June 16, 2014 4:00 pm

The paradox of China’s push to build a global currency

Acceptance into global free markets needs liberalisation, writes James Kynge

Chinese Renminbi notes©Getty

We hate you guys.” This was how Luo Ping, a senior official at the China Banking Regulatory Commission, vented his frustration at the US in 2009. He and others in China believed that, as the US Federal Reserve printed money to resuscitate American demand, the value of China’s vast US Treasury bond holdings would plunge along with the dollar.

Once you start issuing $1tn-$2tn . . . we know the dollar is going to depreciate so we hate you guys – but there is nothing much we can do,” Mr Luo told a New York audience.

These frustrations have been catalysts of great change. The authoritarian rulers of 1.3bn people felt an imperative to reassert control. Imbued with the resentful narrative of a “century of national humiliation”, they felt the prospect of the US squandering Chinese wealth was an indignity too far. In response, Beijing decided to hasten the promotion of the renminbi as a global currency. That way China’s exporters could earn redbacks” rather than greenbacks, allowing their revenues to be invested at home rather than recycled into US Treasuries – the only pool of dollar liquidity big and safe enough to absorb significant investments from China’s reserves (which rose to $3.95tn at the end of March).

Therefore, the genesis of renminbi internationalisation, which will be a key theme during the UK visit this week of Prime Minister Li Keqiang, is indivisible from China’s aspiration to blaze its own trail rather than integrate into a Pax Americana in whose creation it had no say.

The scheme is showing signs of success. Financial capitals are competing for a slice of the fast-growing market in offshore renminbi. London plans to underline its credentials by designating China Construction Bank as a clearing bank for the currency. This should make trading in renminbi more efficient, more liquid and less risky. It could also attract Chinese companies keen to invest in Europe, and make it easier for investors to enter China’s capital markets.

The use of renminbi as a global payments currency is growing rapidly, though from a small base. In April it was the seventh most used currency, with 1.4 per cent of transfers, up from 0.6 per cent in January 2013, according to Swift, the international payments company. In the US the redback is also gaining a following, with the value of renminbi payments between the US and the rest of the world rising 327 per cent in April, compared with the value in April 2013.

At times, adopting the renminbi is portrayed as a snub to the US. Russian politicians have called for a “de-dollarisation” of their economy after sanctions imposed by the US and EU in response to Moscow’s annexation of Ukraine’s Crimea.

Such are the easy wins. Creating a genuine world currency will be much harder, rubbing up against the central paradox of China’s emergence: its political system relies on control while acceptance into global free markets needs liberalisation.

Institutions that hold renminbi have precious little scope to invest them. China has opened only tiny apertures for foreign investors in its domestic capital markets, promoting instead an offshore renminbi capital market that is as yet minuscule in comparison with its US dollar counterpart.

Jonathan Anderson, economist at the Emerging Advisors Group, estimates that in mid-2013 total capital market assets freely available to international investors in US dollars were worth $55tn; in euros, $29tn; in yen, $17tn; and, in sterling, $9tn. The renminbi offered a mere $250bn. “That is about 0.1 per cent of the global market, putting the renminbi on a par with the Philippine peso and just a bit higher than the Peruvian nuevo sol,” Mr Anderson wrote.

Of course, Beijing could throw open its capital markets but doing so might leave it at the mercy of the type of capital outflow that precipitated the Asian financial crisis in the late 1990s. It would also require the opening up of its state-owned banks, local government bond issuers and state companies to scrutiny from foreign investors.

So reasserting one form of control would entail sacrificing another: winning a measure of freedom from the “dollar zone” and the concurrent influence of the Fed would imply inviting in the oversight of global capitalism, the rules of which were written under Pax Americana.

Copyright The Financial Times Limited 2014.

Getting Technical

Gold Stocks Poised to Build on Gains

After a few false starts this year, the technicals have finally lined up to suggest the time is right to nibble.

By Michael Kahn

June 18, 2014 5:23 p.m. ET

Although gold is still languishing below the $1,300 mark, gold stocks are giving hope to long-suffering bulls. In fact, technical signs in many places suggest that a decent rally is now in the cards.

To be sure, there is plenty of work left to do before we can even think that gold and gold stocks are heading back up to their 2011 levels. But even so, there is plenty of room for growth before the comeback runs into serious resistance.

Back in April, the Market Vectors Gold Miners exchange-traded fund seemed to stabilize, and I wrote here that "…the technical evidence for a new bull market is not yet there. It does appear to be getting close, however." (See "Getting Technical, "Gold and Silver Are Almost Ready to Rally," April 28.)

At the time, sentiment was extremely bearish. When the ETF broke down through chart support in May it became extreme. It was as if everybody expected the market's bottom to drop out. Calls for gold to tumble seemed to be everywhere. Indeed, withdrawals from the popular SPDR Gold Trust ETF continue even now at a rather fast clip as demand diminishes.

But to a contrarian technical analyst, this is bullish. If most investors think gold prices are heading lower and sell their positions, then there will be no sellers left. Supply dries up, and any spark can get the market moving higher.

