Gold, China Tell Deflating Tale

12/13/2011 11:46 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Shanghai stocks are back to where they were in March 2009 and bullion has lagged for months, suggesting governments have done too little to offset private thrift, writes MoneyShow.com senior editor Igor Greenwald.

This isn’t just about Italian bond yields anymore. Sure Italy’s in trouble, trapped in a flawed currency union and slowly squeezed by disastrously misguided foreign masters.

But Italy is something of a known problem, its looming recession as predictable as its plans to sell €440 billion in bonds and bills next year.

Meanwhile, China’s near-term outlook is looking dicier by the day, and it’s much more crucial than Italy’s. China’s real-estate bubble has begun to deflate, and its investment splurge looks equally unsustainable.

The Shanghai stock market is down 26% from its April peak, back to where it was in March 2009. Investors fear the government isn’t moving fast enough to relax credit and property curbs; last month’s glimmer of hope on this score seems to have faded.

India’s economy also seems to be slowing, with industrial output down sharply even as inflation and deficits remain elevated.

With Europe mired in austerity and China starting to experience a real-estate bust and related credit problems, deflationary forces have the upper hand across Eurasia.

This comes as no surprise to Nomura economist Richard Koo, who argues persuasively that growth in this balance-sheet recession will continue to disappoint so long as governments fail to offset increased private saving. Bank of Canada governor Mark Carney has been reading from the same depressing script, though his suggested fixes are less radical.

No wonder the commodity complex has been following Chinese stocks lower (the latter finally broke through that key support overnight, while metals are holding on for the moment.)

Gold’s chart looks especially telling. The precious metal hasn’t provided a safe harbor for months, etching a series of lower lows while underperforming equities.

Gold’s fans among the Chinese and Indian investors, as well as Western hedge funds, have suffered serious reverses in other assets over recent months, notes Michael Shaoul, CEO of Wall Street broker Oscar Gruss. Their enthusiasm for buying more seems likely to be tested in the coming days and months.

Earlier this year, Jim Grant of Grant’s Interest Rate Observer described gold as the inverse of people’s trust in fiat currencies, a bet that governments will do anything and print whatever it takes to prop up growth. With cynicism at record highs and overseas economies slowing, gold should be sitting pretty.

The fact that it’s lagging suggests that governments have been more timid than the cynics imagined.

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