The Chinese stock market continues to slide with the Shanghai Composite (SHA:000001) suffering its biggest one-day decline in 5 months, closing down by more than 7.4% last Friday.

Morgan Stanley cited 4 issues that are causing this: increased equity supply, weak earnings growth with a slowing economy, high valuations, slowing investment, and a very high margin debt to free float market capitalization.

The recent turbulence in China’s stock market raised a lot of concern among investors, who started to worry and look for a safe haven for their cash. It seems capital is increasingly flowing toward precious metals such as gold and indeed, imports of gold into China have seen a brisk rise.

Data from the Hong Kong Census and Statistics Department show a rise of 36% month-on-month and 35% year-on-year on gold imports via Hong Kong, reaching the highest level since January.  Capital Economics expects China’s gold demand to be strong this year, rising by 8%.

“We think investors are becoming increasingly worried about a more pronounced correction in the Chinese stock market and will return to gold to diversify their portfolios,” said Simona Gambarini, commodities economist at Capital Economics.

“The sharp rise in the local equity market in China is likely to have weighed on gold demand in the past few months. However, investors might be seeking once again the safety of gold, as recent gains in the stock market are deemed unsustainable” she added.

Although the Shanghai Composite has been on a roller-coaster ride the over last few weeks, sliding 13% two weeks ago and 6.4% last week, it is still up noticeably since the beginning of 2015. The Shanghai Composite rose more than 60% from March to the middle of June and is still up 30 % for the year, ranking it as one of the best performing markets globally.

 

“Don’t Worry About the Chinese Stock Market”, says Morgan Stanley

According to the former chairman of Morgan Stanley Asia, people should “never mind the wild swings”. In a recent interview with CNBC, he has stated that if he had to invest $1 in one market in the world, it would be China.

“Markets around the world are really rich. I think if the Chinese market corrects a little bit more from here then it would be my first choice,” said Roach. “Especially in consumer and services names,” he added.

Roach explains that the mismatch between the small macro-economic harmful impact and China’s sizzling stock market comes down to liquidity. The People’s Bank of China (PBOC) has been taking measures to maintain adequate interbank liquidity by lowering the reserve requirement ratio for banks by 100 basis points to 18.5%, which represents the lowest single reduction since the global crisis in 2008, according to Reuters.

“The U.S., for example, is in the midst of the worst recovery in its post-World War II history. Yet the stock market is up three times from its trough in 2009,” he said. “These are liquidity driven markets and investors believe that central banks are just going to be there and keep pouring punch in the punchbowl.”

However, opinions remain divided. Morgan Stanley made it clear that they think investing now would not be a good idea, noting that it has likely already seen its peak in the current cycle. “Our stance on China A-shares is that this is probably not a dip to buy. In fact, we think the balance of probabilities is that the top for the cycle on Shanghai, Shenzhen and Chinext has now taken place,” reported Morgan Stanley on Friday.

The bank estimated a target price range for mid-2016 for the Shanghai Composite to be between 3,250 and 4,600, representing a rise of 10% in the best case scenario, and a slide of 22% in the worst case scenario. The index closed at 4,193 last Friday.

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