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Has China smothered the ‘reflation’ trade?

29 May 2021


Shae Russell,Shae Russell
Group Communications Manager


What a week.

Gold rallies and another Australian city goes into lockdown. Again.

I’ve woken up twice to see the price of gold has danced with US$1,900 (AU$2,450). That was the good news…

…for those Melbourne bound like me, we won’t dwell on our 4th shut-in in a 12 month period. No! Instead, we look to rising gold prices and perhaps the better days ahead for precious metal investors.

This was something Nick Frappell and I talked about last week over at our You Tube channel.

As Nick pointed out from secret studio location in Marrickville, gold breaking through US$1,900 is an important psychological point for traders.

He confirmed this for me again this morning. By looking at the managed money positions on COMEX, Nick said ‘longs’ for gold are up 7.98% this week. Whereas the ‘shorts’ are only a fraction higher at 0.21%.

Hold up, that would make no sense if you aren’t fluent in ‘trader speak’.

Let me break it down for you.

The ‘longs’ Nick is referring too, simply means the number of futures contracts that betting the price of gold will go higher. And the ‘shorts’ simply means the number of futures contracts that suspect the price of gold will fall from here.

Right now, the longs are growing more than the shorts. Nick says this is a telling a ‘bullish sentiment’ for gold in the short term.

Inflation versus reflation

We’ve covered the good news for gold.

Now we move onto whether all the market fears are coming true. Has the inflation genie been let out of the bottle?

For the past couple of weeks, there’s been plenty of market commentary around inflation, and how perhaps the genie is out of the bottle.

There’s been a couple of data sets that made it appear so.

Aside from a jump in the US consumer price index in the past three months, we aren’t facing some Zimbabwean inflationary scenario.

Spurring this dystopian-inflation-tale however, have been the rapid price rises in iron ore - and to a lesser extent copper. Plus it’s no secret western central banks desire inflation. Their language around interest rate announcements reveal that.

Perhaps the inflationary fears are going to be put to rest.

It could be less a case of inflation, and more a case of the ‘reflation’ trade ending.

For those not used to industry gobbly-de-gook, ‘reflation’ is simply a form of inflation which isn’t ‘bad inflation’ (according to central banks, at least).

‘Bad inflation’ is – in official terms – are price rises that are moving above the long term trend. Whereas ‘reflation’ is simply where prices fell below the trend but are now heading back up to that line.

A simplified way of looking at it, is that after a period of falling prices, they recover and move back to their original trend.

For the better part of twelve months, China was leading this reflation trade with local lending programs aimed at their property sector.

While countries like the US and Australia are awash with various forms of quantitative easing, there’s been much debate about who really is the driver of the global reflation trade. Is it the US or China?

This was something the Australian Financial Review was chewing over this morning, writing:

We will find out soon enough who calls the shots for world inflation in a globalised economy dominated by cross-border capital flows. We will also find out whether these two colliding forces moderate each other, or set off the sort of wild ructions in currency, commodity, and bond markets that make hedge funds salivate.

“We have an incredible situation where the US is throwing the kitchen sink at its economy but China is over the peak and hitting the brakes,” said Mark Williams, chief Asia economist at Capital Economics.

They began to rein in the property sector last September and were very quick to pivot from worrying about growth to worrying about debt. The post-COVID investment boom has mostly run its course,” he said.

The Chinese “credit impulse” has turned negative. This tracks the ups and downs in “total social financing”, Beijing’s key mechanism for regulating the economy.

The China Credit Impulse essentially tracks the growth rate of new public and private credit as a percentage of gross domestic product (GDP).

It hasn’t just turned ‘negative’ as the AFR suggests, it’s completely dived…

Source: Bloomberg Data; ABC Refinery

The China Credit Impulse chart tells us, that the Middle Kingdom has taken its foot off the lending machine. For now.

Easing the amount of money flowing into property likely means iron ore and copper prices will fall in the short term. It may even take the Aussie dollar with it for a time.

However, this one chart doesn’t tell us everything. The data to watch from here, is to see if the Chinese consumer is ready to start spending again.

If they don’t, then perhaps the reflation trade has just been snuffed out.

Until next time,

Shae Russell,
Group Communications Manager, for ABC Bullion

PS – If you are based in Victoria, never fear. Our Melbourne branch on 8/227 Collins Street Melbourne is open for click and collect orders.