The gold price just shot up to its three week high of $1,124.40 per ounce. Why? China just devalued its currency; first by 1.9% on Tuesday, and then another 1.6% on Wednesday. This has sent shockwaves to markets around the world, as investors turn to their “risk off” mode and look for safe haven assets like gold.
China’s devaluation of the yuan came right after the country reported its trade balance. In the month of July, China’s exports declined an astonishing 8.9% year-over-year to 1.19 trillion yuan ($190 billion). Trade surplus also fell eight percent to 263 billion yuan ($42.3 billion).
Moreover, the country’s producers have been facing deflationary pressures. In July, China’s producer price index (PPI) fell 5.4% year-over-year. In the first seven months of this year, PPI averaged a monthly year-over-year decline of 4.7%.
When the yuan loses its value compared to other currencies and assets, investors would not want to hold it. So, what is a good alternative to holding cash? Gold.
It is likely that the hoarding of gold among Chinese investors has already started. If not, it soon will. Markets understand this and gold just had a five-day rally to a three-week high.
The thing is, the Chinese central bank could adopt further measures to boost its economy. Since November of last year, the People’s Bank of China has lowered its benchmark interest rate four times. It could make another rate cut, or it could start printing money. All this would create downward pressure on its currency, and make gold more valuable in the eyes of Chinese investors.
More Countries to Follow?
As China devalues its currency, its products become less expensive compared to other countries’. This would boost the country’s exports. At the same time, people in China will find foreign goods more expensive than before, and demand for imports would decline. Knowing this, other export-oriented countries, such as Australia and India, might follow China and devalue their currencies too. This could spike a currency war.
What does it mean for investors when fiat money is losing its value? Well, gold is an alternative to holding cash, and investors know this. To preserve their wealth, investors would rush towards gold.
Fed Rate Hike Delayed?
Keep in mind, China is the second-largest trading partner of the U.S. A devaluation of the Chinese currency could affect trade flows between the two countries. A lot of U.S. companies have operations in China. A relatively weaker yuan and stronger dollar would crimp the profit margins of U.S. multinationals.
The stock market is already showing strong concerns about this. The NASDAQ, the Dow, and S&P 500 have been falling for two days in a row. At around 11:30 a.m. E.T. on Wednesday, more than half of the companies on the S&P 500 are trading in correction territory.
This makes us wonder whether the Fed is going to raise rates in September. If they do, then the U.S. dollar could further appreciate, further undermining the U.S.’s competitiveness in foreign trade.
So far, the Fed is not so sure about a rate hike in September. On Monday, Federal Reserve Vice Chairman Stanley Fischer told Bloomberg that “inflation is very low […] And the concern about this situation is not to move before we see inflation, as well as employment, returning to more normal levels.” (Source: Bloomberg, August 10, 2015.)
The Fed delaying its lift-off is a bullish signal for gold. Moreover, as the stock market tumbles, gold would attract more investors due to its safe haven status.
But the Fed Will Raise Rates at Some Point, Right?
Yes, but gold will still shine when that happens. You see, the first thing to be hit when the interest rate rises would be the U.S. stock market. This is because the U.S. financial market and the real economy have been all-too comfortable with low interest rates. A lot of the growth we see today is due to these artificially low interest rates.
When the interest rate rises, companies who fund their operations with borrowed money will have a hard time. Home owners will see a rise in their mortgage payments. And the stock market would be the first to react. At that point, even corporate buybacks would not be able to support stock prices. Gold’s safe haven status would be further strengthened at that point, just wait and see.
Is Gold About to Hit $5,000?
Even without China devaluing its currency, gold would still have tremendous upside potential. According to our most recent report, Gold: The Stock Contrarian Investors’ Best Play of the Decade, investors now have a chance to buy the metal at extraordinarily low prices.