Contributed Commentaries
Chinese Yuan Reversal Is Bullish Gold
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
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Grant Mine (circa 1880s), Eureka, Nevada |
Will gold and the yuan find more daylight in the mineshaft?
“As the yuan goes, so goes gold” proved true as U.S./China trade relations started to deteriorate this spring. From mid-April to mid-August, the Chinese yuan (CNY or RMB), fell down a mineshaft – a much longer descent than the shock devaluation in 2015. Gold has been in the same shaft exploring lower levels below $1,200 per ounce. My July 30 Kitco News Commentary examined the curious relation between Comex gold prices and the depreciating Chinese yuan. A stunning correlation between the two suggested a model of gold price based on the yuan would be helpful to determine direction as well as near-term bottoms and tops for the lustrous metal. The July column derived such a model. An August 13 Commentary, expanded the gold/yuan model to include the Japanese yen and euro. The resulting 3-currency regression removes much of the unexplained variance of the first. The current model is bullish gold if Friday’s yuan reversal signals stabilization or further strengthening of the Chinese currency.
Chinese yuan reverses
Figure 1 is an updated one-year plot of USD/CNY, a rising curve denotes a weakening yuan (i.e. one U.S dollar buys more RMB).
Beginning April 18, the yuan weakened dramatically from a triple-bottom of strength established earlier this year around the 6.25 USD/CNY-level. Shortly after the third low, the RMB rose exponentially to peak above 6.90 in mid-August – a nearly 10% loss in value. From this top, the yuan strengthened slowly and then accelerated in a downward plunge to the 6.80-level last Friday. This was accompanied by a strong Comex gold rally that closed at $1,213.3 (December contract).
The percent change in gold value over this same period is shown in Figure 2 in terms of four currencies: U.S. dollar, Chinese yuan, Japanese yen and euro.
In a strong U.S. dollar environment, dollar-denominated gold has suffered the most since April 18 – a loss of over 12% by mid-August. Gold priced in the native currencies of China, Japan and the eurozone have shed less value because their currencies are weaker compared to the greenback. However, it is important to note that gold in terms of yuan has moved sideways after losing only 2% on average for the period shown. The other cases have trended down with dollar- denominated gold; in yen terms worse than the euro.
With respect to realized volatility, gold in yuan is less than 1% and a full 4.5X less than the volatility of gold in U.S. dollars. I suspect that the yuan, which is a managed currency, has been allowed to fall in lock-step with gold to counter-punch U.S. imposed tariffs while mitigating capital flight. China is a top global gold buyer and so are its citizens. Although U.S. dollar gold price is in volatile decline, gold in yuan terms is quiet and relatively flat. Preserving gold value thereby seems a reasonable goal for the People’s bank of China (PBOC) - a societal bromide for an anxious nation with a falling currency.
This rationale may explain the high correlation of gold and the yuan. Table 1 compares rolling correlations for the two on June 26, July 27 and August 24. Three different time bases are shown for each date.
Three-Currency Gold Model
The unexplained variance of the original gold/yuan model model, albeit small, was reduced further by adding in more currencies. Figure 3 shows a three-currency model compared with actual Comex gold futures (most active contract). The added currencies are the Japenese yen (USD/JPY) and the euro (EUR/USD):
The new blue line model over a 3-month period (denoted by shaded boxes in Figures 1,2 and 3) tracks Comex gold quite closely with a statistical error of only $6.98 per ounce (1-sigma) compared to $8.20 per ounce for the single-currency model. The dotted blue lines show upper and lower model boundaries (+/- 2-sigma). Importantly, nearly all the gold futures data fall within these bounds (there were only two marginal outliers on 8/17 and 8/21).
In the July and August commentaries, a goodness-of-fit statistical measure called “R-squared” was used to evaluate the performance of the regression models. In market analysis, a model having an R-squared between 0.85 and 1.0 is typically accepted as “useful” or one that reasonably explains price movements of one security given another. The updated model of Figure 3 has a very impressive R-squared of 0.964.
Looking inside the 3-currency model, it is apparent that the yuan remains the primary driver of modeled gold price followed by the euro and, to a much lesser extent, the yen. In the past month the euro has flip-flopped with the yen; the euro now more significant. Table 2 shows the gold price sensitivity given a 1% change in each of the constituent currencies.
Chicken or egg revisited
Solving the mystery of the current gold/yuan correlation is less important than applying the results of the relation. It is doubtful that the Chinese have figured out a clever way to manipulate gold prices and more likely that the daily PBOC fixing is developed with gold prices in mind. Whatever the case, the model of Figure 3 has successfully anticipated gold moves since August 16 and shows the expected value for Comex gold is $1,220.6 per ounce given the currency levels of August 24.
Kitco News’ Allen Sykora shared my most recent thoughts in his Weekly Gold Survey Friday:
Richard Baker, editor of the Eureka Miner Report, is also upbeat, suggesting that gold may follow the Chinese yuan.
“The People's Bank of China stabilized the yuan before this week's trade talks,” Baker said. “This morning the offshore yuan (USD/CNH) has slipped below onshore currency (USD/CNY) -- a sign traders are betting on short-term strengthening.
“This is bullish for gold; as the Chinese currency strengthens, so does [the] gold price in U.S. dollars. There are also signs that Asian demand for gold is on the rise.”
It is Monday morning and Comex gold futures are showing resilience around their Friday close, the yuan has weakened slightly but the offshore traders are still positioning for further strength. A positive NAFTA outcome should be bullish for both. My present range for gold is $1,207 to $1,235 per ounce.
In the coming weeks, let’s see if gold and the yuan can find more daylight in the mineshaft pictured in today’s headline photograph.
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Richard P. Baker is the author and editor of The Eureka Miner’s Market Report at eurekaminer.blogspot.com. He owns shares of the SPDR Gold Trust ETF (GLD) and PowerShares DB US Dollar Bullish ETF (UUP).
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