So much for the so-called ‘Trump spike’ in the market. The markets have now fallen back to about pre-Trump levels, and the bullishness that retail investors had has also dissipated into thin air.
Take a look at TD Ameritrade’s Investor Movement Index, an indicator of retail investor sentiment.
The green line shows retail investor sentiment, which is now at its lowest levels since mid-2016. The grey line is the S&P 500; as you can see, sentiment has declined far more sharply in comparison. This is worrying when you consider that this divergence between the graphs is only a recent occurrence.
This could mean that there is a lag between the markets and investor sentiment, which may lead to even more selloffs in the equities market in the near future. Of course, the Federal Reserve doesn’t seem worried at all, as data indicates that the Great QE Unwinding continues unabated. The Fed’s holdings fell by $11 billion in March, and its total holdings are now back at July 2014 levels.
The message here is clear. The Fed is not interested in propping up the stock market, which it considers as having ‘elevated prices’. Retail investors may have been bleeding over the past month, but that may only be the beginning. There may be more short term pain on the horizon.
China’s Retaliation: The Petro-Yuan and Treasury Selloffs
Amidst this backdrop of a stock market that is rapidly shifting from a bull to bear market is the specter of a full blown US-China trade war. Although China is playing the calm, aggrieved party in this play, it does have an array of retaliatory measures that it can use against the United States; measures that aren’t limited to counter tariffs (which it has already publicly responded with).
One option that is already being discussed by the mainstream media is the potential devaluation of the yuan. This is actually a rather benign response that also exposes China to risks of its own, such as costlier debt repayments and increased capital outflows.
But China has far more dangerous tools at its disposal; tools that don’t seem to be widely discussed in the mainstream media. The first is its massive holdings of US Treasuries, which at end-January fell to a six month low of a mere $1.17 trillion. Reuters call this the ‘nuclear option’ in the trade war. Back in January, China denied that it was slowing down its Treasury purchases, but that was before this whole trade war started.
There are signs that the Chinese government has decided to go with the slightly-less-nuclear option; halting US Treasury purchases instead of initiating selloffs. Zerohedge reports that SGH Macro Advisors recently released a research note stating:
From what we understand, the Chinese government has halted its purchases of US Treasuries. Despite the direct encouragement, according to Chinese sources, by US Treasury Secretary Steve Mnuchin for China to “stay put,” Beijing has apparently discontinued purchases of US Treasuries “for the past few weeks.
The report isn’t public, and so far Treasury yields haven’t budged. However, that may very well change if China decides to announce such a policy publicly, which given all that’s happening in the world right now, isn’t far-fetched by any means. And who knows how this administration would respond to such an escalation.
The next countermeasure that China appears to be taking is attempting to end dollar hegemony through the petro-yuan; a move that has far longer term implications. This isn’t that surprising as it’s always been one of China’s long term goals. But the trade war may have been a catalyst as in late March sources reported that China will begin paying for imported crude oil in yuan this year. China is now the world’s largest oil importer.
China has also just launched its inaugural crude oil futures contract, aka Petroyuan futures. Reports are that initial trade volumes have already surpassed that of the Brent crude benchmark.
While mainstream sources may be downplaying this news, reporting it as matter-of-factly as possible, the potential effects of this move could be immense. For one, it could start a ripple effect of yuan-denominated commodity payments, such as for mining and raw materials.
More importantly, the petrodollar is a key support structure for the dollar’s status as the world’s reserve currency. An attack on this structure could be a severe blow to the already weakening dollar.
However, there is opportunity in this environment. Because gold is denominated in US dollars, a falling dollar means it’s comparatively cheaper for foreign investors to buy gold, increasing its demand. Further, gold also acts a long term hedge against the dollar as a whole.
The bottom line is we live in uncertain times. And in such times, intelligent investors know the value of gold.
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