-- Published: Wednesday, 25 July 2018 | Print | Disqus
By Craig Hemke
Two weeks ago, we demonstrated that the yuan-dollar exchange rate is now the primary driver of global gold prices. Today, we attempt to decipher some of the important implications of this phenomenon.
Before we begin, we urge you to review this column from earlier in the month: https://www.sprottmoney.com/Blog/has-the-pboc-take...
So again, let's be perfectly clear about this. Though other factors such as headlines and the dollar index can affect price on a minute-by-minute basis, the primary driver of the gold price in the summer of 2018 is the yuan-dollar exchange rate. Though the PBOC has long-maintained a "peg" in the relative valuation of the yuan versus the dollar, the past 90 days have seen a steady devaluation of this peg to the tune of nearly 8%. See below:
Over that same time period, the price of COMEX gold has fallen by more than 10%:
To make this correlation more clear, let's plot the two together. This correlation has become extraordinarily tight over the past month, as you can see below where the CNYUSD exchange rate is displayed in candlesticks and COMEX gold is a blue line:
And when you draw it down to just the past five days, it's quite clear that the two react almost simultaneously:
This is not a correlation searching for a cause, nor is it a simple act of "traders" reacting to a falling yuan by selling digital gold. No, in a market the size of global gold, this type of sudden and direct correlation can only be accomplished through massive interventions, the size and scope of which is only possible at the state/sovereign level. And which state/sovereign would have a direct interest in linking the dollar price of gold to the yuan? China, of course.
In the face of massive U.S. tariffs and possible currency war, China has responded by aggressively devaluing their currency versus the U.S. dollar. In order to maintain an "equilibrium" of commodity prices through this process, it's clear that China is now aggressively intervening in the global futures markets.
Of course, the implications of this are significant, and here is the primary question to consider:
- IF China is moving to systematically devalue the yuan versus the dollar, and
- IF they are actively intervening in futures markets in order to keep the relative cost of commodities in yuan terms stable,
- THEN why would they go to all of this trouble simply to protect against just an 8% devaluation?
With this question in mind, consider the potential impacts of a 20-30% yuan devaluation in the months ahead. Many analysts have maintained that this level of devaluation might be necessary for China after years of managing their dollar peg—and these views were long-held and expressed before Trump's plans of taxes and tariffs came into view.
In August of 2015, the S&P 500 index fell by more than 12% in six days, following a 3.5% yuan devaluation. So far, the S&P has held up in the face of this ongoing 7.5% devaluation, but can it overcome a yuan devaluation of 20%? And what about gold? Since price is no longer driven by fundamentals such as physical supply and demand, how much farther might price fall if China attempts to rig it lower in conjunction with their continuing yuan devaluations?
These are important questions to consider regardless of whether you own physical gold, as crashing global equity markets would greatly impact interest rates and the future plans of central banks.
So, please take some time to consider the now-present link of the Chinese yuan and gold/commodity prices, in general. And then pause to reflect upon whether you are prepared for what this correlation may be foreshadowing.
https://www.sprottmoney.com/
| Our Ask The Expert interviewer Craig Hemke began his career in financial services in 1990 but retired in 2008 to focus on family and entrepreneurial opportunities. Since 2010, he has been the editor and publisher of the TF Metals Report found at TFMetalsReport.com, an online community for precious metal investors. |
