-tech, and we had better make a similar growth spurt out of "Green" or the US economy will be reduced to dependency rather than leadership.

Aug 06 02:27 PM

[MSimon:]

The Prussia and minimum wage article referred to above:

seekingalpha.com/insta...

Aug 06 02:29 PM

[Bion:]

How does this reconcile with over a 100% (loss) tracking error compared to FXI? I guess the brave fish the bottom on these vehicles, but there might be better ways...


On Aug 05 11:35 AM doubleshortetf wrote:

> Been to China over 30 times since 1998 while working for 3 multinationals.
> It's amusing to see "experts" who has not been to China or spent
> few days in the big Chinese cities recommending Chinese stocks...
> Wonder if they ever spent weeks at a time in gritty factory towns
> or poor interior areas...
>
> Some sober facts:
>
> 1. China is a communist country ruled by 1 party with iron grip.
> Party bosses pick the politicians and many private company managements
> since many private companies are ex-SOE (communist state owned enterprises).
>
>
> 2. Corruption in China is rampant and one of the worst even down
> to lower ranking employees. Even factory canteen chef gets "envelopes"
> in scheme where he claims he received 10 bags of rice when only 8
> bags are delivered.
>
> 3. There is almost no "law" since law itself is written to support
> the communist party or corrupt local communist bosses. Judges are
> appointed by the local communist boss and few if any understand law.
> Many judges got job thru "guanxi" or connection and of course bribes.
>
>
> 4. The Chinese banks in are BIG TROUBLE. E&Y got in heaps of
> trouble for discussing hidden bad and uncollectible debts. Local
> communist cadres dictate banks to lend to their pet projects and
> of course friends who bribe them not to mention COMPLETE lack of
> transparency.
>
> 5. No one except pea size brains trusts the communist government's
> statistics which are MANIPULATED.
>
> 6. Many of the listed companies numbers are COOKED. Auditors and
> their management can be bribed and extorted. It's beyond me how anyone
> would trust Chinese companies' financials unless audited by Big 4.
> And even Big 4s audited numbers are suspect since most Chinese companies
> carry multiple books including one for taxation and another for real
> book with slush funds.
>
> 7. Latest Chinese share and commodity appreciation have lot to do
> with communists pumping money to the economy by directing the banks
> to make loans. This kind of stimulus cannot go on.
>
> Now is good time to buy FXP when all the investment gurus in unison
> are recommending Chinese stocks.

Aug 06 03:13 PM

[Jeff:]

Sounds like most of these folks are just sad that they didn't get in for the 90% ride. Even if it goes down 50%, I'm still way up.......

Fear kills.

Aug 06 03:57 PM

[Jade Queen:]

MIT economist Yasheng Huang has a fairly unique analysis of the Chinese economy, stretching from the 70's and processed with the usual intricate and unusual MIT data sets. How he managed to get the information must be a story in itself. I wonder if he is allowed back in.

I would be interested to hear what others think of his ideas. He's easy to search.

What I conclude from reading reviews of his work is that joint ventures end up having enough cachet in China to not get busted and looted with their founders disappeared.

If an individual peasant does well with a food product, he is going to get plundered unless he makes himself into a joint venture before he gets whacked.

I'm wondering how to make a hooky phrase out of this pattern.

How about something like, "Get your material and intangible off-shore capital before you need it!" I know that's not very good, but the challenge is out there. I'd love to hear some other ones.

This is likely a pattern in most places. Being honored in a foreign land is a way to get enough cachet to make bubba think twice before whacking you.

Lest anyone think I am saying this is different in the U.S. from China, I am not. Just take a look at incarceration rates. If you are not wealthy and connected in the U.S., you can easily disappear. If you have made friends with people whose credibility exists in official spheres and preferably off-shore as well, you probably won't disappear forever, but you can advance the return on equity of somebody in the meantime, now that we have private prisons and strong prison unions.

The story of Katherine Austin Fitts is instructive in this regard.

I am not selling out everything Chinese since I read of Yasheng Huang's analysis, but I am feeling far more cautious about China now than I did before.

Aug 06 06:32 PM

[slick5050:]

Pure bubble in China, thing is, when / how will it pop? Will the corrupt infrastructure spending on bridges that go to no where, or where funds are inefficiently allocated to failing companies result in another massive bank loan wipe out? Even if it does, the last time this occurred showed China was relatively immune - the wheels kept turning and the GDP kept pumping up. The true derailer for China will be social unreast through widespread unemployment, rampant inflation. This will be a social depression, not an economic one that pops this bubble.

Aug 06 08:26 PM

[captainjohann:]

Hi,
What about Climate change BUBBLE which USA/China re creating with active support from Gore and Obama and US bankers?
The latest joint economic/strategic talks is creating this bubble along with control of water and seeds.

Aug 07 02:05 AM

[Jeff:]

Wish Al Gores movie came out earlier, before the glaciers melted in Michigan 17,000 years ago. Such a sad story.

Aug 07 02:39 AM

[Rant and Rave:]

"China, a dragon best left asleep"
... Napoleon

Aug 07 08:11 AM

[Conrad de A...:]

Any talk of China being in a bubble is in the context of a tremendous long-term growth story. What few are considering is that demographic factors will cause China’s economy to decelerate for many years, producing very weak performance in its stock market, a la Japan. That prospect is discussed here:

moneywatch.bnet.com/in...;blog-river

Aug 07 01:07 PM