Global gloom provides a silver (and gold) lining

Before the first week of the new year was in the books, the Chinese stock market lost more than 14 percent and triggered circuit breakers that have led to the shortest trading day in the stock market’s 25-year history.

As far as stocks are concerned, the Chinese market made huge gains — up over 100 percent — from early 2014 into early 2015. Then we had the selloff in the summer and the market came back again. Given the massive gains, it’s not surprising that there’s going to be a significant correction, circuit breakers or not.

The circuit breakers, which kick in if the market falls 7 percent during trading, will only slow the correction, not alleviate it. A 30 percent correction in the Chinese market still leaves it up 70 percent over the past two years.

The real issues aren’t Chinese stocks. These are the three main issues as I see them:

  1. The massive devaluation of the Chinese yuan against the dollar.
  2. The effect this is going to have on Chinese dependent companies like Apple that are over represented in all U.S. financial indexes.
  3. The ultimate reckoning this will all have in the energy and transport sectors in the U.S., which will certainly send the financial sector reeling.

Each of these deserves its own space, so here I will talk broadly about the implications of this entire three-part scenario playing out before I drill down into each part.

A cheaper yuan

Here’s how the transmission mechanism works: The Chinese have begun to devalue the yuan against the dollar. That announcement from the Chinese central bank on Thursday is what set off the second massive selloff on the week.

The implications are that the Chinese economy is weaker than it appears and the move is to stimulate growth; and that Chinese businesses and citizens are now holding money that is worth less every day and most can do little about it because the yuan is not yet an openly traded currency.

The U.S. stock connection

What that also means is companies like Apple (NASDAQ: AAPL) and Qualcomm (NASDAQ: QCOM) and GM (NYSE: GM) and everyone else looking to China as their main engine of growth are going to earn less money in China on the goods they sell, which will hurt earnings for the company as a whole. Plus, a weaker Chinese economy means less spending and economic expansion.

The slower economic expansion means less need for energy and commodities. That’s why oil is down to 12-year lows again and dropping.

U.S. energy and banking problems

This will be another blow to the U.S. energy sector, which needs higher prices than most of its global competition to produce oil profitably. And one area where we can see the problem clearly is in rail transportation numbers, since much of the oil from U.S. shale fields is moved by rail.

Bank of America analyst Ken Hoexter has found that rail loads have fallen 5 percent year over year for 11 successive weeks, something not seen since 2009.

And the the largest drops by sector: coal, metals and ores, and oil, which are all down by at least 26 percent year over year.

This is why the Dow Jones Transportation Index was off 20 percent in 2015 even with record low energy prices. If you’re not moving goods, it doesn’t matter how cheap the fuel is.

The other shoe to drop here is when the banks have to cover the losses of the U.S. energy companies that go under. The banks have underwritten loans, junk bonds and any manner of investment vehicles into this sector of the years and now they’re as exposed as they were during the mortgage debacle eight years ago.

And in all this doom and gloom: One piece of good news is that gold hit a nine-week high this morning.

The coming hard assets rally

The flight to safety is on and gold should see a very good 2016. And as I’ve discussed in previous articles, silver is a leveraged play on the return to hard assets.

Given the fact that the Chinese prefer hard assets and that most individuals can’t trade in the foreign exchange market, there will be a significant increase in gold demand in coming days and weeks.

Find a good dealer (like and pick up bullion, non-investment grade coins that more closely track the real price of gold and silver, or closed-end funds like Sprott Physical Gold Trust (NYSE: PHYS) or the Sprott Physical Silver Trust (NYSE: PSLV).

–GS Early



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