August 30, 2018
Money Managers (“Funds”) continue to cut longs and add shorts, while Gold remains oversold technically and overbearish from a sentiment perspective. This has been the situation since May, and yet Gold continued to fall. I see this as a massive build-up of fuel for the coming rally.
China controls the dollar price of Gold via USD/CNY—and XAU/CNY to a lesser extent—which is the catalyst for any moves in Gold.
USD/CNH (offshore USD/CNY) fell ahead of trade talks between the U.S. and China last week, something I predicted on Aug 8 ( https://www.sprottmoney.com/Blog/no-bottom-in-gold...):
Gold finally caught a bounce as a result.
However, as forecast, the talks failed to produce anything meaningful, and USD/CNH reversed much of its losses. Then the PBOC unexpectedly announced shortly after the talks ended that it was resuming its use of the “Counter-cyclical Factor" ( https://www.zerohedge.com/news/2018-08-24/yuan-surges-after-pboc-resumes-use-countercyclical-factor) in the calculation of the daily fixing of the yuan, which essentially smoothes out volatility in the USD/CNY exchange rate. This was perceived by the market as a sign that the PBOC was now capping USD/CNY, so it fell back down again and Gold continued higher.
I don’t believe the PBOC was capping USD/CNY. The real reason for the PBOC’s action, in my opinion, was as follows:
Two things were clear. First, USD/CNY was still clearly driving the Gold bus. Second, the failure of the talks, with no schedule for future discussions, meant that the additional 25% tariffs on 40% or $200bln of Chinese exports to the U.S. were still due to go into effect on September 5 th. If there is no postponement or cancellation of these tariffs, then USD/CNY is likely to go higher again and break the key level of 7, regardless of the counter-cyclical factor. This would send Gold down to new lower lows. For this reason, I call this D-Day for Gold.
On the contrary, if the tariffs were delayed, USD/CNY would fall, and then Gold would soar in the short-term. This is when the extreme positioning and bearishness would factor into Gold’s performance. But the issue would not be resolved, just pushed down the road.
Sept 5th tariffs are the key issue facing Gold in the short-term.
There is a second alternative scenario. If the tariffs go ahead on Sept 5 th, China could decide to instantly devalue the yuan an additional 10-15% overnight instead of the mini daily devaluations the yuan suffered since April 11. USD/CNY would rise, XAU/CNY would too, and Gold in dollar terms would basically remain unchanged. However, this would likely be peak USD/CNY. Such a devaluation would likely cause global turmoil in equities, including the U.S. stock market, subsequently forcing the Fed to reverse policy and cause the dollar to fall. At that point, USD/CNY would likely fall from its peak post devaluation and Gold—with all that positioning, technical and sentiment fuel—would explode higher from a historic low.
I consider this scenario a possibility, but only a remote probability, seeing as it would undermine China’s efforts to make the “yuan as good as gold” in order to promote its use in international trade, increase foreign investment in China, and ultimately rival the dollar in the global monetary system.
I should point out here that a crash in the U.S. stock market, followed by a reversal in Fed policy to “stimulus on steroids” which in turn would cause the dollar to peak and slide, is when I expect Gold to truly bottom and take off.
If a U.S. stock market crash seems a remote possibility to you, I have given several interviews since February providing the specific reasons why I expect a crash from new all-time-highs this Fall or shortly thereafter:
Adding credence to this argument, last week the Fed shared their plans for a return to what I call “stimulus on steroids”, vowing to do “whatever it takes” should a crash occur. They did this not once, but twice: In the FOMC minutes last Wednesday and in Powell’s speech at Jackson Hole on Friday. This confirmed my expectation that the Fed will again ride to the rescue when stocks crash. But more importantly, consider this:
In my opinion, the Fed just signaled that a crash is coming, and it’s coming soon. The crash itself will likely be negative for Gold initially, but given the stimulus we now know will follow, it won’t be long before Gold shoots higher from prices we will likely never see again.
One last scenario I wanted to share is that the dollar could have peaked already and is falling now. What happens to Gold in the short-term is unknown, because the tariffs may still go into effect and push USD/CNY higher, even if the dollar falls against other currencies. Hence in the short-term, the trade war is the key issue for USD/CNY and Gold.
But a precipitous slide in the dollar over time could prevent a crash in stocks and end the trade war at the same time. Exports in dollar terms would become cheaper, and imports more expensive, reducing the trade deficit and eliminating the need for tariffs. This would also mean a lower USD/CNY and higher Gold prices.
I also believe this scenario to be remote, but I am sharing it, as it is a possibility.
In conclusion, whether the tariffs scheduled to be implemented on Sept 5 th go into effect or not will decide whether we have already bottomed at 1167 in Gold or we have a date with lower lows first. My targets for such lows would be circa 1124 (the low in December 2016), but it could go even lower.
However, I do expect a crash in the U.S. stock market this Fall or slightly thereafter that will force the Fed to reverse policy. This would confirm a peak in the dollar and begin a significant decline, which in turn would eliminate the need for tariffs. This will be the bottom for Gold, if not before, in my humble opinion.