Chinas stock crisis bodes well for gold as bank predicts 27% plunge

Is it safe to come out yet after this weeks carnage in the Chinese stock market? Not according to at least one major investment bank. And if Chinas economic woes persist, look for a potential resurgence in gold demand from the citizens of the worlds most populous country.

The Shanghai Composite stock index could lose 27% by the time 2016 is over, thanks to slowing growth and major debt, predicts Bank of America Merrill Lynchs head of Chinese equity strategy, David Cui.

High risk of credit crunch: Historically, any country that grew debt this fast inevitably ran into financial-system problems, including currency devaluation, banking recap, and high inflation, and we do not expect China to be an exception, said Cui. We believe that the government had maintained system stability over the past few years by allowing various implicit guarantees to get firmly entrenched, which has made the financial system fragile.

Cui expects further financial instability to manifest itself in the form of a combination of RMB devaluation, debt write-off and banking sector re-cap and possibly high inflation. Given the sizeable and unstable shadow banking sector in China and the potential of capital flight, we also think the risk of a credit crunch developing in China is high.

Battered investors swear off stocks: If this is just the beginning of turbulence in the Chinese stock market in 2016, then gold could gain in allure as Chinas gun-shy neophyte investors return to what they know as a traditional safe haven: bullion bars, coins, and jewelry.

According to one Associated Press story, Chinese investors are already getting frazzled as their equity investments sour. I do not want to invest anymore, one citizen complained. This is just too miserable. It hurts, emotionally, a lot.

Battered by market gyrations, Chinese small investors are swearing off stocks, the AP noted. Despite a rebound in prices from their August lows, no significant new money from small investors has flowed into stocks.

They have either no more money to invest or they just dont want to invest anymore, said Guo Yanhong of Founder Securities.

Global economy is slowing: In contrast to stock investing, gold has been a culturally important form of saving and investing in China for thousands of years. No doubt the Chinese will be holding onto their yellow metal a bit more tightly this year if Bank of Americas forecast pans out.

Western investors should be paying attention, too, because according to The Lindsey Groups chief market analyst, Peter Boockvar, the Chinese stock correction is sending a dire message about the U.S. economy.

The Chinese economy has been slowing for years, but its a wakeup call to the markets that the U.S. economy is slowing down, the global economy is slowing down, and central bankers are losing their effectiveness in propping things up, Boockvar told CNBC.

Bottom could be in for gold: If the stock bear takes hold, where should investors turn? Investors have to go to whats already been beaten up, and commodities are now 4 years into a bear market. I believe that the drop in oil last year was the last phase of the bear market, Boockvar said.

If what we saw yesterday in the markets is a precursor to more, the Fed, I dont see them raising rates again. Therefore, the dollar strength is not there, commodities may get a bottom from that, gold and silver will be a big beneficiary of that. Theyve had a rough four years, and I think the bottom is in.

Meanwhile, China is making clear that the foreign banks it invited to participate in its bullion markets had better buy into its yuan-denominated benchmark fix this April or else they will be effectively banned from using their import licenses to bring gold into the mainland. Those banks are the Australia and New Zealand Banking Group, HSBC, and Standard Chartered.

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