-- Published: Friday, 28 September 2018 | Print | Disqus
By David Brady, CFA
We now have confirmation that the trade war between the U.S. and China is going to be a protracted one, given that neither side is willing to back down. China has declined any further talks because they refuse to negotiate under the threat of further tariffs, or as they put it, with a knife at their throat. At the same time, Trump is clearly intent on pressing ahead with tariffs on all of China’s exports to the U.S., regardless of rising opposition at home.
So how does this end, and what does it mean for Gold?
China has devalued the yuan relative to the dollar in response to U.S. tariffs. Given the relatively fixed range for Gold in yuan terms, XAU/CNY, the higher USD/CNY exchange rate has led to a dramatic decline in Gold in dollar terms, XAU/USD. However, at least officially, China has said they will not devalue the yuan further. USD/CNH (offshore USD/CNY) reached a peak of ~6.95 on Aug 15 th. XAU/CNY reached a trough of ~8064 the following day, Aug 16 th. If we assume these are the worst-case scenarios for Gold, the bottom for XAU/USD is 1160:
However, the Chinese said that USD/CNY’s rise since March has been driven by “market forces” (nonsense, in my opinion), so who is to say that a rise to 7 or above wouldn’t also be attributed to such market forces also? The XAU/CNY could also fall further than 8064. Lastly, and perhaps most importantly, China could devalue the CNY overnight by 10-15%, which could push Gold down to $1045 or lower before it bottoms out.
That said, if 1160 doesn’t hold, 1124 is a huge support level for a number of reasons, and when you get a confluence of signals at the same price, it can be a truly powerful level. 1124 is…
- The December 2016 low
- The 76.4% Fibonacci retracement level of the entire move up off the December 2015 low of 1045 to the July 2016 peak of 1377
- A positively divergent lower low and double bottom
- The current support level based on the downtrend line from the peak of 1918 in Aug 2011 (in purple below)
Clearly 1124 is an extremely strong support level and may provide the bottom that sets us up for a truly historic rally ahead.
You may have also noticed the clear “cup and handle” formation on the chart above (in orange). This is an extremely bullish pattern as long as 1124 holds and we break the resistance line currently at ~1210.
Continuing with the upside for Gold, what could cause the dollar to fall? And more specifically, USD/CNY?
The dollar could fall due to rising budget deficits, a loss of confidence in U.S. finances, a rapid increase in de-dollarization and reduction of global trade in dollars, an end to the Petrodollar, the sale of U.S. assets by foreign holders, China declaring how much Gold it has, or it could simply fall of its own accord. Whatever the reason, such a decline would do what tariffs couldn’t and reduce the U.S.’ trade deficit with China, eliminate the need for tariffs and likely end the trade war. However, this is a low probability as it would almost certainly mean a significant rise in U.S. treasury bond yields, crash the U.S. economy and markets, severely undermine confidence in U.S.’ solvency and end the dollar as the global reserve currency. No President would want that.
My preferred scenario is a crash in the U.S. stock market which forces the Fed to reverse policy to monetary stimulus on steroids—including QE—enabling the Fed to prop up the stock market and cap and reduce bond yields. This would keep the boat afloat for a little longer but would likely mean the peak and fall in the dollar. This would also increase the likelihood of an end to the trade war and a fall in USD/CNY. I provided the signals for such a crash in my previous article ( https://www.sprottmoney.com/Blog/signals-for-the-coming-crash-in-stocks-and-rally-in-gold-david-bradycfa19-092018.html?platform=hootsuite), and many of them have already been hit or are close to doing so, indicating that a crash is coming soon.
A somewhat extreme-but-not-impossible scenario is the impeachment or resignation of Trump should the Democrats take control of one or both houses of Congress in November. The Democrats would likely reverse most of Trump’s policies and end the trade war. USD/CNY falls.
Whatever the reason, I do foresee a peak and dump in the dollar before the end of the year at the earliest or by mid-2019 at the latest. China, Russia, and many other countries are already preparing for this eventuality by producing, buying, or repatriating Gold. This is what I mean when I repeatedly say: follow the smart money. “When” the dollar does fall and USD/CNY with it, Gold will begin its meteoric rise from a price level we will likely never see again. This is why I am so bullish looking beyond the short term.
However, in the short-term, I have also repeatedly stated the risk of lower lows first, to between 1124-1160.
Following its $200 drop from a peak of 1369 in April, Gold had been trading in a narrowing range. It broke that range to the downside yesterday. This increases the likelihood of a test of the prior low at ~1167. We could see a double bottom there or a break to a lower low to somewhere between 1160-1124. My bet is on the latter.
I would also note that the dollar index, or DXY, has likely not seen its highs yet, but Gold is not following the DXY, it is following USD/CNY. That said, if the DXY does rise to a peak of 100, it is probable that USD/CNY rises also, further weighing on Gold in the short-term.
In conclusion, I am bearish in the short-term down to somewhere between 1160-1124 or possibly lower, but remain extremely bullish long-term.
David Brady has managed money for over 25 years for major international banks and corporate multinationals both in Europe and the US, with experience in Bonds, Equities, Foreign Exchange, and Commodities
In 2016, he created GlobalProTraders.com, an interactive online community for traders to share their views on financial markets.