As we are all well aware, 2020 has delivered one of, if not the most eventful year(s) that we have seen in the last 30.
Around 2-3 weeks ago we had considered that there would be a lull in markets, as markets begin to assess new risk/rewards and investors reappraise the future.
In a relatively quiet time, there has been significant signalling across multi-spectrum macro factors and we should head into the second half of the year with eyes wide open.
We have the quarterly numbers below, showing the change in markets from near to the bottom of the market crash in March.
The numbers show a bounce back in most assets, with nothing too suprising.
A closer look at the VIX shows a simmering world of investments.
Additionally, the 1 week performance shows the potential for an emerging inflation issue with increasing costs in soft commodities and some energy prices.
The world has finally begun to wake up to China in the wake of the coronavirus. After Donald Trumps election in 2016, the Chinese communist party initiated a new phase of its strategic plan in which intellectual property theft was ramped up significantly with Trump scribing the writing on the wall for access to Western markets, capital and intellectual property.
Already committed to this result, the gentle nudge of trade negotiations was taken as the end of the Chinese carte blanche on bad faith action in business dealings with the western world, especially one-way access to markets, stealing intellectual property and ham-fisted but determined attempts at controlling and subverting the interests of anybody but themselves.
This was boosted in 2019 when George Soros gave a speech in Davos that signaled that the rest of the Western World had also decided that enough had been enough. China had not, and was not, going to join the world as a member of the existing order.
Although the rest of the worlds reaction had been slow to progress, the last couple of weeks have seen the acceptance of the reality China had been signalling and preparing for, for around a decade.
Where the Chinese economy had benefited from a weaker Yuan historically, now that it has restricted access to the export markets that allowed it to challenge as the worlds largest economy a weaker yuan is now more of a strategic risk than it had been in the past.
When the Yuan finally breaks and weakens, there is an enormous risk in the impact of the failure of manufacturing in domestic politics that will be filled with military venture – most likely to Taiwan first. China has already been out to give somebody a bloody nose, antagonising Vietnam, Indonesia, Taiwan, India, Phillipines, Australia and basically challenging anybody to respond for its domestic political initiative.
The Communist party is showing a determination to have a fight, and the world has finally taken them at their word.
Amongst this, it is possible that the Yuan has been intended as a terminal currency.
The Institute of International Finance estimated that China’s total debt hit 317 % of GDP in the first quarter of 2020.
China was always destined to suffer from an enormous problem of poor capital allocation. The Chinese system is dominated by, saturated in political decision-making and you simply cannot have politicians making capital allocation decisions, you cannot expect central planning to spend money the most efficient way. The level of this type of debt (local government) is estimated to be 40 trillion yuan – 4.2 trillion USD – by Standard & Poors.
As long as credit and debt was expanding, rates were low and there was cash-flow from international trade it was not such an issue.
Even before the current and significant situation now close enough to call a cold war, China has already been bailing out banks, with non-performing loans already spiking in 2019, before coronavirus hit. There are suggestions that a 2020 figure of 1.5 trillion yuan of bad debt could be more like 2.5 trillion yuan when including non-performing loans that have been re-categorised as ‘overdue, rescheduled and special mention loans’ according to Rhodium group.
In addition to these potential bad-debts, CLSA Ltd. estimate that 2.5 trillion yuan of new non-performing loans will be generated in the next 12 months.
As of late 2019, the nonperforming loan ratio’s were as follows.
Probably as a result of these internal problems, in late 2019 China had begun signalling an intention to open up to foreign capital. After all, somebody is going to have to pay for this mess.
PWC had deployed $1 billion of capital into Chinese NPL in 2019 with 13-15% annualised returns sought. With early rumours of early deals under performing, it is very hard to imagine the good deals going to foreigners.
And if we take a look at the Chinese GDP figures, we can see when real numbers became fake numbers through the lack of complexity in the figures. These politically necessary outcomes tell us there has been a full decade of deception on the health of the Chinese economy.
But after all is said and done, there is a metric that cannot lie, at least not forever. The Yuan has made a temporary double-top
Kyle Bass, who has been a China bear for some time has said that China’s currency would ‘collapse 30-40% if they stopped supporting it’. Ergo, the implication for a weakening Yuan is that China is losing its ability to continue supporting the Yuan.
