No Bottom in Gold until Trade War Ends

No Bottom in Gold until Trade War Ends 

Written by David Brady,CFA - Sprott Money News

I keep getting the same arguments trying to undermine the existence of a Chinese peg for Gold in yuan terms, despite having clearly provided the rationale for why the Chinese would enforce such a peg and the simple math for why it is now almost exclusively driving Gold price. Yet people continue to question its existence. To avoid repeating myself any further—and make better use of people’s time for those who already “get it”—the articles below cover all of the issues raised:

https://www.sprottmoney.com/Blog/gold-the-chinese-connection-david-brady-27-102018.html

https://www.sprottmoney.com/Blog/china-takes-contr...

https://www.sprottmoney.com/Blog/gold-cny-devaluation-and-crash.html

 

https://www.sprottmoney.com/Blog/usd-cny-the-mirro...

At the end of the day, as we say in Ireland, “the proof is in the pudding”. This means that if Gold continues to track movements in XAU/CNY, and USD/CNY in particular, then you have your answer. It’s self-evident, simple math. 

Instead, I am going to focus on where USD/CNY is likely headed and, therefore, where Gold is headed.

USD/CNY’s rise began when President Trump first floated the idea of tariffs on Chinese exports to the U.S. It is no coincidence that the closing low in USD/CNY at 6.2680 on Apr 11 th coincided with the peak in Gold at 1369 the same day. It is also no surprise to me that USD/CNY has risen close to 10% since then, or put a different way, the yuan has been devalued by ~10%, the same amount as U.S. tariffs on Chinese goods until very recently. You see, China imports a lot fewer U.S. goods than it exports to the U.S., hence the massive U.S. trade deficit with China. So it cannot respond in kind with tariffs on U.S. goods and therefore must resort to other methods, such as devaluation of the yuan. And if there were any lingering doubt that China was using a weaker yuan to offset U.S. tariffs, this was dispelled in a Global Times article on Tuesday: 

Therefore, in order to determine where USD/CNY and Gold are headed, we need to consider the next possible steps in this escalating trade war—and when and how it might end.

The latest salvo from the U.S. was the Aug 1st announcement by U.S. Trade Representative Robert Lighthizer, following direction from Trump to consider increasing the proposed level of tariffs on $200bln of Chinese goods from 10% to 25%. These would go into effect on Sept 5 or later, following an observation or comment period. Put simply, this was to give time for the Chinese to respond or, better yet, agree to U.S. demands.

China did respond almost immediately, but not in the way the U.S. wanted. China vowed it would retaliate with its own countermeasures. Foreign Ministry spokesman Geng Shuang stated in Beijing:

  • “China’s position on the China-U.S. trade issue is firm and clear. Pressure and blackmail from the U.S. side will never work on China.”
  • “Dialogue should be established on the basis of mutual respect and equality, and on the basis of rules and trust.”
  • “Unilateral intimidation and pressure will not achieve the desired effect.”

USD/CNY continued to rise from 6.82 to a high of 6.90 by Aug 3 rd, its highest level since May, 2017. Meanwhile, Gold fell from $1233 to $1212 at the same time. More importantly, this response illustrated a key point in this trade war: China is clearly not going to back down but will continue to respond in kind to escalation from the U.S., which means that this will not be resolved quickly but will be a protracted war.

This view is supported by numerous comments to this effect in Chinese media since. Below are just a select few:

  • “The U.S. is trying to conclude the trade disputes swiftly, but China is prepared for a protracted war.” Aug 5
  • “Kudlow should warn the Trump administration not to underestimate China's determination to fight to the end.” Aug 5
  • “We don't fear sacrificing short-term interests… China has time to fight to the end.” Aug 5
  • “If the U.S. insists on fighting a trade war, China will fight back.” Aug 4
  • “China will eventually defeat the trade blackmail of the U.S. and it is impossible to force China into surrender to the U.S. coercion.” Aug 6
  • “China didn’t choose a trade war but was forced to accept it. China will not surrender to the U.S., nor could it ignore the trade war. The only way is to face it and win it.” Aug 6

 

Speaks for itself, doesn’t it. The core of the issue for the Chinese is not so much the U.S. demands but the manner in which they are being delivered. China is all about saving face, and they believe the U.S. is using “bullying tactics” to force them to agree to U.S. demands. “China's leaders do not wish to appear as buckling under U.S. pressure.” China has repeatedly stated that they are willing to sit down and negotiate the trade issues between the two countries, but it must be on an “equal footing”. This doesn’t marry well with Trump’s negotiating tactics nor those of John Bolton in particular.

