Would A Trade Deal Wreck Gold's Recovery?

Includes: IAU
by: Clif Droke

A U.S.-China trade deal would likely result in a short-term gold pullback.

Gold's long-term upside potential would be strengthened, however.

China's gold consumption trend would benefit from a trade deal.

One of the questions I’m frequently asked is whether a trade deal between the U.S. and China would have a negative impact on the gold price. This is a difficult question to answer with a straight “yes” or “no.” Yet there are important reasons for believing that while gold would likely suffer a short-term setback from an amicable trade resolution between both countries, gold’s dominant intermediate-term (3-9 month) recovery would continue - and even benefit eventually - from such a deal. We’ll discuss this in today’s report.

Since last week, the U.S.-China trade tariff dispute has taken center stage in the financial media. The global equity market has gone from pessimism last week to extreme optimism this week as hopes for a trade truce fall and rise. On Tuesday, Wall Street expressed enthusiasm over a potential summit between President Donald Trump and Chinese President Xi Jinping next month. This resulted in an across-the-board leap in U.S. equity prices and a pullback in the U.S. dollar index. The April gold futures price, meanwhile, was slightly higher and remains above its technically important 15-day and 50-day trend lines (below).

April Gold

Source: BigCharts

Not everyone is optimistic that a deal to avert a scheduled tariff increase on March 1 between the U.S. and China is imminent, however. While the benchmark S&P 500 Index (SPX) has been rallying in impressive fashion all year, China stocks have significantly lagged the U.S. major averages. This becomes apparent when comparing the SPX with the graph of the iShares China Large-Cap ETF (FXI), shown below. FXI can be considered as a proxy for China’s broad market trend, and the conspicuous lag in the shares of China ADRs since last summer (when trade-related fears reached fever pitch) is a sign that China investors remain unconvinced that a trade truce will soon be made. This isn’t to say that a deal can’t be reached soon, only that there are still significant obstacles standing in the way of one.

iShares China Large-Cap ETF vs. S&P 500 Index

Source: BigCharts

Let’s say for argument’s sake, however, that the U.S. and China are able to amicably resolve their trade dispute in the upcoming weeks. What would this do to the gold price? After the initial euphoria of a trade deal announcement, which undoubtedly would rally U.S. and Chinese equity prices, the gold price would likely see a pullback as investors around the globe embrace a “risk-on” trading posture. This would mean that a knee-jerk selloff in safety assets, including gold, would almost certainly follow.

However, after an initial pullback, the gold price would still benefit from a U.S.-China trade deal. For such a deal would boost China’s economic prospects and allow it to ramp up its industrial sector. China, as the world’s leading gold consumer, would demand more gold as its exports increase and its manufacturing sector improves.

China’s yuan currency would almost certainly benefit from a trade deal, and this in turn could eventually brighten gold’s longer-term prospects even more. This outlook was recently articulated by analyst Fawad Razaqzada, who wrote:

A U.S.-China trade deal could boost the yuan, allowing Chinese investors to purchase more gold than would otherwise be the case.”

Shown below is the WisdomTree Chinese Yuan Strategy Fund (CYB), my favorite proxy for the yuan currency. While the yuan has a lot of lost ground to recover from last year’s high, the fact that it has established an intermediate-term bottom since last August and is starting to trend higher is a potentially bullish sign for China’s economic outlook in the coming months. The fact that the yuan is at least no longer weakening is a sign that stability is likely to be achieved in China’s manufacturing economy despite the threat of higher tariffs if a trade deal isn’t reached by March 1.

WisdomTree Chinese Yuan Strategy Fund

Source: BigCharts

Turning our attention away from the U.S. and China, let’s briefly examine another of the major countries which exercises an outsized influence over the gold price. As one of the world’s biggest gold consumers, India is an important driver for the gold price over the longer-term outlook. Any long-term analysis of the gold market which doesn’t include India’s jewelry consumption and demand levels is incomplete. Thus, it behooves us to keep an eye on the factors which determine India’s economic strength.

One of those factors is India’s stock market, which has historically proven to be a leading indicator for the longer-term trend in the price of gold. Shown here is the Direxion Daily MSCI India Bull 3X Shares (INDL), an ETF which can be used to track India’s broad equity market. As you can see here, INDL peaked last February - just ahead of the price peak for gold - and warned of the trouble ahead for the yellow metal later that summer.

Direxion Daily MSCI India Bull 3X Shares

Source: BigCharts

Indian stocks have since bottomed and are trying to turn around. A U.S.-China trade deal would also indirectly benefit India and would also be a reason for further longer-term recovery in the gold price due to India’s voracious gold jewelry demand. For that reason, investors should closely monitor INDL for signs of strength in the coming weeks.

Meanwhile, the iShares Gold Trust (IAU) continues to closely track the gold price and also remains above its 15-day and 50-day moving averages. IAU is my preferred trading vehicle for gold and I’ve had a buy signal on this ETF since October. For now, that buy signal remains intact as long as IAU remains above the $12.35 level on an intraday basis. In the event that this level is violated in the coming days, I’ll advocate a return to cash for short-term ETF traders based on the conservative rules of my trading discipline. For now, though, a bullish stance is still warranted.

iShares Gold Trust

Source: BigCharts

In conclusion, while a deal which mutually benefits trade between the U.S. and China could result in a temporary “knee-jerk” pullback in the gold price, the longer-term implications of such a deal would be bullish for the metal. Anything that increases China’s industrial prospects is sure to bode well for its gold consumption, in turn boosting gold’s attraction as an investment. For now, investors are justified in maintaining long positions in gold since the metal’s price remains above its key short-term and intermediate-term moving averages mentioned above.

Disclosure: I am/we are long IAU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.