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Black cygnet

Commentaries & Views

It’s not just beer anymore.  Corona stole the headlines, and that’s saying something for a month that included impeachment trials, almost war in the Mideast and (!) locusts. 

But liquidity uber alles. Even in the face of all the real and potential bad news, markets fared pretty well.  Traders continued to BTFD and to treat interlopers who wondered if stock markets occasionally go down with (barely) tolerant amusement. 

Let’s hope the fun continues.  I think it probably will, but coronavirus, in particular, looks like something that could derail things.  I think it’s already sure to have many negative impacts throughout Asia, especially China. And this isn’t your fathers China.  Big impacts there WILL be felt across the world’s economic landscape.  Let’s hope the virus itself stays mainly contained within the Middle Kingdom, and that they find a way to kill it, and quick.

Gold had a couple of thrusts higher. It’s consolidating a bit now, which is fine.  I think there are still many higher highs ahead of it and that we should position accordingly.

The January MIF was a massive success, the busiest ever.  I think it’s possible the next one, right ahead of PDAC in Toronto, might top it though.  RSVP while there are seats open.  We had to close the list for Vancouver and may have to again for Toronto.


  Eric Coffin

“May you live in interesting times.”

The quote above is, of course, Chinese and is also, of course, intended as a curse, not a blessing. It tells you a lot about China, a country with 5000 years of history.  The Chinese have had more than their share of war and disruption.  Interesting times don’t necessarily equate to good times. Usually, it’s quite the opposite.

China is going through one of those interesting times now.  Its too early to say how serious the Wuhan Coronavirus outbreak will be.  But it doesn't look good.  This could easily become a deadly problem even outside the borders of China, though its isn’t yet.  Right now, for western markets at least, it’s a “baby black swan”.  The pullback you can see in the S&P500 chart below isn’t too scary.  It hasn’t even breached the 50-day moving average, something it did three times in just the last year.  It’s early days though.

It’s early days for all of this and the fact that China was slow off the mark with both reporting and quarantine isn’t helping.  I’ve seen scores of market commentators childing others for sowing panic.  They’re drawing comparisons to SARS and Swine Flu.  In the case of both those viruses there was plenty of early stage melodrama and short-term market impacts that quickly petered out.  Basically, we’re being told to BTFD, and many are.  Those bullish cynics may be right at the end of the day but its too early to assume it. 

The chart below is already a couple of days out of date, but helps get across the point that, in terms of speed of spread this virus shouldn’t be shrugged off. Note that this a log scale chart.  Confirmed cases of Coronavirus, in a couple of weeks, already exceed the ultimate total for SARS and, at the current rate of 2000/day, will pass the ultimate total for Swine Flu by mid-February. (Confirmed cases are 17.2k on February2, 2020)

It’s already clear that The Wuhan virus is travelling faster.  We don’t have an accurate estimate for the N-0 value, the number of new cases created by each existing case. That will define the speed of spread.  We also don’t know the mortality rate, though the current guess is in the 2-3% range.  That’s bad, but how bad really depends on the ultimate number of cases before it either burns itself out or we get a vaccine.

There have been plenty of commentators pointing out that the “common” flu kills about 10,000 people in the US per year.  That’s a valid point. But it ignored the mortality rate, which is what’s spooking medical professionals.  The common flu infects millions (at least) in the US every year.  It’s mortality rate is about 0.04% on average. The best early estimates of the mortality rate for Wuhan are 50 times higher.  Still not “really” high—as long as it’s not spreading too fast.

Speed of spread is unknown for Wuhan and will probably stay that way until there are at least several weeks of statistics outside China.  It’s known now that China started reporting late.  That messes up the statistics.  There are also unconfirmed stories that the medical system in and around Wuhan is limited to +/-2000 test kits per day because of supply issues. We don’t know if that’s true but it’s worth noting that the last 3-4 days increases are all suspiciously close to that 2000 number.  That doesn’t make sense for a number that should be a geometric progression. 

