A New or False Dawn for Gold? David Brady, CFA (16/08/2018)

August 16, 2018

Good timing for this article, given that we got the expected thaw in the U.S.-China trade war overnight, with news of trade talks later this month between the two countries. Further proof that the yuan is driving Gold’s bus was exhibited in the immediate dump in USD/CNH from 6.96 to 6.88. Gold bottomed at $1168 and is now up $20, its first decent bounce in some time. Again, driven by the yuan.

The question now is, ‘Is this bounce sustainable or just another so-called dead cat bounce before falling to lower lows?’ More on that shortly.

XAU/CNY (Gold in yuan terms) broke the support line of its pegged range of 8200-8360 yesterday for the first time since January 2017. This does raise several questions, the most obvious being: why? What caused it? Honestly, I am not sure. Does it mean the whole concept of a peg in yuan terms is done? Maybe, maybe not. With a soft peg like this one that has been narrowing since the yuan joined the SDR, you can get temporary breakouts to one side or another. The most important question of all, though, is what does this mean for Gold? Unfortunately, it is not good if it continues.

Gold in dollar terms, or XAU/USD = XAU/CNY divided by USD/CNY.

With Gold in a <2% range against the yuan [8200-8360], this meant that any rise in USD/CNY meant a lower Gold price. This is why the correlation between USD/CNY and XAU/USD has been so tight in recent months, almost tick for tick, and why Gold has fallen so precipitously since April. This is covered in detail in my previous articles. However, if XAU/CNY falls also, that could signal disaster for Gold. If XAU/CNY goes down and USD/CNY goes up, then Gold in dollar terms falls even further. Example:

Reducing the numerator and increasing the denominator in the XAU/USD equation is a double whammy for Gold, as outlined above.

Given the seemingly relentless drop in Gold, I have been asked repeatedly how low it could go. Based on the premise of XAU/CNY being pegged within a range of 8200-8360 and an additional 10% devaluation of the yuan in dollar terms to offset 25% tariffs from the U.S., I came up with the following at the time:

This put the bottom at ~$1100, just above the December 2015 low of 1045, which would make sense for a Wave 2 bottom in Elliott Wave terms for a truly massive rally to follow. But given that XAU/CNY has broken down below support at 8200 now, all bets are off and Gold could go even lower.

I don’t know if XAU/CNY is going to continue to fall, rise back into its range or go higher, but if it falls while USD/CNY rises, that would be a huge problem for Gold. We have to see how this develops in the coming days and weeks.  

Back to USD/CNY. I stated the following at the end of my previous article:

I have also shared on my website and Twitter that many people, including myself, have been predicting some kind of thaw in the trade war that would boost stocks and other risk assets, and we got that last night.

Now we are seeing USD/CNY fall, Gold bounce as expected. But here’s the key point: Unless there is a definitive agreement later this month to resolve the trade war between the U.S. and China, this drop in USD/CNY and rise in Gold is nothing more than a temporary reprieve. If we do get such an agreement, the Gold party has truly begun, and a massive rally has likely already started.

However, if this turns out to be another false dawn, and the U.S. implements 25% tariffs on $200bln or 40% of Chinese exports on September 5 ^th or shortly thereafter, coupled with a threat of 25% on the remaining $300bln—which Trump suggested a little over a month ago—then look out below in yuan and Gold terms. The disappointment that follows the current optimism would likely send USD/CNY through 7 with ease and Gold down to new lower lows.

The fact that this trade meeting involves lower level officials from both countries, and with comments like that below coming out of China beforehand, I’m not as hopeful as everyone else right now.

This could go either way, but this is the key issue affecting Gold. Not technicals, sentiment, positioning, the dollar index, USD/JPY, real interest rates… this trade war and its effect on USD/CNY is all that matters for Gold right now. Nothing has been resolved yet, and it may get a whole lot worse.

I’ll end on some positive notes. The U.S. stock market is facing a perfect storm of headwinds that could cause a crash later this year or slip into 2019. If and when that occurs, given the importance of the stock market to Federal Tax Receipts in particular, I expect the Federal Reserve to reverse policy back to ‘QE’ and zero or negative interest rates. This would likely mean a major peak in the dollar and a historic bottom in Gold.

Secondly, I understand that many people are long Gold (and Silver) and have suffered significant and painful losses. They are beginning to wonder if precious metals will ever reach fair value. In response, I say this as always, “Follow the Smart Money Long-Term.” China and Russia continue to accumulate Gold and Silver and have been doing so for over a decade. Central Banks all over the world are either buying or repatriating their Gold also. They are not doing this because it is shiny or because they collect barbarous relics. I believe they are preparing for and hedging against a crash in the dollar. But they are not traders and do not care about mark-to-market values in the short term, so this may not happen for a while yet, although they have also been preparing for quite some time already.

And then there is JP Morgan, sitting on a massive mountain of physical Silver it has accumulated since 2011 and which it continues to add to. Bankers don’t get out of bed in the morning unless they plan to make a profit, and neither does one of the biggest banks in the world. When Gold soars, Silver will explode higher in my opinion, and JP Morgan knows this too.