Why is all of this relevant? Because it means the U.S. and China are in a stalemate. Neither is willing to back down. I prefer to put it this way: The U.S. and China are playing a game of chicken, and both are waiting to see who breaks first. As the U.S. increases tariffs and their scope, China just responds in kind. One of the tools the Chinese are clearly using is a weaker yuan, a higher USD/CNY, which is what has been driving Gold lower since April. Given that a resolution appears to be nowhere in sight, this trade war is likely to continue a lot longer than many expect, which doesn’t bode well for the yuan or Gold.

So how does this all end and when? The U.S. is clearly betting on the fact that rising tariffs will bring the Chinese economy to its knees, and therefore China will ultimately capitulate to U.S. demands. By contrast, China is betting on two potential outcomes:

  1. U.S. tariffs hit U.S. businesses and consumers, such as farmers and the fishing industry recently, dramatically slowing the U.S. economy and becoming politically unpopular in the U.S. ahead of Midterm elections in November, thereby softening the U.S. stance. Much like proposed tariffs on car imports from the EU were widely unpopular and forced a negotiation between the U.S. and EU on the issue.
  2. A crash in U.S. financial markets, most notably the stock market, which unlike in China is key to U.S. Federal Tax Receipts and, therefore, U.S. Government finances. A yuan devaluation of 3% in August 2015 caused a sharp reversal in stocks. That was when the S&P was 30% lower than it is today, and the yuan has already been devalued ~10% to date. Such a crash would likely force the Fed to reverse policy towards ‘QE’ and lower interest rates, causing the dollar to drop. USD/CNY would also drop, negating the need for tariffs by making all Chinese exports to the U.S. more expensive in dollar terms and U.S. exports to China cheaper in yuan terms, reducing the trade deficit between the two countries.

 

As I said earlier, 25% tariffs on 40% or $200bln of Chinese exports are due to go into effect on Sept 5 or thereafter. Given the rhetoric on both sides since then, I wouldn’t be surprised to see Trump threaten what he said a month ago and propose a 25% tariff on ALL Chinese exports to the U.S., ~$500bln. If China were to remain consistent and respond in kind, one would expect a dramatic response to such a move that could tank U.S. and world markets.

This would also come at a time when the Fed and global central banks are tightening global liquidity, the lifeblood of stock markets, which is expected to be negative in Q4. The punchbowl is being removed. Furthermore, the Fed’s balance sheet reduction program will hit $50bln per month in October, at a time when treasury issuance is already increasing $100bln per month and foreign demand is waning. Sounds like a perfect storm for a stock market crash, in my opinion.

Should such a crash occur in September or October, given the importance of the stock market to U.S. finances, I would expect the Fed to reverse policy to stimulus on steroids and the dollar to fall. USD/CNY also. This would be the peak in USD/CNY and the bottom in Gold for the foreseeable future, perhaps ever.

In the short-term, there is an observation period before the 25% tariffs are implemented. China could try to appease the U.S. by allowing the USD/CNY to fall temporarily, which would cause Gold to bounce. If they do, it is unlikely to work, and USD/CNY will go higher again, perhaps beyond 7, and Gold will fall to lower lows before the endgame is reached.

In summary, Ivan Martchev put it best in his “original” Marketwatch article:https://www.marketwatch.com/story/trump-is-foolish-to-think-china-will-back-down-from-a-trade-war-2018-08-02

No Bottom in Gold until Trade War Ends 

Written by David Brady,CFA - Sprott Money News

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Check out these other articles by our contributors:

Trump buys into the Krugman con - Peter Diekmeyer (08/08/2018)

COMEX Gold and the Commitment of Traders Report - Craig Hemke (07/08/2018)

“If the U.S. dollar goes down, you might want to own gold.” - Eric Sprott on the looming crisis -Weekly Wrap-Up, Aug 3,2018)

Sales of Physical Gold Explode as the Currency Wars Continue to Unfold - Nathan Mcdonald (03/08/2018)

USD/CNY – The Mirror Image of Gold - David Brady (02/08/2018)

Top Gold Miners Production Declined 15% While Costs Escalate - Steve St. Angelo (01/08/2018)

 

 

