(Aug 19): The release of three apparently disparate pieces of information last week combine to provide a better picture of China’s position in US President Donald Trump’s ongoing and erratic trade, tariff and currency war with China. Each piece of information offers a new set of opportunities for investors and for adjustment to portfolio settings.
Gold has been on an extended rally for the past few weeks and even some gold bugs are beginning to wonder about the sustainability of this trend. The classic interpretation of this uptrend is that it reflects a shift in risk analysis — a flight to safety in the face of competitive currency adjustments and weakening stock markets. It is primarily seen as a Western-driven process and, to some extent, this is certainly true. Exchange-traded gold funds are the seventh-largest holders of gold after six sovereign nations. Increasingly, the price of gold is supported by these funds buying and selling at the behest of individual investors who hold them.
Which begs the question: What drives this demand?
A significant part of the answer comes from the activity of the People’s Bank of China. The central bank expanded gold reserves again in July, raising holdings to 62.26 million ounces from 61.94 million ounces a month earlier, according to data on its website. The July inflow was about 10 tonnes. This follows the addition of 84 tonnes in the seven months to June.
China demand is likely to increase as currency instability ramps up, and that is an opportunity for gold bugs to remain long.
Despite Trump’s attempts to isolate the Chinese economy, other strong forces are pressing for greater inclusion and integration into world capital markets. The MSCI will raise the inclusion factor of all large-cap China A shares in the MSCI indices from the current 10% to 15%, effective after market close on Aug 27.
The China International Capital Corp estimates that lifting the inclusion factor by 5% adds US$22.7 billion ($31.5 billion) to the market. The -changes bring the weighting of China A shares in the MSCI China Index and MSCI Emerging Markets Index to 7.79% and 2.46% respectively. The next 5% step-up is scheduled for November and may include China’s new science and technology innovation board.
These changes add institutional investment stability to the Shanghai Index and make direct personal investment more attractive. The changes also implicitly reject the view that Trump’s rampages will inflict significant damage on the growth of the Chinese economy.
The release of export figures supports this view. Chinese exports rose in July, growing 3.3% y-o-y, following a 1.3% decline in June. Exports to the US fell 6.5%, resulting in a $27.97 billion trade surplus because imports of US goods fell 19% in July from a year ago.
July’s export growth reflects the fact that exports to the US make up a relatively small portion of China’s trade. Trading relations with other countries have become more significant. The rising trend in China’s exports to non-US markets is acting as a cushion and is a classic example of market substitution. China’s Belt and Road Initiative is first and foremost a trade and market policy rather than an infrastructure build or security threat.
Investment in markets, suppliers and business outside of the US-China link are becoming more attractive at a time when China-reliant business in the US, such as Walmart, are under greater threat as Trump escalates the trade war.
Technical outlook for the Shanghai market
The Shanghai Index has recovered rapidly from the external shock delivered by Trump’s most recent Twitter broadside, but then succumbed to the broader market fear about bond yields that drove down the Dow Jones Industrial Average. The recovery is quite strong, but proof of its sustainability will come as it moves above the resistance features. The downtrend has not ended but its momentum has been reduced. The recent rally is unlikely to develop immediately into a new uptrend, but it can be part of a longer-term uptrend recovery.
There are four key resistance areas. The first is the value of downtrend line A. The breakout above this trend line is a little weak. The index breakout is a down day, with the close lower than the open. This does not show good strength in the breakout, so there is a good probability that this downtrend line will act as a support level. This is actually bullish because the index can use this as a support level base for a new rally rebound to attack the next resistance feature.
The second resistance feature is the value of the lower edge of the trading band near 2,830. This has been a strong support level previously, so a breakout above this level is strongly bullish.
The third resistance feature is near the 2,830 level. This is the value of the upper edge of the short-term group of averages. A strong rally is confirmed when the index moves above the upper edge of the short-term Guppy Multiple Moving Average, and the short-term GMMA also compresses and turns upwards. This would show strong trader support for a rally recovery.
The fourth resistance feature is the value of the lower edge of the long-term GMMA currently near 2,870. The usual behaviour of a rally breakout is to test the lower edge of the long-term GMMA and then retreat prior to another rally challenge that lifts the index into or above the value of the upper edge of the long-term GMMA.
It is too early to know whethere the recent rally will continue and how it will develop and whether it will have the strength to push strongly above 2,830. However, these are the critical points that traders are watching.
Failure of the rally and a sustained retreat below the value of trend line A creates a bearish outlook. The width of the trading band in the Shanghai Index is projected downwards and sets a target near 2,630. The historical support and resistance level is near 2,650. This suggests that the first downside support for any continued fall in the Shanghai Index is the area between 2,630 and 2,650.
Daryl Guppy is an international financial technical analysis expert and special consultant to AxiCorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for more than a decade. Guppy appears regularly on CNBC Asia and is known as ‘The Chart Man’. He is a national board member of the Australia China Business Council.
