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GOLD, CNY, Devaluation and Crash - David Brady,CFA (27/07/2018)

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July 27,2018

Back in mid-May, I wrote my first article for Sprott Money, entitled “Gold Preparing to Launch”, where I stated the following:

“In summary, based on positioning, sentiment, technicals, inter-market analysis, Elliott Wave Theory and similar readings prior to previous rallies, Gold is at or close to a low here that is likely to set off a rally to 1360 or higher in the coming weeks.”

Based on the data to date at the time, which had accurately pointed to every peak and trough in Gold in the previous three years, it appeared that Gold was about to bottom and rally yet again.

But it turned out that such data was no longer relevant for the time being, and Gold continued to fall. There were two new drivers for Gold: $/CNY and the SDR. A clear inverse correlation developed between Gold in dollars and $/CNY, seen in the chart above. The DXY was no longer a factor. Then Jim Rickards pointed out that there was also a direct correlation between Gold in dollars and Gold in SDR terms, with the latter pegged to a range of 25-50 around 900 SDR.

I covered this in greater detail in the following article: China takes control of Gold

My colleague and fellow writer for Sprott Money, Craig Hemke, also covered the $/CNY correlation in his article earlier this week: Potential Impacts of Yuan-Gold Peg

He also mentioned the risk of USD/CNY devaluation and the impact it could have on equities and gold. It is one of the factors that could trigger the crash in global equities markets I expect this Fall—a crash likely followed by a reversal of policy by the Fed and global central banks, resulting in monetary stimulus on steroids. This would catapult Gold and other precious metals to new highs, just as it did when QE1 and QE2 were rolled out.

I provide several other reasons why I expect a stock market crash later this year in this interview I had with Craig a couple of weeks ago.

I believe that when this stock market crash occurs, we will see the low in Gold at a price we will never see again. So what happens between now and then?

ONE-OFF MAXI YUAN DEVALUATION

Jim Rickards recently suggested that China could devalue the yuan against the dollar by up to 25% overnight in response to U.S. tariffs. Given Gold’s new connection to the USD/CNY, many assume that this would mean a massive drop in Gold prices. I disagree. I believe a one-off maxi Chinese devaluation of the yuan would therefore signal the bottom and pending rally in Gold. Why?

The yuan would be devalued against Gold also. The XAU/CNY peg would be revalued higher, meaning Gold in dollar terms would remain relatively unchanged immediately after such a devaluation.

Gold is not a commodity, it’s money. In the past, when the British pound was devalued against the dollar, it was also devalued against Gold and every other currency too. It had to be. For example, the pound cannot devalue against the dollar and stay at the same exchange rate against the euro, as that would also devalue the euro against the dollar. The pound devalues against both of them, leaving the euro/dollar exchange rate the same. The same happens for Gold. Gold in dollar terms would more or less remain unchanged.  

So why do I believe such a one-off massive devaluation of the yuan would be bullish Gold? As said already, it would precipitate a U.S. and global stock market crash, one that would likely lead to a Fed reversal to QE. This would be extremely negative for the dollar, in my opinion. How about the yuan? It has already been massively devalued, and it is unlikely to go much lower at that point. Quite the contrary, it is more probable that it rises against the dollar in such a scenario. With Gold pegged against the yuan at a new higher rate, a lower USD/CNY means a higher Gold price in dollar terms.

STEALTH DEVALUATION

On the other hand, if China decides to devalue the yuan by just letting it continue to fall against the dollar from one day to the next while Gold remains relatively fixed in dollar terms against the yuan, then Gold will continue its inverse relationship to the $/CNY and drop further.

Simply put, a massive one-off yuan devaluation is good for Gold, and a slow and steady daily decline in the yuan is negative—until the U.S. stock market crashes, that is.

One last point: Although Gold is now being led by USD/CNY and the SDR, COMEX positioning data provided in the COT reports is still a valuable tool. The big Bullion Banks are insiders. I believe they know long before any of us what is going to happen on the world stage. If the Commercials are loading up long positions in Gold to extreme levels while the Large Speculators (aka “Funds”) add to shorts, then do as I always say: “Follow the Smart Money.”

Funds are the shortest they’ve been since Dec 2015:

Commercials have their lowest short position since Jan 2016:

 

Doesn’t mean that Funds cannot increase their short position nor Commercials go long. Watch USD/CNY and keep an eye on XAU/SDR also.

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About the Author

David Brady has worked for major banks and corporate multinationals in Europe and the U.S. He has close to thirty years of experience managing multi-billion dollar portfolios including foreign currency, cash, bonds, equities, and commodities. David is also a CFA charter holder since 2004.

Using his extensive experience, he developed his own process utilizing multiple tools such as fundamental analysis, inter-market analysis, positioning, Elliott Wave Theory, sentiment, classical technical analysis, and trends. This approach has improved his forecasting capability, especially when they all point in the same direction.

His track record in forecasting Gold and Silver prices since has made him one of the top analysts in the precious metals sector, widely followed on Twitter and a regular contributor to the Sprott Money Blog.

*The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.

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