The Gavekal corner: big questions, short answers

12 Min Read

Since I was recently on the road meeting with clients, I thought it might be interesting to discuss the frequently asked questions.

Question: Given China’s overcapacity in cars, solar panels, telecom switches and home appliances, shouldn’t we expect the global economy to experience another major deflation in the coming years?

Answer: The first way to look at this issue is that China has been the world’s leading deflationary force for the past thirty years. This raises the question of whether the deflationary impact will become even greater from here on out. A second view is that the Western world’s relationship with China has changed dramatically in recent years, making the country less open to Chinese imports or Chinese control over supply chains.

Typically, more protectionism means higher prices, not lower ones. Third, China’s rise up the value chain could prove less deflationary than many investors expect, as China’s recent trade growth has been mainly with emerging economies. For example, over the past six years, Chinese exports to the US have remained largely stable, while those to Southeast Asia have almost doubled, as shown in the chart below.

Chinese export destination by region chart from Gavekal Research/Macrobond

This observation brings me back to the chart below showing China’s rising auto exports, which I may have overshared over the past year. From nowhere, China has become the world’s largest auto exporter by producing and selling cars cheaper than anyone else. But these cars are not sold on the streets of New York, London or Toronto, but on the streets of Jakarta, Santiago and Jeddah.

Graph of passenger car exports from Gavekal Research/Macrobond

Will China Devalue the Renminbi?

The argument for a devaluation is that the yen is crazy undervalued today and that a clear goal of Chinese policymaking in recent years has been to move away from a real estate-based growth model to an industry-based growth model. Meanwhile, growing through industry is quite challenging when one of the world’s largest and more efficient industrial powers has an exchange rate that is undervalued by up to 40% on a purchasing power parity basis.

Annual net new bank loans by sector chart from Gavekal Research/Macrobond

In contrast, China’s efforts over the past decade to reduce its dependence on the dollar have forced China to offer investors better returns on renminbi bonds than those on government bonds.

Chart of bond indices from Gavekal Research/Macrobond
Bond yield chart from Gavekal Research/Macrobond

The problem for China today is that while government bond yields were more than twice as high as government bond yields five years ago, today the opposite is true. Such a yield difference raises the question of how Chinese government bonds can continue to outperform government bonds. There seem to be three possible answers to this question:

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Option 1: Given the yield differential, the CGB’s period of outperformance is coming to an end and China’s efforts to de-dollarize the dollar will fail. Too bad for Xi Jinping’s grand geopolitical plans and his hopes to ‘make China great again’. This is the scenario that most investors I’ve spoken to in recent weeks have in mind.

Option 2: As long as US interest rates continue to rise, China can largely ignore the value of the renminbi. If the Chinese currency remains broadly stable, this should be enough to ensure continued outperformance of CGBs versus face-planting government bonds. This is the scenario currently unfolding.

Option 3: Given the low returns, it will be difficult for CGBs to generate large capital gains here. So if Chinese policymakers want to continue internationalizing the renminbi and convince foreign central banks to hold more reserves in the currency, they will need to achieve exchange rate gains. This shouldn’t be too difficult.

Is the AI ​​craze over?

It was interesting to see Meta announce plans to spend tens of billions of dollars on a better artificial intelligence platform, only to have its stock price crushed under the news. Meanwhile, Alphabet announced a buyback and dividend and the stock rose to a new record high. At the very least, it “feels” like the tech industry is experiencing a shift in zeitgeist.

Another interesting development is that stock market performance has broadened in recent months: small caps, Chinese stocks and financial institutions are no longer dogs with fleas. Yet performance within the fast-growing technology world has become more concentrated. The Magnificent Seven stocks became the Mag Five (as Apple and Tesla fell off the wagon), and then the Mag Three to finally center around Nvidia, which itself seems to be struggling to reach new highs. So yes, it ‘feels’ like the AI ​​craze is stalling.

Are we ready for more “China is uninvestable” rhetoric?

The broader Chinese news in recent weeks has been about as bleak as I can remember. First, of course, there was the TikTok ban. Then news “leaked” in the US media that the Biden administration was considering financial sanctions against China’s major banks, including the Bank of China. Then a trip by Janet Yellen in which the Treasury Secretary criticized China for creating ‘overcapacity’, followed by a trip by Antony Blinken in which the US Secretary of State deplored the same, along with Chinese sales of key industrial goods to Russia ( a trip in which Blinken did not even have a red carpet rolled out upon his arrival in Shanghai).

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Then came the arrest of four suspected Chinese spies in Germany and another two in Britain, the raid on Nuctech’s buildings in Warsaw and Rotterdam and the European Union’s notification to China of plans to add more Chinese companies to the blacklist for ignoring sanctions. against Russia.

So yes, strictly looking at the news, it feels like the gap between China and the Western world is widening. In fact, in recent weeks it has felt that it is not just China on one side and the US on the other, but that the EU is suddenly also starting to aggressively turn away from China.

Perhaps this latest development is not surprising. As China increasingly transitions from a target market for major EU companies to a highly productive competitor (whether in cars, machine tools, chemicals or specialty steel), Europe is probably right to feel more skittish.

But here’s where it gets interesting: In January, when Chinese and Hong Kong stocks collapsed, the kind of news we’ve seen lately would certainly have led to a -10% to -20% drop in Chinese stocks. But since the Financial Times a much-discussed column by Stephen Roach it seems no amount of bad geopolitical news can derail the rise of Hong Kong and Chinese stocks.

Price return chart from Gavekal Research/Macrobond

The market even ignores macroeconomic developments such as a strong dollar, rising long-term government bond yields and a collapsing yen. In the past, such factors would have been enough to push China’s beaten-down stock markets further down. But not anymore.

It now appears that a Chinese market that always fell even when there was good news is planning to rise even when there is bad news. This shift likely reflects the fact that most foreign investors who started selling their Chinese assets due to geopolitical concerns or fears that Xi Jinping would take over all private sector assets have done so. We may again hear the refrain ‘China is uninvestable’ in the Western media, but market behavior shows that this time it may not matter.

Is gold, along with other precious metals, now in a structural bull market? And if so, what could end it?

I think so. I’ve always argued that gold is a low-beta way to play emerging markets, with a geopolitical appeal on top of that if the world falls apart. Today, most people view the rise of gold as the realization of this call warrant. After all, we live in a world with hot wars on the European continent and in the Near East, blocked shipping lanes and rivalry between great powers.

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Yet gold only really started to rise after the Bank of Japan made it clear that it would remain on the yield curve and after the People’s Bank of China threatened to devalue the renminbi if the yen continued to fall.

So a threat to the gold bull market would be if both Japanese and Chinese private savers stopped buying gold – or even started selling it. This is unlikely to happen until we see tighter monetary policy in both countries. At the same time, gold’s upside could be significant if Westerners get serious about buying precious metals, instead of bitcoin and technology stocks.

So far there is little sign of that, as evidenced by leading exchange-traded funds offering exposure to gold after recently seeing net outflows. This seems to indicate there is still room to run.


These are just some of the most common questions I received during my most recent trip. Unsurprisingly, concerns also ran deep over geopolitical issues, over the US Treasury sell-off and whether rising rates would destroy business (apart from the yen and overvalued tech stocks), over energy needs for data centers, about exploding US budget deficits and about US commercial real estate. . Such issues probably deserve their own full papers.

Louis Gave is the founder and CEO of Gavekal. This piece was originally published by Gavekal and has been republished with permission.

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