Comments

JIMSJOE2 DarkPurpleHaze Fri, 08/10/2018 - 07:33 Permalink

Actually you are incorrect as there are computer models at Armstrong Economics that track every market including domestic and international capital flows. These make forecast without any human intervention. Their clients are the so called smart money. Some examples are back in 2009 models forecast that Europe is beginning to collapse and capital will flow out and move into dollars and dollar based assets. This capital flight accelerated in 2011 and still in effect. When the ECB went to negative rates the models alerted clients in June of 2016 that if gold did not break the 1362 reversal level at July's close this would indicate that capital is on the move again. Gold closed at 1361 and moved down to around the 1100 handle with the dollar gaining massive strength and the Dow kept breaking record after record all due to capital flight. The whole purpose of the negative rates, (charging banks to park capital at the ECB), was to get them to lend. This failed immensely as banks opened up branches in the US converting euros to dollars and parking at the FED and lending in the US causing even more capital to flee Europe. The models forecast as we move into the end of 2018 capital will again accelerate and move into dollars and dollar based assets as there are few place to park capital. The models forecast the shit hits the fan around 2020/21 and the EU, euro, most banks, many corporations and countries will not survive in their present form. The euro is expected to collapse no later than 2021. Currently we see currency traders in London today monkey hammering the EUR/USD and GBP/USD as they are taking advantage of the models forecast. The euro is below 115 and the pound below 128 as the models forecast.

    The models also forecast that capital will flow from emerging markets as their currencies weaken and move to dollars causing even more strength. We are just seeing this now. Emerging markets go first then Europe. The ECB has completely destroyed the sovereign and corporate bond markets by either buying or guaranteeing the debt. If they keep buying the euro collapses faster. If they stop rates skyrocket and the whole EU collapses. This is why Draghi says one thing but actually does another. He is responsible for the collapse of Europe along with Merkel and the EU. There is no place in Europe to park capital and it has and will continue to move out.

     For years now those who push metals have claimed that the dollar and the Dow will collapse "any day". When that did not happen they all claimed the FED, Plunge Protection Team and the Exchange Stabilization Fund were all propping up markets and the "cartel" was suppressing gold to instill dollar confidence. These people are clueless. Yellen was furious with Draghi when he went to negative rates as she knew this would only accelerate capital into dollar and cause unwanted strength which is exactly what happened. As Martin Armstrong as stated if you want to see a world wide collapse just watch the dollar keep strengthening. This is why the FED has been desperate to weaken the dollar and to stop the capital flight from Europe and now emerging markets. The problem is they cannot.

   By the way back when the Dow was around only 6000 the models forecast the Dow to hit 22,000 first then 23,000 and then as the last leg of Europe collapses going to around 40,000. To say they have been spot on is a huge understatement. Their clients have made billions and capital is still moving out of Europe as we move closer to the collapse.

    To say nothing can forecast capital flows is just completely wrong! It is these flows moving in or out of markets, countries and trading blocks that create the long term trend along with economic and social changes. Just look at Europe!

     By the way the models also forecast the next commodity boom mostly in food starting around 2024/25.

In reply to by DarkPurpleHaze

Davidduke2000 Thu, 08/09/2018 - 21:25 Permalink

China is having fun buying on the cheap however you still have to pay the price to buy physical gold.  Just bought from Kitco 20  oz of 1 oz Royal Canadian Mint that cost me $55 on top of spot, the order said booked and I was assured they had the gold, when I went to pick them up, they had none in stock, they wanted me to pay because I was there already and they will call me when they get them who knows when, of course I refused and told me to call me when they get stock.

Albertarocks Thu, 08/09/2018 - 22:38 Permalink

And the very instant that the grand announcement is released cheering the new "worldwide trade agreements", the BIS will use it as an excuse to continuing to hammer the absolute shit out of gold claiming something like "now that the trade war is over, there is no further use for gold.  We're going to continue the bash the ever living shit out of it, drive it down to zero and put a nail in that infernal coffin for evermore.  Free gold for everybody!"

divingengineer Fri, 08/10/2018 - 01:18 Permalink

 Why would geopolitical uncertainties be driving the price of gold down? Isn’t that golds bread and butter? It’s raison de etre?

Gold should be on a rocket ride.

What planet am I on?

boostedhorse Fri, 08/10/2018 - 01:44 Permalink

We are getting a nice preview on exactly what will happen in the next downturn in stocks/recession. Dollar will be bid just like the last time. Time to buy will be when crash happens and they'll slash to zero again and announce QE. Gold could halve in price briefly until that happens.

ItsAllBollocks Fri, 08/10/2018 - 04:26 Permalink

Another talking head with no other agenda than deceiving people out of their money.

Gold will not bottom until China decides they own enough and not one second before.

 

groundhogday CarpetShag Fri, 08/10/2018 - 06:00 Permalink

Ahhh... I remember a time when I used to take these articles seriously and even consider what the author said as a reasonable possibility.  years later, i realize just what you have stated CarpetShag.... all crap. But I must ask myself.  What is the bigger waste of time? Writing this dog crap, reading this, or posting a response to someone else's response to it?

In reply to by CarpetShag