A closer look shows that 2020 will likely give us a very clear picture of the future of the Yuan, and by proxy the health of the Chinese financial system and state apparatus.
Connecting the dots, it is impossible to separate aggressive Chinese military behaviour from this chart of the Yuan.
When the resistance level is breached, it is a matter of time for the regime to make its moves – political, geo-political and militaristic moves – before a full financial collapse.
The failure of the United States to present an apolitical reality to its citizens means that their coronavirus pandemic is only just getting started and will impact the entire country.
Daily cases begin to increase almost precisely to the 2 week incubation period after nation-wide protests and riots in the United States at the end of May and early June.
Due to the politicisation of the virus, wearing a mask has become an article of faith for one side of politics, and by virtue of this also became a symbol of authoritative overreach for the other side.
The United States cannot afford to close its economy again and is going to have a difficult time with this out of control virus. We have to presume that the second half of the year could be far worse than the first for the global economy. It is an unknown and unquantifiable risk.
The first half of 2020 saw unprecedented central bank action to support markets during the coronavirus pandemic. These broad spectrum measures included lower interest rates, asset purchases including corporate debt, financing, social security, fiscal expenditure as well as swap lines and contain the potential for additional future spending.
There was already a warning sign in 2019 with the financial sector requiring upto $500 billion of emergency liquidity in December after a year that the US Fed had been shrinking its balance sheet after its extravagant response to the Global Financial Crises. If this was the beginning of a systematic issue – of a dependence on extraneous liquidity – then the system was already broken.
In any case, we will have a clearer idea of this before the end of 2020.
After the second world war, the United States had adopted a strict, ordered and controlled culture, potentially as a response to the chaos of the war. The first generation to be brought up into this control rebelled against it, giving us the 60’s hippy and free love movement.
60 years later the dominant social theme is the opposite of that control – chaos. This will naturally lead to an instinct towards more control, and we should hope that a balance can be found towards the two. The political dichotomy between the two things is Marxism/Socialism/Communism and Fascism and each support the other.
In 2020 we have seen this instinct taken to its logical conclusion given the cultural and political reality of the United States. It is Socialism with American Characteristics where the oligopoly funds Marxist organisations as instruments of power through which there is an attempt to synthesise the power of capital, politics, morality into a single political organisation.
It is hard to see how this is permanently resolved in 2020. It is hard to see how a Donald Trump re-election or a Joe Biden who can barely put a sentence together election can create an adequate solution for this problem.
The prevailing thought at the moment is that in terms of markets and central banking it doesn’t matter who is in charge, that the US Federal Reserve bank must continue down the path it has taken.
Gold, Bitcoin and the Index
We’ve seen an increased correlation between stores of value and risk assets recently, as gold emerges as a superior reference rate for assets than the USD.
Bitcoin has enjoyed one of its strongest and most enduring correlations ever lately, trading with risk products. It is likely a result of an attachment to the global liquidity event that saw Bitcoin collapse by around 50% in March.
Future relationships are not guaranteed – an equity collapse could see Gold and Bitcoin move together under the recognition that there will be an aggressive response in expansionary monetary policy with equity weakness. Alternatively, Gold, Bitcoin and equities could move together higher as stores of value keeping risk movements appropriate.
Bitcoin has had an interesting half year, being caught up in
Viewing this years movements from the long timeframe, the liquidity event in March is shown as a false-break of a longer upward trend.
A closer look at the most recent price action shows a break from the ascending wedge in the market, but still within the longer-term up-trend.
On this weekly chart over the lats 6 months we can see that after a spike in March, volumes have settled down to normal levels the last month.
Volatility has collapsed the last couple of weeks.
The sentiment index has barely changed
There has been a clear break in the trend-line for BTC Dominance.
How we see money and what we view as money – USD, other fiat currency, Gold and Bitcoin is going to have a large role in how the second half of 2020 plays out. As mentioned, the Yuan is also likely to be a key asset for the rest of the year.
Gold continues to trade in its upward channel that we had identified a month or so back. The asset is expected to stay strong for now.
It looks like the USD is about to become a very interesting asset for the rest of the year.