The ‘Sniff Test’

On the front page of today’s AFR we see the headline “Japanese shares soar on weak economy”.  A misprint you think?  Nope.  This is so indicative of the ‘fundamentals’ of our financial markets.  Yesterday Japan released its Q4 GDP print and it turned negative for the 6^th time in 6 years – and not just by a little, but -0.4% for the quarter or 1.4% annualised.  So what happens?  The market surges the most in years as the poor GDP signals more central bank stimulus to come.  Yep, the sharemarket surged because things are so bad…

Also yesterday, coming back after a week’s NY holiday, China’s central bank surprised everyone by strengthening the Yuan fix (in light of the weakening USD over that holiday) plus telling the market it saw no basis for continued devaluation.  This despite simply awful January trade figures of exports down 6.6% and imports down 14.4%, albeit that results in a much stronger trade and current account balance given exports were down less…  The point is, the market reacted arguably more on the ‘words’ and interim actions than on the fundamentals behind it which has seen all the commentary and public ‘bets’ on further devaluation.  These are words and actions from a regime famously with no accountability.  But it’s what the market wanted to hear.  Down goes gold and silver, up goes the Aussie dollar.  It was a nasty day for Aussie gold and silver holders.  Arguably though gold and silver needed a little correction after going so hard.

But again, give all of the above the ‘sniff test’.  Does this smell sustainable?  Is your gut telling you everything is awesome and you don’t need a hedge on it going wrong.  Greg Canavan of Daily Reckoning gives his take on it:

“What are the fundamental reasons behind gold’s strength?

I don’t believe that gold is an inflation hedge. It’s a reflection of confidence in the financial system, and confidence in those who manage it. I also see it as a form of financial insurance.

When confidence is high, the need for insurance is low. When confidence is low, as it clearly is now, the desire for insurance increases. Hence the rising gold price.

And then there’s this scary statistic doing the rounds right now. According to JP Morgan, there are US$6 trillion worth of government bonds offering negative interest rates. I repeat, $6 trillion.

That’s a retardation of the laws of finance on a huge swathe of assets. Gold, often criticised for yielding nothing, suddenly looks good. If the Fed tries to do something as stupid as pushing rates negative, the gold price will explode.”

At a time when markets seemed to be losing faith in the central bankers’ ability to get us out of this mess, yesterday showed some are still clinging to that hope….