China intervention cheers the markets

2012-FEB-15

Up, down, up, down. One minute the markets sense signs of improvement in the eurozone, and stocks and commodities go up and the dollar goes down. Then there’s some bad news and stocks and commodities sell off, while the euro goes down and the dollar goes up.

The last 24 hours have provided another demonstration of this dynamic. News that the Greek parliament had agreed a new austerity package encouraged bulls; but then came news that eurozone finance ministers had scrapped a meeting to approve a new bailout package for Greece, with ministers claiming that Greek politicians hadn’t given enough assurances about the immediate implementation of cuts. Result: stocks sell off and the dollar rises as traders’ dash for the warm embrace of the world’s reserve currency. Not surprisingly, precious metals came under selling pressure yesterday afternoon and evening (GMT time) as a result of this, though neither gold or silver fell below important support levels on the price charts.

But now the markets have been encouraged by news that the China’s central bank is looking to invest in more euro-denominated assets. People's Bank of China Governor Zhou Xiaochuan told visiting European Union leaders in Beijing yesterday that his central bank has 'full confidence in the euro's role and its prospects'. As The Wall Street Journal notes, however, the Chinese have stopped short of a specific investment plan. Not surprisingly, the euro rose against the dollar on this news.

Readers may be asking why the Chinese would want to support spendthrift western nations that (on paper at least) remain far wealthier than China on a per capita basis. The answer – as with the Bank of Japan’s efforts to trash the yen yesterday – is all about trade, and China’s desire to maintain its place as an export powerhouse. As with the Japanese, the Chinese monetary authorities view a weak currency as an important tool for achieving this objective. So it’s important for them that the euro remains strong relative to the yuan.

Further signs that China is serious about supporting the eurozone should lead to weakness in the dollar as traders move back into risk trades. Silver, platinum and palladium will likely benefit from this, but gold’s gains could be more modest in relation to these other metals, on account of it being less of a risk asset and more of a safe-haven play.