There are also many stories and videos being leaked from Wuhan, purporting to be from medical professionals, that claim the true number of infected patients is several times the reported total.  There’s simply no way to know what’s really happening over there.  That’s why watching what happened outside China is so important. The good news there is that most countries got onto the task of isolating patients much faster.

The chart above shows the effects of the SARS virus on retail sales and industrial production in China during the 2003 outbreak. There was a real impact, but it was relatively mild and short lived.  It would be nice to think we’ll see a repeat this year with Wuhan.  That’s the bullish argument but, frankly, it already feels a bit naïve.

One example of why I think that is the copper price.  The chart below shows the percentage changes in the copper price after the SARS outbreak in 2003 and the current Wuhan outbreak.  Copper only dropped 5% during the SARS outbreak and recovered quickly.  So far this time, copper is off 11% and is showing little sign of stabilizing yet.

The drop may be exacerbated by New Years closure of the Shanghai Metals Exchange, but that’s only part of the story. In 2003 China was growing much faster than today, even before the virus outbreak.  And its much more indebted now.  I have no doubt the Bank of China will try and flood its markets with liquidity.  I just don’t know if there will be as much multiplier effect this time.  

We’ve already seen quarantine and travel restrictions imposed on a vast scale compared to 2003.  Its very likely both the size of the quarantine area and the length of the closures will increase.  New flight restrictions and business and school closures are still being announced daily.

Keep in mind too that that China’s share of the world economy is about four times higher than it was in 2003.  The outside impacts will be a lot bigger.  The Chinese are among the world’s biggest spending tourists now.  150 million Chinese travel overseas each year.  You can toss that spending out the window until it looks like the Wuhan flu has cleared up.  That’s real money.

Of course, China’s importance to metals and mining is far larger than its tourism impact.   I sent out an SD Alert a week ago urging caution when if comes to base metals and patience in waiting for bottoms.  I didn’t love doing that, but the table below shows you why I felt compelled to. 

It shows China’s share of world consumption of several metals, bulk materials and manufactured products, compared to 2003. For most major metals, and for iron ore, steel and coal, China IS the market.  Any major, extended, dislocation in China demand hits metals hard.

The downward move in copper in the chart on the previous page may be an over reaction.  We’ll know better over the next few weeks and months.  But, viewed in the context of China’s dominant position in the demand side, the reaction so far by metals prices isn’t surprising.  My view expressed in the SD Alert hasn’t changed.  At some point, maybe soon, there will be a great buying opportunity in base metals. But we should wait for a bottom, not try to get ahead of one.

As you can see from the bottom of the list, a big pullback in China won’t do tech and industrial products any favors either, but more of that demand is supplied by domestic companies.  The impact in those sectors may be less visible in western markets, though there will be impact.
 At this point, this is all conjecture.  I don’t want to sound like I’m “crying wolf”.  This is a fast-moving situation though.  Ignoring it could lead to a lot of portfolio damage, not to mention human misery. 

Governments worldwide are working hard to assure everyone things will be fine.  Plenty of comparison are being made to the annual flu epidemic which routinely kills thousands with little fanfare and certainly no panic.  That’s all true.  This may prove to be a tempest in a teapot like so many market scares before it.

That said, in situations like this I prefer to “watch not what they say, but what they do.” For governments that keep telling us to stay calm, they’re not acting too calm themselves. The level of action, size of the population quarantined, and travel and border restrictions are, literally, unprecedented.

As noted above, I think the number of cases outside China will be the most important determinant of ultimate market reaction and economic impact.  I think the short-term impact on China’s economy is large. That’s baked in the cake at this point. Knock on effects elsewhere will depend on whether this virus is taking hold overseas.  So far, the number of ex-China cases is low and growing slowly.  There isn’t a lot of evidence, yet, that there has been much transmission outside of travellers returning from Wuhan.  If that doesn’t change, I expect markets will calm down.  Western governments have gotten onto this fairly fast. They are only dealing with a couple hundred cases worldwide.

