Two seemingly unrelated events occurred yesterday. China announced 60 infrastructure projects amounting to a huge 1 trillion yen while Australian dollar staged a picture perfect technical bounce from the 200 day moving average and on Friday closed nicely above its the shorter term 50 day trend.
So how are China and Australia connected to one another?
China is Australia’s biggest minerals customer so a 1 trillion yuan stimulus translates in more need for Australian dollars to pay for more minerals.
Some traders are agnostic on the Australian dollar while others are bullish on the Australian dollar and the discourse of these two views can be seen here (scroll video to 17:10).
Over a period of time, perhaps longer than a day, however, there is not much in the fundamentals of the Chinese-Australian relationship that could be translated into agnostic let alone bullish… and we may soon see that in the charts.
First, Chinese GDP growth has been downshifting for the last half decade and the 2008-10 growth rate increase looks like a blimp in this general downtrend (see graph above). The country is experiencing tremendous productive overcapacity so the 1 trillion yuan stimulus is a drop in the ocean of inventories that China needs to work off.
For years now, Chinese authorities have been smearing lipstick on their ugly numbers so suspicion is held by many that this latest stimulus announcement, being ahead of this weekend’s major economic data release, is another attempt at the make-up vanity. A look at the Chinese electricity production growth, however, can be more telling as to where China is going rather than the lipstick counter we may be presented with this weekend.
Now, if Chinese are not using the electricity to do things to these Australian minerals than it means that China is not and likely will not buy as many minerals.
We can see the relationship between the weak Chinese GDP and the low demand for minerals in the chart below where falling Shanghai index is tracked very well with the falling S&P Metals and Mining Select Industry index ETF, the XME.
XME also had such fitting correlation with the Australian dollar but the fit broke down earlier this year when fixed income people fled Europe and were in need to park their cash in bonds that may look even semi-safe. With many quality sovereign bonds going negative, cash flocked to Australia.
The chart below shows this story where the blue minerals line has trended its own way while the Australian dollar went sideways, kept higher by the influx of the global fixed income cash.
Now that the ECB is saying that it will use unlimited cash, the need to move into Australian debt paper has also reduced the need to hold Australian dollar which means that the Australian currency will resume to behave just like what the country makes – the minerals.
As a result, we have a very ugly technical picture in both China and Australia.
Price pattern of the minerals (XME) has carved out a bearish flag and this price formation is suggestive of two things: Shanghai index may not be done going down, while the Australian dollar, now that there is no need to own its debt, may be set to catch up with this move. The Australian predicament is seen in the chart with the head&shoulder price formation on its currency and the defined neck line, a price pattern suggestive of a break down.
There are also some data headwinds for Australia. On Monday, Australia will release July home loans number and given that the country’s China-induced mining boom has spurred a housing bubble this number could be rather turbulent for the currency and their banks which hold loans on such bubbly house equity.
Additional look on this issue here.