The gold miners ETF has already started to make that move. After dropping sharply in mid-May as gold broke down, it immediately stabilized (see Chart 1). In fact, on-balance volume began to rise, indicating that money was starting to flow back into the ETF. Within days, the May plunge was erased.

Chart 1

Market Vectors Gold Miners ETF

In Wednesday's trading, the ETF confirmed its rally by moving nicely above its 200-day moving average.

From a long-term perspective, we can see a developing bottoming pattern that some may interpret as an inverted, or upside-down, head-and-shoulders (see Chart 2). This pattern spans more than one year with its important lows occurring in June 2013 and December 2013 with last month's bottom likely being the final low.

Chart 2

Market Vectors Gold Miners ETF, Long Term

I am not so sure a head-and-shoulders is the proper label, but despite the semantics there are other pieces in place that suggest the bottom has been made. The most obvious is the shift in momentum to the bullish side. One indicator, the relative strength index (RSI), has been sporting higher lows over the past year

This tells us that the power in the market reverted to bullish hands. Price moves are somewhat stronger to the upside than to the downside.

We can also see the same pattern and characteristics in the Global X Silver Miners ETF to add even more confirmation to the mix.

Of course, not every stock in the group offers such good news. But from giant Goldcorp to the much smaller Iamgold there are plenty of candidates from which to choose.

As gold stocks are linked with gold itself, let's take a quick big-picture look at the gold ETF. Starting at the major low set in 2008, the ETF rallied to 2011 and then retraced roughly 62% of that gain at last year's lows (see Chart 3). Chart watchers will recognize this as an approximation of a 61.8% Fibonacci retracement and a level at which demand often re-emerges.

Chart 3

SPDR Gold Trust ETF

If we move further back in time, last year's lows also occurred at the 50% retracement of the rally from 2005. While that was not the lowest point of the prior bear market, it was the low that occurred just before the rally really got moving.

Finally, last year's lows were also at the measured downside target for the break of a large triangle pattern seen in 2011 and 2012. Projecting the height of a pattern down from the breakdown point often yields an objective for the bears.

With gold seemingly reaching a solid floor and gold stocks starting to make real technical progress, it does seem that now is a good time to take a nibble on the latter.

Again, the proof for a long-term bull market is not in place, and the gold miner ETF has a rather strong ceiling above in the $31 area (it closed Wednesday at $24.77). But the opportunity for profit in the short term seems real.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

Read This, Spike That

The Cloudy View of Stocks from 30,000 Feet

How useful are broad-based market stories? Is a P/E ratio of limited use?

By John Kimelman

June 16, 2014 6:00 p.m. ET

Broad-based articles about the stock market and the economy are usually hard to ignore

Because of their breadth and big-picture perspective, these articles tend to get great placement in both print publications and on Website homepages. And online editors know that broad stories tend to get more clicks than pieces about individual stocks.

But how helpful are they to investors? As you may have guessed, I think they have limited value at best. That's because most of these articles are based on information that the markets already know and thus already have factored in to the prices of securities.

What moves markets is the stuff that isn't in these articles. And most of those news nuggets, the best of which are tied to individual securities, are either not publicly known or known but underappreciated.

Another problem is that most of these market stories offer a mix of opposing views; a list of market "pros" that often match up nicely with the "cons."

The pieces that tread on the softest ground are the ones that suggest where stocks may be heading.

I was reminded of the limitations of broad-based market and economy stories when I read a collection of otherwise thoughtful pieces published Monday and over the weekend.

Robert Samuelson, the veteran business columnist with the Washington Post, wrote Sunday that "Stocks and bonds are sending mixed — and conceivably contradictory — signals" on the economic outlook.

"Stocks are routinely setting records, suggesting a recovery that's on track and strengthening. Meanwhile, interest rates on bonds have dropped," he added. "One possible interpretation is that bond investors expect the economy to weaken, pulling down interest rates and inflation in the process. Both messages can't logically be correct."

Despite this seeming contradiction, Samuelson argues that the surprise flight to bonds for safety and resulting lower yields doesn't necessary preclude consistent economic growth in the coming months

"Economic growth will average three percent or more through at least 2015, according to the median response of 47 forecasters surveyed by the National Association for Business Economics (NABE)," Samuelson writes. "Consumer spending, housing construction and business investment will expand. The unemployment rate, 6.3% in May, will drop to 5.8% by year-end 2015.

Samuelson adds that "Mark Zandi of Moody's Analytics doubts the bond market is warning of a weaker economy. Zandi instead argues that the low interest rates result from a recent proposal by the Federal Reserve requiring banks to hold more "liquid assets" as a way of defusing future financial crises.

In the end, Samuelson argues that "the stock market's optimism trumps the bond market's (possible) doubt. Or does it? Could the economy disappoint again?"

Though it raises interesting points, the story should have most investors scratching their heads.

Meanwhile, E.S. Browning, the Wall Street Journal's veteran markets writer, suggests that "money managers and analysts are beginning to talk about an idea that dates from the roaring '90s: a rapid stock gain known as a melt-up."
Browning defines a "melt up" as a sudden double-digit percentage rise that often follows months of positive stock returns. "In late 1999 and early 2000, the Nasdaq Composite Index surged to 5000 from 3000 amid the Internet frenzy. It then collapsed," he writes.

