Relief rally in emerging markets

The emerging markets crisis has died down recently and we are resuming a normal bull market. That is bearish for gold. But when the emerging markets crisis heats up again due to the Chinese slowdown, a flight to safety will occur again.

The big headline in EM is China. The Chinese credit crisis has become messy as bad loan writedowns soar at Chinese banks. The FT reports that:

The five biggest Chinese banks, which account for more than half of all loans in the country, removed Rmb59bn ($9.5bn) from their books in debts that could not be collected, according to their 2013 results. That was up 127 per cent from 2012, and the highest since the banks were rescued from insolvency, recapitalised and publicly listed over the past decade.

And we can see the slowdown in real economy data. The first two months’ data was weak. Industrial production was rising at the slowest rate in five years and fixed investment was the lowest since 2002. A lot of people pointed to unusual calendar events to explain the sharp slowdown in growth. However, the March figures tell a different story because they were also weak despite a normal calendar.

Today, we learned that the official purchasing managers’ index (PMI) rose to 50.3 from February’s 8-month low of 50.2. This is barely above breakeven. In addition, the final Markit/HSBC PMI came out today and it fell to an eight-month low of 48.0 in March. This is below breakeven and makes the Goldman prediction of a 5% annualized growth rate in Q1 seem plausible.

The question still is about how much of a downturn Chinese policy makers are willing to accept from the writedowns of previous malinvestment. Premier Li has said employment is the key to what it is prepared to accept. If the slowdown does not have a large untoward impact on employment the Chinese may be willing to accept more of a slowdown in the economy than most expect.

Elsewhere, the data were mixed. Factory PMI surveys for India and Indonesia also came in softer while South Korea’s HSBC/Markit manufacturing gauge rose. In terms of the fragile five, Turkey, Brazil, India, South Africa and Indonesia, we have mentioned Indonesia’s weakening figures.

Things are looking better for Turkey largely because the political turmoil has subsided somewhat despite the heavy-handed and undemocratic Twitter ban. The Turkish finance minister Mehmet Simsek and I follow each other on Twitter. He used to be a regular poster on Twitter and I have noticed he has not posted once in 11 days ever since the Twitter ban. I can’t imagine he believes this ban is a good thing. Though I have not heard of any public statements from him on this issue. I expect political turmoil to continue to be an issue.

I still see the possibility of recession in Brazil. The central bank meets today and the investing community is mixed about whether they will hike rates. Win Thin at Brown Brothers Harriman says that the central bank’s inflation report last Thursday raised its inflation forecast this year to 6.2% from 5.6% forecast in December. Since real interest rates are very high in Brazil, a stronger currency may be accepted as part of the battle against inflation. But this has to choke off credit and export growth. Of course, Brazil was downgraded to a notch over junk by S&P and Rousseff’s ratings are falling. The Ibope poll showed the government’s approval rating fall from 43% to 36%.

And India’s GDP growth is at 4.1%, the lowest in a decade. I have not been following South Africa.

Bottom line: the data continue to be poor in some of the weaker countries of EM but for now I think we are in a relief rally. That’s bearish for gold because I believe the bid for gold was mostly about its status as a safe haven since real interest rates in developed economies are increasing as inflation declines.

But weakness in all of the BRICS only confirms the generalized slowdown. Russia reports Q4 GDP growth on Thursday and its expected to be only 1.56% year on year. I mentioned India and Brazil.

I continue to believe that the slowdown in China and its need for commodities is a major determining factor for the emerging markets crisis. And so to the degree that China continues to slow, this will put pressure on the emerging markets’ real economies.