Gold initially began its bounce on Wednesday on the back of news that China hawk Peter Navarro had been muzzled by the White House and there were ongoing trade discussions between China and the U.S. at all levels of government. The same evening, Fed Chair Powell made some statements that were supposedly hawkish, but were dovish, in my opinion. Specifically: his references to global growth concerns and housing market weakness in the U.S.
The bounce continued on Thursday on the back of rumors that U.S. Trade Representative Robert Lighthizer had told industry executives that future tariffs had been put on hold, another sign of softening relations between the U.S. and China on trade. However, yet again, hopes were disappointed by firm denials from Lighthizer himself and U.S. Commerce Secretary Wilbur Ross. Gold did not reverse, though, as the rumors did raise hope that although the G20 meeting would likely not provide a definitive agreement, it could produce at least a delay in the implementation of 25% tariffs. Something which would likely lead to further devaluation of the CNY and lower Gold prices.
Then today two Fed members, Kaplan and Clarida, both cite concerns about slowing global growth and its potential impact on the U.S. economy. The Wall Street Journal also published an article stating that “the Fed should rethink its December rate increase.” The market interpreted this as being dovish for monetary policy, and expectations for a further rate hike in December receded. The dollar fell across the board as a result, and the USD/CNH (offshore USD/CNY) dumped to 6.91, its lowest level since November 7. Gold continued higher.
Over the course of those three days, Gold has risen from a key Fibonacci support level at 1197 and is now approaching another one at 1224 on a closing basis, its 61.8% retrace of the decline from 1239.
As usual, everyone desperate for Gold to rally is jumping on the bullish bandwagon. They may be right this time, but there are several caveats.
First, let’s review my scenario for “the” bottom in Gold from which we will see a historic rally, in my opinion.
Developments in the U.S.-China trade dispute have been the sole driver of Gold since April 11, via their effect on the Chinese yuan and its direct impact on Gold priced in dollar terms. Put simply, the risk of higher tariffs has meant a weaker yuan and therefore lower gold prices.
For this reason, I have repeatedly stated that Gold cannot rally sustainably until the USD/CNY has finally peaked and falls. This is unlikely to occur until the trade war between the U.S. and China ends and/or the dollar peaks and drops, particular against the yuan.
Given that I strongly believe there can be no voluntary agreement between the U.S. and China on trade—China cannot accept U.S. demands, and the U.S. is not willing to back down—then one side or the other will have to be forced to agree, or the issue of the U.S.-China trade deficit is resolved by a far weaker dollar and tariffs are no longer required. In my opinion, a U.S. stock market crash followed by a Fed reversal in policy would do just that. This would cause the dollar to slide in general, including against the CNY. A peak in USD/CNY equates to a bottom in Gold. This is my primary scenario for a sustainable low in Gold and the massive rally to follow.
There are numerous potential triggers for the coming crash in the U.S. stock market. A complete breakdown in relations between both sides at the G20 summit and the imposition of 25% tariffs on all Chinese exports to the U.S. would likely lead to USD/CNY breaking the critical 7 level and the yuan undergoing another 10% devaluation. This would undoubtedly cause global turmoil, including a U.S. stock market crash, and force the Fed to reverse policy.
However, should the Fed decide to signal a reversal in policy ahead of a crash by pausing its program of rate hikes or balance sheet reduction, this could have the same effect on USD/CNY and Gold. We’re getting a glimpse of that today. Everyone is excited by this possibility, but let’s consider it objectively.
First, will the Fed pause raising rates in December? I don’t think so. The Fed has done the following time and again: The Fed Chair pays a dovish nod to global and domestic concerns, but says that the economy remains strong and that gradual rate hikes will continue. Then soon afterwards, several members of the Fed come out and focus solely on those concerns. The Wall Street Journal too. Markets get excited that the Fed may pause its monetary tightening, the dollar falls, liquidity returns to the markets, and one market in particular gets a reprieve from a potential crash scenario: the stock market. If the stock market rallies back up to near its highs, will the Fed raise rates again? Of course they will.
The S&P has been extremely weak recently with the risk of further lows to come. There are few, if any, catalysts left to drive stocks higher from a narrative perspective other than a deal with China on trade or pause in the Fed’s quantitative tightening or “QT”. So what happens next? We get tentatively positive news on the trade front, and Fed members suddenly become dovish. Hey, presto, stocks rise.
But will we get anything of substance from the G20 on November 30? Highly unlikely, in my opinion. Will the Fed pause in December? Even more unlikely, if stocks rally from here.
The Fed will continue to raise rates until something breaks, and that something is the stock market. There will be no voluntary agreement between the U.S. and China. The trade war will only be resolved by one side or the other being forced to back down by an event such as a global market crash, including the U.S. stock market in particular. This is just my opinion, but please keep this in mind to avoid the risk of euphoria on the back of headlines designed to boost stocks, not Gold.
Gold will soar soon. I am just not convinced that we have seen the bottom yet. But I could be wrong, I hope so.
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