FURTHER DEVALUATION OF THE YUAN WILL DRIVE GOLD PRICES HIGHER / SEEKING ALPHA

Further Devaluation Of The Yuan Will Drive Gold Prices Higher

by: Mark Yagalla           

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Summary

• Gold has broken out, and the $1,080 level remains a solid support.
• Investors owning gold in non-U.S. dollar terms have actually done okay in the past year and some quite well with gold priced in Russian rubles.
• Further yuan devaluation will spur Chinese buying of gold.

Anyone that follows gold knows that there's little love for the commodity. Even with the rally this week, most of the headlines that I read were that this is a temporary bounce and that gold is still heading lower. The calls from the so-called experts range from gold falling to $900 and even as low as $350. I believe they are all wrong for several reasons.

For one, just by looking at the gold price chart, one can see that there is a huge amount of support around the $1,080 level. A solid base has been built and what can't go lower must go higher. China's devaluation of the yuan was just the catalyst that gold needed to break out to the upside.

(click to enlarge)

Second, gold is not a commodity like oil where the majority of transactions are conducted in U.S. dollars. Gold is a currency and is used as a hedge against inflation and more importantly - currency devaluations. If you look at gold priced in non-U.S. dollar terms, gold has done better than those holding gold in U.S. dollars. As the U.S. dollar strengthened, the price of gold has indeed gone down.

However, in looking at Russian rubles, euros, yen, Australian dollars, and Canadian dollars, gold has gone up in those currencies over the past year. Gold priced in rubles has increased by 52% in the past year, euros 1.78%, yen 3.11%, Aussie dollars 7.48%, and Canadian dollars 1.76%.






Source: Bullion Rates

Third, the recent yuan devaluation will drive gold priced in yuan higher. This will come from increased Chinese demand looking to hedge their currency exposure. The absence of Chinese demand was one item that gold bears were able to argue as to why gold prices should be weaker. Judging by the history of a weaker currency, the price of gold in yuan will go higher and it has already done so.

Gold priced in yuan is up 6% this week compared to gold priced in U.S. dollars which is only up 2%.


Source: Bullion Rates

What about gold in U.S. dollars?

I've been a U.S. dollar bull; however, I am starting to reconsider my position. U.S. dollar strength has been largely a result of rate differentials and the expectations of a Fed rate hike.

However, this week was quite interesting for me.

Now in trading, most traders pay attention to the U.S. dollar index on the ICE futures exchange. In this index, the euro represents 57.6%, yen 13.6%, British pound 11.9%, Canadian dollar 9.1%, Swedish krona 4.2%, and Swiss franc 3.6%. Because of the strength of these currencies this week, the U.S. dollar index dropped this week from 98 to 96.

(click to enlarge)


I believe China will devalue the yuan further, and we'll see more of what we saw this week as a result. In other words, a stronger euro, stronger gold prices, and a weaker U.S. dollar index.

What about the Fed?

I'm of the opinion that the Fed will not raise rates in September. I've discussed it here and it explains the U.S. dollar weakness that I saw last week. What's interesting is that this week has me reconsidering the long-term bullish case for the U.S. dollar. I previously thought the weakness was temporary. What we saw this week might indeed be a trend change. I was quite intrigued by an article from Bloomberg that said when it comes to past interest rate hikes, it was buy the rumor and sell the fact. The article said:

The U.S. currency strengthened an average of almost 9 percent during the six to nine months prior to the past three rate-rise cycles. After that, it's been a downhill ride, with the six-month drop averaging about 6 percent.

This goes against everything investors have been thinking recently. Most have been thinking that once the Fed raises, it will keep raising and boost the dollar. Well, from this article and from what I'm seeing, it looks like a rate hike might already be priced into the market and that's why the U.S. dollar is selling off regardless of whether we get a hike in September or not.

Bottom line

I do believe we are going to see buyers coming back into gold and higher prices over the long run.

While we may indeed test the $1,080 level again in the short term, I do believe buyers will emerge and defend that level again. I think the currency wars are here to stay and this will drive gold prices higher. If anything whether you're a U.S. dollar bull or bear, it's probably wise to invest some of your non-U.S. dollars into some gold.