The Chinese Panda (bear)

The Chinese cash crunch took centre stage yesterday, Shanghai ended up with two black eyes (down 5.3%) and officially entered a bear market.

The dragon economy now resembles a panda. It has been over a decade since China has experienced a cash squeeze like this. Shadow banking and small institutions are the ones most hit by the squeeze as they have the highest reliance on interbank funding. The higher the shibor rate, the faster net interest margins are squeezed for these firms and that causes a bottle neck effect.

Moody estimates that mid-sized banks and credit unions in China get approximately 23% of their funding from the shibor market compared with the big state-owned bank at 9%, this means competition is strong for deposits, and the cost of funding follows right behind.

There is a slight misunderstanding right now with shadow banking - it is not a bad thing and it exists everywhere. In Australia for example credit unions and building societies can be classified as shadow banking. What the central government is trying to do with mid-tier and shadow banking firms is reign in ‘over’ leverage. Moody’s see this as a net long term positive as it will help with sovereign and individual credit ratings and will deleverage China from a possible credit crunch similar to that seen in the GFC.

In the short term however, pain is almost a guarantee because  mid-tier bank lending is the life blood of the Chinese economy. Their major clients are small to medium enterprise. These clients are the ones heavily involved in the manufacturing of consumer goods, mid-sized construction and low-end refinement the major driver of the export economy.

Once this bottle neck is cleared and deleverage is complete, China will roar back into life with a lower risk level. However, unfortunately this will not happen overnight and the Chinese panda is set to continue in the interim.

Moving to the commodities space, gold came under even more pressure overnight with US treasuries hitting positive real rates. This is a massive nail in the coffin for the gold price. The whole idea of gold is a store of value, if a ‘no risk’ asset like US treasuries are offering investors a store of value and a real return there is only one place funds will flow too.

This heaps even more pressure on already beaten up gold miners. Overnight PRU dropped 13% on the TSX, as it cut its gold production forecasts and sees costs increasing which has been the double strike in the gold mining space - you only have to look at NCM which has announced a similar issue. NCM itself cannot escape the market stoplight; it is set to announce 150 jobs to be lost at Lihir as it too lost 7.5% in Toronto last night as it tries to cut costs.     

Ahead of the open today, we are calling the ASX 200 down 33 points to 4636 (-0.71%). This will mean the ASX will have given back all of the year-to-date gains, having opened the year at 4649. The question we are being asked right now is; where will it stop?

This is a very tough question in the current market. China, our largest trading partner, is current experiencing a structural change to its banking system which is causing instability. While our biggest lead market in the US is throwing a hissy fit after being told its liquidity pacifier could be taken away, making predicting the floor very hard.

BHP yesterday was under immense pressure as short selling hit the stock and today looks like being no different with BHP’s ADR suggesting the security will lose a further 37 cents (-1.18%) down to $30.98 as it heads towards its year-to-date low.  So brace yourself for a very rocky ride down the rabbit hole.

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