Saturday, July 19, 2014

I'm starting to get concerned about China and it's not just because they're a country of 1.4 billion people and can't field a half decent soccer team.

China has been a source of preoccupation and concern for some time now (years in fact). The dichotomy of course is that as an area of cheap labor, huge currency reserves, and rapid development it is integral to the global economy. This is contrasted by the fact that it is a single party system, notoriously corrupt, with an educational system that does not reward independent thinking. China's addiction to 7+ percent growth year over year is simply unsustainable and when something is too good to be true, it often is. Certain developments recently have made me think China is currently facing severe adversity on numerous fronts simultaneously which could represent a tectonic shift for their current economic momentum. Problems can often be easily managed when faced one at a time, but numerous problems all at once have been shown to fell even the greatest of opponents.

To review:
  • The rehypothecation scandal and Qingdao probe
    • "Industrial and Commercial Bank of China (ICBC) has applied for the right not to settle a letter of credit it issued earlier in the year due to the Qingdao probe" (Zero Hedge)
    • Over-leveraged ling of credit deals
  • Rising money market rates with increasing liquidity demand
  •  The 1.5 trillion dollar (maybe, but probably not) Chinese shadow banking system that has been generating money to trusts and companies with deteriorating loans.
    • Defaults have occurred but none where investors have had to absorb substantial losses. 

For these reasons I have begun to study ETF's following China to identify when such a "Lehman event" might occur and as a (poor) representative of the country's financial health and future direction. Additionally I have included a chart from a triple leveraged China Bear ETF (YANG) to provide you with cover should the situation deteriorate. All of this presupposes that the market is "free" and not centrally controlled by centrally banks, which it is. In short, I am not sure how effective an exercise this will be.  

For this exercise I have chosen FXI, the most liquid ETF and the one with the greatest amount in assests. On the weekly chart one will see an ascending triangle which smacks of bullish sentiment. Higher lows began in mid-2011 and about every ten months thereafter. Four hits already exist on the upper band with the next one possibly representing a breakout. This chart, in short, stands in stark contrast to the picture I painted above. My indicators such as the RSI, TRIX and MACD are all showing either overbought conditions or the beginning of movement downwards. My favorite indicator, PPO, has not shown this yet, however. If I were a betting man the feel of the current curve is one that is going to decline regardless of it's overall bullish configuration. However, go long if it breaks $39.00.

FXI: long term view.
The daily chart for FXI lends to this near-term decline scenario. As yet no hint for a catastrophic long-term demise is seen, but I have shown on the daily chart a pattern of lower-highs with a possible short at around $39.00. I would exercise serious caution at that point - movement higher is a possibility so have some really tight "stops" in place. Should it break beyond $39.00, I would say that the longer term health of FXI is good but failure to put in a higher high would point to some near-term health issues for the stock.

FXI: short term view.
Let's now turn our attention to some of the marketed "bull" and "bear" ETF's. First off, YANG, which seems quixotically situated at a bit of a crossroads at the moment. Having declined since March from $30.00 to its current resting place just below $18.00 it sits at a major resistance point. Failure to hold this line will mean long-term capitulation for the stock. There is no resistance beyond this point and YANG will continue to move into uncharted territory, just as it has since 2010. Holding it however will continue to develop the current bottoming pattern. YANG is no longer declining with steep descents and uninterrupted cascades. It's movement since August 2013 has been horizontal, albeit within a $15.00 range. I have to ask myself, is this a "double bottom?"

YANG: short term view

YANG's twin triple leveraged bull ETF brother YINN is showing imminent weakness and downward movement in the daily indicators. This may continue to squeeze up, but afterwards, then where? Will it form a blow-off top? We are beginning to see a pattern of critical transition zones in several ETF's so far.

YINN: Short term view.
Oddly enough though if one zooms out to include the last five years on the daily chart it appears as if YINN is making a massive downward channel (I could be fantasizing this because we do not have much data for such extrapolation).

YINN: Long term view.
I find this odd because if we now turn back to YANG, the bear ETF, we are not finding an inverse pattern of it's twin. We instead see a much tighter declining channel with what appears to be the development of a bottoming pattern. How these equities play out in the next few weeks will confirm or deny my proposed scenario. If we are in-fact seeing two declining channels in supposedly inverse ETF's, one much much wider than the other, this simply translates to the existence of increased volatility in the bull ETF, YINN, and increased volatility is exactly what the theme has been in China's story over the last five or six years. Given the challenges currently facing China I expect this volatility to increase. We may be pivoting to a long term bearish scenario as shown by this proposed 'pivot' in inverse ETF's.

YANG: long term view.

Jakob Richardson © 2014