Gold in the Event of a Chinese Hard Landing

January 10, 2013 at 09:02

truthing

China exerts a massive amount influence on commodity markets. It is said to account for 40 percent of base metal consumption and 23 percent of major agricultural commodities, according to an IMF working paper by Shaun Roache. It’s an even bigger market for commodities than the U.S.

And since a Chinese hard landing isn’t completely off the table, it’s worth considering how this would impact commodities.

In a new note titled “What If China Lands Hard?” Societe Generale’s head of commodities research, Michael Haigh writes, that a Chinese hard landing would both lower demand and hurt investor confidence, thereby delivering a double blow to the price of commodities.

Even gold prices could plunge because China is the second largest consumer of gold.

However, gold’s reaction is not so obvious.

Haigh writes, that the impact on gold was the most difficult to forecast. Their model suggests that a significant drop in Chinese PMIs (which they use as a proxy for a hard landing) would send gold prices surging 15 percent in the first quarter after a hardlanding to $1,963 per ounce. Gold he points out would be the only commodity to experience this initial rally.

But it would also decline rapidly after.

This fall would be triggered by three key things:

A strengthening of the U.S. dollar in a risk off environment that would cause gold prices to decline because it is priced in dollars.

Easing concerns about inflation.

A rush to cash that would see a move out of long gold positions.

Patrick Legland, head of research at Societe Generale wrote that investors polled on the impact of a Chinese hard landing on commodities and stocks were most uncertain about the impact on gold price.

The average response was for a 5 percent decline, while Asian investors in particular expected a 21 percent decline. A third of those polled thought gold prices would rise in a hard landing scenario.