If, and its still a big if, transmission rates outside China are the same as within, we’ll know in a week or two.  If we see confirmed cases outside China at 1k, then 2k, then 4k in the space of a few weeks, all bets are off, but there’s no evidence of that yet. 

For now, we need to stay alert and watch developments.  Some markets have already priced in a big impact and we could see near term bounces in some areas. Those bounces will only hold if things don’t get worse, however. 

Beijing has made it clear it’s going to throw everything, and the kitchen sink, at the market to try and retain calm.  Overseas futures were trading several percent blow the last close, but I wouldn’t put it past Beijing to step in and buy if it thinks things are turning fast enough.

The Bank of China injected $175 billion in liquidity into the system on day one. Short selling is banned for an undetermined period. I don’t think banning short selling ultimately helps much but it shows Beijing isn’t kidding around.

Xi sees the potential for his legacy to be Corona virus, not economic growth and stability.  He’s not having that.  Don’t be surprised if we a massive spending/stimulus/infrastructure program announced once the worst appears over with the virus.  That’s another reason I think we could see a great bounce and trading opportunity in base metals once the virus subsides.

Things look brighter for the gold and silver markets.  The gold below is a thing of beauty.  A lot of the recent buying was fear induced, which I don’t like, but we take the market we’re given. Gold will settle back as soon as virus fears calm, then we’re back to bond yields, currency and Wall St determining price.

The last Journal editorial was a long walk though my argument that we could see a long decline in the US Dollar.  I also noted that the move could be derailed at times by USD “fear buying”.  We’ve seen lots of that in the past couple of weeks, as the USD chart in the middle of the previous page shows. 

The USD rallied on uncertainty.  That didn’t hamper the gold price at first.  Gold too was helped by fear buying not only of gold but of bonds. The chart below shows the real 10-year yield.  It fell back into negative territory as yields approached October lows.  A large chunk of the US yield curve has inverted again. 

Negative real yields are as good a predictor of higher gold prices as the level of the USD, some would say even better. I still think we’ve got even higher gold prices coming, though the markets view of the coronavirus will make for plenty of short-term swings, both ways.

Continued massive liquidity injections—with China now in on the act—and the general market euphoria means Wall St will keep gaining unless a day’s headlines are terrible.  Things are already at, if not beyond, the stage of dangerous speculative excess across several sectors.  As Keynes was fond of saying however ‘the market can stay irrational longer than you can stay solvent’.

I’m not suggesting we should all go short the S&P.  The same positive factors for gold are also positive factors for equities.  Indeed, a continuation of the Wall St rally will be downward pressure on gold, even with other positive factors going for it.

Whatever you want to blame it on, high demand for bonds means that the US yield curve has inverted for the second time in a year.  Many consider it a meaningless signal, and one that tends to crop up well in advance of an economic slowdown.  That’s true, but its also one of the most reliable advanced signals of a coming recession, regardless of why it happens.

We’re now about eight months from the start of last year’s curve inversion, and the lead time in the past averaged eight months.  There are few signs of weakness in the US economy, but the change in US Leading Indicators has gone negative for the first time since 2009 and advance employment indicators are also flattening.  I don’t think the party’s over, yet, but we might be getting “last call” soon.

I hope the market’s quick calming about coronavirus is right, mainly because of the human misery its causing.  Don’t start ignoring the issue though, not until we’ve clearly turned the corner or there is a vaccine.  Don’t underestimate how much damage a longer slowdown in Asia can wreak.  It’s a big part of the world now.  If Asia gets the flu, the rest of us are going to have an allergic reaction, at a minimum.

So far, the damage is contained to China, though its still spreading.  Its still just a black cygnet.  Keep in mind though, that black swans are defined as much by the market backdrop they occur in as their independent size.  An event that passes with little market damage early in a market cycle can be the swan that breaks the bull’s back near the peak of the cycle.  I don’t think there’s any doubt which end of the cycle we’re near right now. That’s what makes coronavirus, or African locusts or anything else so dangerous.  Don’t feed the swans and don’t lose your gold exposure.

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