China’s software giant Tencent fell more than 5% on Friday after the US government announced that it would ban WeChat – a messaging and social media app little used in the United States – along with the video app TikTok. A nearly billion-dollar private equity valuation for TikTok’s US business hangs in the balance, but Tencent’s US exposure is de minimis. That makes Tencent (700 HK) a buying opportunity.

The imperturbable Chinese yuan continues to ignore Washington’s tech war-dance against China. The Chinese instrument has risen against the US dollar along with the trade-weighted dollar index DXY.

More to the point, the cost of hedging the yuan in the offshore market (CNH) is about half that of the Euro or the Japanese yen. The market’s confidence in the Chinese currency is noteworthy, given the ferocity of Washington’s rhetoric against China.

We continue to like Chinese companies with low American exposure. As we’ve noted in the past, China’s exports to the US are less than 3% of the country’s GDP, and companies like Tencent with zero debt or overseas exposure have a clear path before them.

We continue to like CNH as a hedge against future dollar weakness, although the hedge of hedges is, of course, gold.

Currency exchange rates rarely directly reflect the relative overall strength of the underlying national economies, financial-economic fundamentals or even shorter term conjunctural developments.

For example, the JPY has a tendency to strengthen, sometimes sharply, as the Japanese economy tanks and weaken again with economic recovery.

Japan for nearly 30 years has been the world’s top creditor nation with net of external assets held by government, businesses and individuals totaling US$3.5 trillion) in 2019, considerably higher than Germany’s US$2.8 trillion and China’s US$2.2 trillion.

(The list of the world’s largest debtor nations is proudly headed by the United States at $12.1 trillion, 12 times that of number two Spain and 16 times that of number three, the UK. And the United States Treasury needs to borrow $2 trillion a quarter).

Thus, when Japan falls on hard times, its corporations repatriate assets and the yen shoots up.

For the US, the opposite tends to be in store as dollar demand declines.

What we have seen in the context of the Covid-19 pandemic is an unusually tight alignment of currency exchange rates with relative national performance in coping with the coronavirus and actual and expected virus-impacted economic performance, a picture in stark contrast with stock market movements.

In a nutshell, the US dollar has underperformed, the Chinese yuan and the Korean won have outperformed, and gold – seen as end-of-the-world hedge – has climbed to its historically highest levels.

Here are the pictures that tell it all.

Friday’s better than expected jobs numbers lent a bit of support to the US dollar and pushed down gold.

Actually, the jobs numbers showed only one thing very clearly: that the economy stalled in mid-July at the onset of the second Covid-19 wave in the US, which is continuing to rage with no near-term end in sight. The consensus forecast for China shows a 6% p.a. real GDP growth rate in the fourth quarter of this year vs. Q4 of 2019, while the US consensus forecast calls for a 6% decline.

A man walks past a WeChat ad in Hong Kong. Photo: Richard A. Brooks / AFP

Meanwhile, the Chinese and Korean economies in Asia and the German economy in Europe are making better than expected recoveries. China’s trade with Asia ex-Japan is expanding, and exports to the US in June returned to the pre-tariff peak as US demand for computers and other consumer electronics jumped.

A man walks past a WeChat ad in Hong Kong. Photo: Richard A. Brooks / AFP

The bottom line: The Covid and related economic impact metrics are intact.

America’s inability to get the pandemic conditions under control forces ever more government debt to be loaded on the Fed balance sheet to support consumption, while investment continues to fall. Households continue to increase precautionary savings. At some point the United States will face a reckoning in government debt. That’s why gold will continue to rise.  

China and South Korea, by contrast, are recovering rapidly, not on the government dole but by restructuring their economies on the Covid=19 lessons learned and without taking on massive amounts of debt for consumption.

The Trump Administration’s attempt to suppress Chinese tech companies, meanwhile, will have unintended, adverse consequences. Responding to new Commerce Department rules which restrict the sale of chips to China made with US equipment, the US Semiconductor Industry Association warned, “The new rule has created a structural incentive for designated entities [such as Huawei] to fund the development and production of new merchant items by competitors of US companies. This income, which is not available to US companies, will further fund the R&D of the foreign companies, which increases their ability to out-compete the US companies in critical technologies such as 5G

Investment implications

Gold remains a BUY much as we recommended in our August 3 article, “Gold like the price of life insurance on the Titanic.”

Our near-term target price for Gold is $2,500. But clearly, there is event risk: There are several companies in Russia, China, Germany and the US, who claim an effective coronavirus vaccine will become available before or near year-end 2020.

A highly commendable alternative to hedging gold decline directly is diversification into Chinese or Korean stocks. Our CNH target is 6.90-6.95 to the US dollar over the coming three months. Any equity investment in China will be protected by an appreciating currency.

The same is true for stock investment in Korea. The Korean won (KRW) has appreciated steadily since late March. Our near-in target is 1160.000, the January 2020 level. We continue to like Samsung at 15X forward earnings.