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Gold breaks above $1,200

By David Morrison  |  15/10/2018 15:00
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Gold traded sideways over the past six weeks with many commentators arguing that it has lost its ‘safe-haven’ status. But recent moves suggest it could be coming back in favour.

There’s plenty for investors to worry about currently. Concerns include, and in no order of significance, US/China trade tariffs, tighter monetary policy from developed world central banks (especially the US Federal Reserve), rising bond yields, dollar strength with the resultant emerging market sell-off and Italy’s budget proposals which are being opposed by the European Commission. With all these issues bubbling away, it’s hardly surprising that global equity markets are having a wobble, if that’s not too much of an understatement. Yet despite all these worries, the price of gold (historically considered the ultimate ‘safe-haven’ asset) has repeatedly struggled to break and hold above $1,200 per ounce. The old school view that gold offers protection in times of uncertainty was beginning to look as outdated as the typewriter.

Gold breaks out

But last week gold suddenly surged through the $1,200 level and has managed to build on its gains in early trade on Monday. Some of this move has been attributed to a pull-back in the US dollar which came as US investors dumped equities and piled the proceeds into Treasuries pushing yields lower. Investors also took the opportunity to raise their exposure to gold and silver, two precious metals which have suffered a beating since April this year.

Gold and the yuan

But some analysts are pointing out that the most important correlation currency as far as gold is concerned isn’t the US dollar but the Chinese yuan. Looking at a daily gold chart together with a chart of the USDCNY (US dollar versus the onshore (official) yuan) we can clearly see a striking correlation. From the mid-April high to the August low, gold lost around 14%. Over the same period the yuan lost 10% versus the US dollar. Now, it can be argued that this is just another way of saying gold fell as the dollar rose, but the theory is that China is informally pegging its currency to gold, setting the stage to challenge the dollar’s reserve currency role sometime in the future. Of course, that 10% fall in the yuan pretty much counters Trump’s 10% tariffs – currently set on the best part of the $50 billion-worth of Chinese exports to the US. The question is what happens if Trump goes ahead with his threat of upping tariffs to 25% and applying then to $200 billion worth of Chinese goods? Would China respond by allowing the yuan to fall by a commensurate percentage? A sharp 25%-yuan devaluation would cause market devastation. The USDCNY is now little more 1% below 7.00, a level some consider a red line when it comes to exacerbating an already dangerous stand-off between the US and China. As things stand a move to 7.50 or beyond seems unimaginable. Nevertheless, if this trade war hots up further there’s little doubt the yuan would be a casualty.

Yuan devaluation and gold

But ironically, if this analysis is correct, a potentially catastrophic trade war which should drive investors out of risk assets like equities and into safe havens like gold may not work that way. If the yuan falls sharply from current levels to 7.50 or so (around 8%) the danger is that gold could plunge below its December 2015 low of $1,050 and head to $800. But as posited in the TFMetalsReport of 1st August 2018, this would cause pandemonium in the physical gold market. The report points out that gold production costs have risen since 2015 and many miners are already sustaining losses with gold below $1,300. So, supply is falling while stockpiles are down. Consequently, there would be mayhem if buyers of futures contracts began to demand delivery and these contracts couldn’t be fulfilled. If this were the case, then the gold/yuan relationship would break, and gold would soar as dealers rushed to grab inventory to fulfil their contractual obligations.

Consolidation?

But that’s something to consider for another day. In the meantime, if gold can consolidate above $1,220 this week, then a retest of resistance around $1,240 looks reasonable.


Daily USDCNY - chart courtesy of Tradingview.com

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Daily Gold chart

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