China "Gold Mania" on Property Bust
Saturday, 6/07/2014 10:53
Gold is already a key asset in China. The property bust only adds to that...
IN THE EYES of Chinese investors, property is transforming from a wealth creator to a wealth destroyer,
writes Dan Amoss in The Daily Reckoning.
Western investors ignore this transformation at their peril. The bursting of China's real estate bubble has huge implications for the global monetary system.
Most areas of China feature a glut of property. Speculators were the driving force behind demand. Now they're watching the smart money sell, and they'll flee the market as prices gain downside momentum.
Momentum works on the downside, too – only two or three times faster. Like the crazy software stocks that fell 50% from March to May, empty Chinese properties, yielding no rental income, could fall very rapidly.
The smart money is already bailing out; a high-profile Chinese tycoon just compared China's property market to the Titanic.
"I think China's property market is like the Titanic and it will soon hit an iceberg in front of it," said Pan Shiyi at a financial forum last Friday. "After hitting the iceberg, the risks will not only be in the real estate sector. The bigger risk will be in the financial sector."
Pan Shiyi is chairman of Soho China Ltd., one of the largest China-based, Hong Kong-listed property developers. Mr. Pan believes there are serious problems in the shadow-banking sector.
Here's the key quote from Mr. Pan, who was unaware that there were media members in the audience: "When housing prices fall 20-30%, these problems will be all exposed."
Once the dormant credit market stresses are exposed, China will face a deflationary crisis that it's never before experienced. In response to the 2008 financial crisis, China ordered state-controlled banks to dramatically expand lending. But that sort of reflationary response has gone as far as it can; total banking assets in China amount to an alarming $26 trillion – more than a third of global GDP.
Moreover, a rising percentage of China's $26 trillion in bank assets are going bad. Jim Grant explains in
Grant's Interest Rate Observer:
"In addition to being perennially short of capital – one of the consequences of breakneck lending – Chinese banks are caught in a cycle of self-defeating forbearance. If, for instance, a real estate developer can't meet a scheduled interest payment, chances are that the obliging lender will not write down, let alone write off, the debt. It will rather add the unpaid interest to the outstanding principal. A favorite banker's gambit is to restructure commercial loans as short-term interbank assets, the latter requiring less regulatory capital than the former. An authority with whom [Grant's analyst Evan Lorenz] consulted, and who asks to go unnamed, estimates that between 50-60% of banking assets are annually refinanced or reissued [emphasis added]."
That's an alarming estimate. Even if it's too high by a factor of two or three, it means China's banking system is deeply insolvent; it's turning Japanese. After its real estate market crashed in 1990, Japan failed to acknowledge and restructure bad loans and has suffered stagnation for the past 25 years. China could choose a similar path of procrastination...or rip the bandage off now and salvage some of the economic gains it has made.
Could China's leadership order the expansion of the shadow-banking sector? Besides the fact that the leadership can't control the demand for wealth management products, shadow banking has already grown to the point where investors are starting to doubt the return of their principal. It will be difficult for borrowers to find lenders willing to refinance outstanding shadow bank loans, let alone expand lending.
Here's how China will respond to its growing deflationary crisis: The Chinese central bank (the PBOC) will have no choice but to ease policy. China will likely follow Japan, the EU, the UK, Switzerland and the US down the path of massive quantitative easing. Its unprecedented growth in lending, which has led to surging nonperforming loans, will result in an accelerating demand for liquidity among Chinese savers and investors. The PBOC will have to allow the renminbi to devalue against the US Dollar so it can flood the banking system with the supply of liquidity that investors and savers will demand.
In the meantime, while the property market loses its luster, what asset class might draw more attention as a store of value?
Gold bullion is a natural, logical candidate. Besides land, gold is the oldest store of value in the history of civilization. And unlike land, gold is a mobile and liquid asset. China already has a cultural affinity for gold.
The Chinese government actually encourages the public to own gold. And the central bank is bound to dramatically ease policy. Easier policy would make cash deposits less attractive.
Without a clear catalyst to drive the move, gold prices took a hit this week. The gold bears' key talking point is as follows: "We are entering a self-sustaining economic recovery. Central banks, including the Fed, can hike interest rates and there will be no negative economic effects."
The immediate situation doesn't fit a bearish scenario for gold. Official measures of inflation remain stubbornly high, while sovereign bond yields fall. Real interest rates are falling, which reduces the opportunity cost for holding gold. Plus, the European Central Bank (ECB) is widely expected to unleash another easing cycle next week.
Over the long term, central banks will feel compelled to maintain easy policy because the stock of total debt has reached an unstable level. And the Federal Reserve will stick to its tightening narrative while China debases its currency to bail out its banking system. Other central banks will print and ease policy, too. No country seems to want a strong currency.
If the Chinese property market is the Titanic of today's global financial system, then gold is an ignored yet inviting lifeboat.
In an interview with
The Gold Report, Franco-Nevada (NYSE:FNV) Chairman Pierre Lassonde discusses gold investing in today's depressed environment. As a director of the World Gold Council, Lassonde is very familiar with the supply-and-demand factors driving the gold price.
Of all the executives in the gold sector, Lassonde's track record of creating wealth is unparalleled. He's earned the reputation as an expert on the gold market, and predicts that Chinese speculators will eventually drive gold prices much higher.
This interview gives
Lassonde's view of China's gold appetite, and is worth reading in its entirety. Lassonde predicts a speculative mania on the Shanghai Gold Exchange. And despite the fact that Western investors see no need to own gold, the Chinese desire to own it today.
As Chinese QE proceeds, the desire to own gold will increase.
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