"Now, Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, is warning clients that the market could see 'an unhealthy, speculative increase in asset prices,' which would leave stocks and bonds both vulnerable to sharp declines," Browning writes.

But Browning concedes that such events rarely happen when people are worried about them. "It is when people forget their concerns and go for broke that markets get in trouble," he adds.

At the end of the day, what's a reader to conclude? Should one alter one's investment strategy based on the possibility of a "melt up?"

It's not having that effect on me.

I'll close this column with a critical look at the most widely used investment yardstick of fundamental analysis: the simple price-to-earnings ratio.

For decades, investors have used the relationship between a stock's price and either a year or trailing earnings, or a year of estimated "forward" earnings to help determine whether a stock is overvalued or undervalued.

But an article in the Financial Times quotes a recent study by BCA Research that makes a solid case against a simple P/E ratio.

"A company's equity is not just a claim on the next 12 months of earnings," according to the study. "It is a claim on a long stream of future cash flows. Therefore, the forward PE is a meaningful measure of value only if next year's earnings forecastassuming it turns out correct – is a representative statistic for what investors will receive over an extended period of time. However, it rarely is a representative statistic.

"The first flaw is that the forward PE takes no account of whether the 12-month forward earnings are near the business cycle peak, and therefore unsustainable, or near the business cycle trough, and therefore likely to grow rapidly. The second flaw is that the forward PE takes no account of whether the profit margins embedded in the earnings are structurally high, and so likely to trend down, or structurally low and likely to trend up."

French politics

Trains, strikes and philosophy

Jun 16th 2014, 12:24 

by S.P. | PARIS


THREE French institutionstrains, strikes and philosophycollided this morning to create a near-perfect political storm. On June 16th a rolling national strike by trade unionists at the SNCF, the national railways, entered its sixth day, disrupting the start of the countrywide philosophy paper at the annual baccalauréat exams. It is the worst industrial action that François Hollande has faced since his election to the presidency in 2012.

The two unions leading the strike, the Communist-linked CGT and the even tougher-talking SUD, are against the government’s plans to merge two companies: the heavily indebted RFF, which runs the tracks, and the SNCF, which manages the trains. Although no jobs are at stake, the unions suspect that this reform could lead to changes in work practices, and want the government to take on the debt. In a meeting with SNCF management on June 16th, they also pressed for pay rises.

When the strike began on March 11th, it looked as if it might be short-lived. Yet it has already gone on longer, and been more far-reaching, than expected. In some regions, half of all TGV fast trains have been cancelled for the past six days, as well as half of regional trains and two-thirds of suburban trains into Paris. The SNCF says that this has already been the most costly strike for 13 years. The unions plan a seventh consecutive strike day on June 17th.

For the two unions leading the strike, the industrial is in part a reflection of their weakness, not their strength. Unions as a whole are divided: the more moderate CFDT, for example, is against the current strike, and backs the planned SNCF reform

Both the CGT and SUD are under particular pressure from their grass-roots to flex their muscles because industrial action has lost much of its punch. The sort of paralysing strikes once wearily common in France have become rare. By law, public services have to run a minimum service during strikes, and days of industrial action are no longer paid. Between 2005 and 2011, the number of days lost to strikes per 1,000 employees fell from 164 to 77.

Yet the timing of this strike, reaching into the baccalauréat week, is also a public-relations risk. Every June, as part of a national ritual, over half a million school-leavers sit down to take the first bac exams. For half of them, this involves a four-hour philosophy exam based around a single essay question; this morning’s choices included Do we live in order to be happy?” The prospect of pupils arriving late due to the train strike has prompted much indignation and an emergency scheme by the SNCF to encourage car-pooling and other alternatives.

For its part, the government seems to be betting that public incomprehension, combined with divided unions, will undermine the strikers’ ability to hold out. Manuel Valls, the prime minister, said in a radio interview that there wasno question” of shelving the reform. There have been months of discussions with the unions already, he added. It will be debated in parliament on June 17th.

At a time of high unemployment and economic stagnation, there is little sympathy for those in protected public-sector jobs, least of all railwaymen. The French are well aware that train drivers still get extraordinary perks, including retirement for most train drivers at the age of 50. Laurent Berger, the moderate CFDT leader, has accused the striking unions of “contempt” for bac pupils. As it is, participation in the strike has dropped from 27% of SNCF workers on day one to 14% on June 16th.

Yet this is all the same a perilous moment for the Socialist government. It is the first real test of its ability to face down industrial action, and comes at a time when Mr Hollande’s popularity is dismally low and distrust of the moderate Mr Valls within his own Socialist Party is high. The prime minister is also trying to push controversial public-spending savings through parliament, as well as cuts in social charges for companies, both of which are regarded by the left of his party as a betrayal of campaign promises.

Mr Valls can ill afford to let the chaos on the railways continue. But, billed as a bold reformist who would be tough in a way that Mr Hollande has failed to be, he cannot be seen to give in at his first test on the streets either.