By David Brady, CFA
Twenty-five percent tariffs on $200bln or 40% of China's exports to the U.S. are due to go into effect today or shortly thereafter. There seems little doubt that the U.S. will proceed with these tariffs: the U.S.'s trade deficit with China hit a new record high in July. All that remains to be determined is how they will implement them and how will China respond?
The tariffs could be implemented in several ways:
All at once, imminently
China continues to allow the yuan to devalue daily
China devalues the yuan 10-15% overnight
USD/CNY ↑ then lower
Gold UNCH then higher
All at once, weeks from now/post Mid-terms
Allows time for negotiation; kicks the can down the road
Gold ↑ then ↓
In stages, e.g. $50bln per month over 4 mos.
China continues to allow the yuan to devalue daily, but at a slower pace
The worst-case scenario is that the tariffs are implemented all at once and immediately, which would prompt the most negative response from China. If they choose to continue to devalue the CNY on a daily basis, then Gold will continue to fall to lower lows.
They could also devalue the yuan overnight by 10-15% on top of the depreciation in the yuan to date. I have covered this in detail in prior articles, but suffice to say that this would mean USD/CNY would rise 10-15% overnight, but Gold would remain unchanged in dollar terms, at least initially. Such a devaluation would likely cause a U.S. stock market crash and Fed policy reversal to "stimulus on steroids", causing the dollar to peak and drop - USD/CNY too - and Gold to rise from that point forward.
Alternatively, the U.S. could decide to implement the tariffs all at once, but weeks from now or after the Mid-Term elections. Initially, I would expect a relief bounce in the yuan, drop in USD/CNY, and Gold to rise. However, as the date for implementation approaches with no resolution, USD/CNY would likely rise again and Gold fall.
Lastly, the tariffs could be implemented in stages. For example, they could roll out tariffs on $50bln of Chinese exports per month over four months. This would delay the impact to U.S. consumers and businesses and therefore, would reduce their potentially negative impact on the Mid-Term elections. However, it would likely not impact China's response. USD/CNY could resume its daily appreciation under such circumstances, and Gold would continue to fall.
The trade war and its effect on the USD/CNY exchange rate remain the primary determinant of Gold prices in dollar terms. Until either the trade war ends or the dollar falls, either of its own accord or due to a Fed reversal in policy, USD/CNY is likely to go higher and Gold lower. Until then, the uber-bullish positioning, sentiment, and technical data will simply remain as fuel for the coming rally, in my opinion.
Switching gears to other recent developments related to the long-term outlook for Gold…
Big companies investing in mining companies at relatively low prices are a clear sign that the bottom is close in Gold, in my opinion.
Perth Mint's August gold, silver sales rise on lower prices.
Sales of gold coins and bars surged 30% from July to their highest since October 2017 and nearly doubled from August 2017. Clearly, the smart money is accumulating "physical" Gold and Silver at what they perceive to be bargain basement prices.
Bloomberg: With inflation rapidly spiraling out of control, Iranians have turned to gold. Bar and coin sales tripled to 15.2 tons in the second quarter of this year.
Widespread weakness in emerging market currencies encourages the rest of the world to buy Gold at the same time that the smart money in the U.S. and elsewhere is picking up Gold on the cheap.
The Reverse Bank of India (RBI) has bought 8.46 tonnes of gold in financial year 2017-2018, its first Gold purchase since 2009 when it bought 200 tonnes from the IMF. This brings its total to 566 tonnes at the end of June - Economic Times.
It may not be much, but it is also India's first official gold purchase since 2009, notably following the global financial crisis, which may provide insight as to rationale for their more recent purchases. According to analysts in Mumbai, the Reserve Bank of India also added 6.8 tonnes to its reserves in July.
That takes its total gold reserves to 573 tonnes in July, the fifth consecutive month of purchase by the RBI.
Simply put, this means that yet another central bank is purchasing Gold. Clearly, demand from the smart money for physical Gold and Silver and mining operations is increasing as prices fall. Emerging markets are also buying, as global risk aversion increases.
Foreign institutional investors' holdings of yuan-denominated bonds in the onshore market increased by 58bn yuan to 1.412tn, 64.7% higher y/y, higher for the 18th straight month - Yuan Talks.
Just as M&A in the metals mining sector is picking up when mining stocks are plumbing new lows, institutional investors are buying "yuan"-denominated bonds when the yuan is near its lows relative to the dollar. What does this tell about the smart money's view on the yuan vs. the dollar long-term? A lower dollar and a higher yuan mean higher Gold prices.
Washington uses the US dollar as a lever of pressure when it "wants to punish someone".
- Sergei Lavrov, Russian Foreign Minister
This speaks to the acceleration of global de-dollarization, as the U.S. attempts to impose its will on the Gold Axis of China, Russia, Iran, and Turkey to protect the dollar's status as the global reserve currency ("GRC"). Gold is the anti-dollar. If - or rather "when", in my opinion - the dollar loses its position as the GRC, Gold will explode higher and Silver will too. I believe this will occur following the Fed's response to the next crisis when I expect them to print the dollar into oblivion to cover all of the U.S.'s debt and unfunded liabilities, and they will likely resort to helicopter money to keep the consumption-led economy from imploding.
Odds of a bear market now higher than before 2000 and 2008 crashes - Goldman
Although this comes from Goldman, it's hard to argue with its track record. According to Fed Chair Powell and the FOMC recently, a stock market crash means a policy reversal will follow shortly thereafter. I have said repeatedly that a reversal of policy by the Fed to "stimulus on steroids" will likely mean the peak and fall of the dollar and a truly historic low in the dollar price of Gold.
I'm sharing my holistic mosaic approach with you to emphasize that although precious metals have fallen significantly recently and remain under pressure, the outlook beyond the short term is increasingly bullish. With this in mind, I'll leave you with this final chart, courtesy of Charlie Bilello. This is the best graph on Gold out there, in my opinion. It clearly shows just how undervalued Gold truly is, how overvalued stocks are, and why "Cycles" matter. What happened to Gold and Silver prices post-2002?
Follow the smart money long term.