Can China Engineer a Soft Landing?

• Posted by Robert Sinn
• on July 9th, 2012

While most market participants have been focused on the eurozone debt crisis and a slowing US economic recovery, China’s rapidly decelerating economy has arguably had more market impact during 2012 than the former two. Early in the year (January/February) there were some rumblings about drastically reduced energy usage in China and a widening gap between the HSBC PMIs and the official government PMIs:

Click to enlarge (h/t @M_McDonough)

As it turned out February was an important inflection point for markets as the Chinese yuan halted its appreciation against the US dollar, and China related equity market sectors have significantly underperformed sectors with little China exposure:

 

 

$GDXJ/$KOL/$IYR/$QQQ/$XLE/$XLE since early February

After the latest batch of Chinese economic data it is clear that the Chinese economy is slowing rapidly and there is even some talk of a “deflation threat” ( see also “China heads for a deflationary shock”) hitting the mainstream press. We do know for certain that China is committed to further policy easing and it is reasonable to assume that China’s central planners will stop at nothing to prevent deflation or even inflation that is too low by their standards. Therefore, how do investors play a heavy dose of additional policy easing in the face of a troubled Chinese economy?

It seems to me that the scale and success of China’s easing (as well as other global central banks) will be effectively judged in real time by gold prices and US treasury yields. Buying $GLD straddles is one way to express a view that either global central banks will be able to stave off the deflationary vortex or become decisively sucked into it – gold could easily make a +/- $100 move over the next 6 weeks depending upon market perceptions of central bank actions. The options market is currently pricing in a $70 move by August 18th and a $100 move by September 22nd. The GLD options market appears to be reasonably priced but perhaps slightly on the cheap side particularly when one examines the tightening coil on the weekly gold chart and the potential for a breakdown from a descending triangle or breakout above the 50-week SMA and the downtrend line off the August 2011/February 2012 highs:

 

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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