Last week, gold futures ticked slight higher and settled at $1,206.90 per ounce. But it is still down 1.6 percent in August and down more than 7 percent this year. Investors are nervous about escalating US-China trade disputes after US President Donald Trump threatened to impose tariffs on $200 billion more in Chinese goods. Although the US and Mexico reached an agreement to overhaul the North American Free Trade Agreement (NAFTA), the US-China dispute is seen as the main trade war, so a NAFTA accord is not enough to move the gold market. In fact, gold futures short positions by large speculators rose again for a sixth consecutive week.
One of the big casualties of the current trade tensions between China and the US has been the Chinese currency, the Yuan. In July, after the US talked of tariffs on Chinese goods, the offshore Yuan fell by the most since a devaluation in August of 2015. But an interesting correlation has now materialized between the Yuan and the price of gold. In the chart below, the price of gold (white line) has been declining all summer, but the Yuan (orange line) has also been declining against the US dollar. The day to day movements are almost a perfect correlation.
It does not appear that China is pegging the price of gold to the Yuan, since that would mean they are both buying and selling gold. Instead, they seem to buy gold when the Yuan rises, but are not selling any when the Yuan declines. But if the Yuan keeps declining, the Chinese are not bidding for any more gold which are priced in US dollars. But if the Yuan rises, the Chinese buy a lot of gold.
Commentator Jim Rickards has written extensively about the coming revaluation of gold as the major global economies turn away from the current system in which the US dollar is the world’s reserve currency. In a realignment of the global monetary system, each country’s currency would be valued according to the amount of gold reserves they hold. After the end of World War II, the Bretton Woods system was forged to manage payments for global trade based on fixed exchange rates and a US dollar tied to gold. Then the US ended the system in 1971 by removing the dollar peg to gold. In any new global system, authorities such as the International Monetary Fund (IMF) will probably issue a new currency called Special Drawing Rights (SDR) to each country which requests it. The value of the SDR will depend on each country’s value of gold reserves, so countries such as China and Russia have been quietly accumulating gold over the years. Based on current trading behavior, a US-China trade deal could lead to a rebound in the Yuan, which could prompt the Chinese (one of the biggest buyers of gold in the world) to purchase more.
A trade deal could also cause gold to have a big rally because of positioning. 2018 has not been a good year for gold. Sentiment has now become so bearish that, according to the Commitment of Traders Report (COT) published by the Commodity Futures Trading Commission (CFTC), large speculators have never been more bearish on the outlook for gold prices since 2006. The paper gold market is divided between large speculators and large commercials. The large commercials have historically been the people involved in the business of producing and purchasing precious metals in the course of their regular business activities. Large speculators have historically been hedge funds and other money managers who bet on precious metals prices.
At major market turning points, the large commercials typically are positioned correctly since they mostly trade counter to the trend. Large speculators typically are positioned wrong at market turning points and have to liquidate their positions as the market moves against them. When large speculators have to desperately cover their shorts, you can have very extreme price moves, as in 2001, when large speculators were net short and gold went into a multi-year bull market. In the chart below, large speculators’ short positions in gold futures (light blue area) are now net short by 255 ton, after being long 20 tons at the start of the year.
In the daily chart below, gold broke out on August 15th below a long term support line (dotted red line) at 1200. It then reversed quickly over the next few days to regain the support line and also break out above a falling price channel (in yellow)
In the weekly chart below, gold had been consolidating within an expanding symmetrical triangle (in red) with its volume-weighted-average (VWAP) at the center line (dotted red line). After touching the top trendline on July 4, 2016, gold had a chance to make a quick return trip to the bottom trendline but instead reversed back up at the VWAP in January of 2017. It now appears to be finding support at the same level.