China devaluation, gold falters then spikes higher
OPINION
In the immediate aftermath of China’s devaluation announcement, gold declined, but as the import of the new yuan mechanism sunk-in, the price spiked higher. Why? Obviously the other side of the devaluation coin is that the dollar would be forced higher which would be gold negative, but there are a couple of other factors at work, and gold’s reaction is not what some might have expected.
1. In a recent News & Views Special Report we suggested that the Shanghai stock market crash would be an inducement for greater gold demand in China – a nation whose citizenry already has an attachment to the metal. That has already happened with Shanghai Gold Exchange draw downs in the first week of August posting their third biggest week in history. This devaluation will only add to gold’s luster among the Chinese people as the currency loses purchasing power, and one can only wonder what the draw downs will look like in the weeks ahead. In fact, devaluation is likely to become an even greater driver to gold demand in China than stock market weakness. You will recall that when the United States devalued the dollar in the early 1970s, both the demand for the metal and its price moved significantly higher over a decade long period, while stocks languished.
2. The Federal Reserve will have to think twice about raising rates in an environment where global currencies are at war with each other and devaluation – formal or not – remains the principle weapon at nation states’ disposal. Deflation is already a concern in the United States. A rate hike at this point might serve as a dagger to the heart of the wobbly U.S. economy and the Fed – particularly this Fed – will be loathe to unsheathe it. If it were to raise rates now, after China’s devaluation, it might be considered the greatest blunder in Fed history. In a Bloomberg interview yesterday, Fed vice chairman Stanley Fischer stated that the U.S. central bank is now looking at employment and inflation as inducements for policy changes. He went on to say that inflation and inflation expectations are well below Fed targets, and a factor in Fed thinking. Fischer’s comments will likely change the checklist Wall Street has been monitoring for the past several years – and could even induce some not so subtle changes to the algo formulae employed in trading various markets, including gold.
3. China’s interest is in a return to a cheap yuan, and the specter of further yuan devaluations will now be on the front burner. The currency war has just been pushed to the next level with echoes of the 1997 Asian currency crisis, only this time the value of gold as a hedge is well-known in all corners of the globe and embraced by a significantly greater number of people than it was at any time in the past.
“In a weak global economy, it will take a lot more than a 1.9 percent devaluation to jump-start Chinese exports. That raises the distinct possibility of a new and increasingly destabilizing skirmish in the ever-widening global currency war. The race to the bottom just became a good deal more treacherous.” – Stephen Roach, Yale University (formerly Morgan Stanley Asia expert)
4. The purpose of the new regime in China is to ramp-up exports. If China is successful, it will push up raw material imports which in turn will boost commodity prices in dollar terms, the exact opposite of the conditions that have driven commodities lower across the boards.
I suspect that China’s new yuan policy will become a place marker. China kick-started this new yuan trading mechanism as a means to combating disinflation, systemic market risks, risks to the banking system, etc. It implies economic difficulty, but China is not alone in either the economic situation this policy is meant to counter, or the means by which it hopes to navigate it over the long run. In other words, same circumstances dictate the same policies – in China, in the United States, in Europe in the emerging world – and, all around, these policies in turn encourage gold ownership in the form of coins and bullion. And perhaps that is why gold unexpectedly got off the dime in the wee hours of a late summer Tuesday evening, 2015. MK
Final note: Once again, we do not advocate speculation in the precious metals, but rather believe that gold and silver should be purchased as portfolio insurance and an alternative savings vehicle IN ALL NATION STATES, i.e. against ALL CURRENCIES.
