Last week brought an odd twist to commodity markets, with crude oil rising more than 12% and gold prices falling by just as much. The dichotomy played out as markets swung wildly, trading on weak Chinese data and a strong U.S. dollar. Ultimately, the flight to safety didn’t include an upswing for gold, but I think a currency war between China and South Korea could change that.
Gold has severely underperformed this year, shedding over a fifth of its value since January. The yellow metal has lost more than 65% since its peak at $1,900 per ounce in mid-2011. There are several reasons for the decline, chief among them a voracious stimulus program undertaken by the Federal Reserve.
But now, winds of change are blowing in from the East. China wants to secure its geopolitical strength by convincing the world to grant the yuan reserve currency status. The country has been manoeuvring quietly, integrating itself into global finance and buying up gold to hold as reserves.
However, the country’s stock market crash and declining exports threw a wrench in the works. Chinese officials grew afraid of an economic collapse, and they responded with haste. The People’s Bank of China forced down the yuan in an effort to foster economic growth. (Source: The Wall Street Journal, August 11, 2015.)
But they may have kicked off a currency war that will cost them what they really want: reserve currency status.
Reckless Money Printing is Bullish for Gold Price Forecast
A big portion of South Korea’s overseas shipments go to China, and worse still, China is their main competitor in other export areas.
As such, a depreciating yuan damages the attractiveness of South Korean exports, and unfortunately, many analysts are expecting Seoul to respond by putting downward pressure on their own currency.
But with both currencies falling, no one wins. It’s a race to the bottom, with both sides moving so aggressively that we should expect a currency war.
But there is one upside for commodity investors—all the uncertainty is making people nervous. South Koreans are on track to buy record amounts of gold in 2015 and China’s finally disclosed the size of its gold reserves.
Buying gold in its current slump could pay off big since there are both institutional and consumer forces working for the upside.
Gold Bullion: Hedging Against a Currency War
For the average South Korean, holding gold is a security measure against the contagion from China’s stock market crash. They are on track to buy 1 trillion won ($860 million) worth of gold bullion this year. (Source: Reuters, July 31, 2015.)
The Asian Financial Crisis of 1997 and 1998 looms large in the rearview mirror for many South Koreans. They remember selling their gold impulsively and being unable to recover it when times got rough. It’s clear they’re eager to avoid the same mistake.
Chart courtesy of www.StockCharts.com
Korean households are estimated to hold 800 tonnes of the precious metal. Since August shipments fell by 14.7% from the same month last year, we can assume they will continue to add bullion to their stores.
On the institutional side, things are also encouraging for gold investors. For the first time in six years, China announced it held 1,658 metric tonnes of gold bullion. The reserves reflect a 60% increase from 2009, an obvious attempt to bolster the yuan. (Source: CNBC, July 18, 2015.)
But China is trying to juggle competing objectives. The government is putting out fires on too many fronts while also trying to build a solid foundation for the nation’s future.
Financial regulators were still cementing a policy response to the stock market crash when the PBOC devalued the yuan. It was an overt warning sign about the country’s economic health. China would simply not randomly depreciate the currency when it’s preparing for a run at reserve currency status. The situation must have been critical.
Race to the Bottom Boosts Gold Price Outlook
In any case, the greater the damage, the more gold China will need to lend credibility to the yuan. They will not have abandoned hope for reserve currency status, but only by adding more bullion to back their currency do they stand a chance of success.