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Potential Impacts of the Yuan-Gold Peg - Craig Hemke (24/07/2018)

One gold bar on the top of other two gold bars placed on red flag

July 24,2018

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.

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Head shot of Craig Hemke

About the Author

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.

*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.

Comments

John Burnett
July 25, 2018 at 4:59 AM
I'm not saying your wrong, but we here in New Zealand are facing the same thing. The price of Gold is only fallin against the USD. In terms of the NZD the price is not moving a lot. Also Russia would be on a real win, selling its USD's high and buying Gold while the price is down.
Chris
July 25, 2018 at 9:29 AM
Hi Craig I love your work, but check out the writings of Jeff Snider of Alhambra Investments over the last few days (and years). If China is devaluing it’s currency intentionally at the moment, is that also true of Argentina, Brazil, India, Turkey? Or are they all trying desperately but uselessly to avoid being run over again by another pass of the Eurodollar steamroller? Gold is also very closely correlated with the Yen over the last few weeks. Everything on top is reacting to the tidal forces roiling underneath...? Best wishes
John
July 26, 2018 at 5:09 AM
I guess I must apologize for my ignorance. But if China is devaluing the yuan then that would mean that gold is selling at relatively higher prices in China since gold is pegged to the U.S. dollar. So why is it advantageous for traders in China to be selling gold? They should be buying since the price of gold is going up in China. Hence, the price of gold would be going up, even in America against the rising dollar, since demand in China should be sufficient to warrant such rise. BUT, it's not because worldwide manipulation exists using paper in order to discourage physical buying by it's people so fiat is not damaged.