Gold prices soared after China announced a surprise measure to devalue the Yuan, raising fears the country’s policy makers are taking desperate actions to stave off an economic collapse.
On Tuesday, China’s central bank cut its daily reference rate by 1.9%, causing the largest decline in the Yuan’s value since Beijing ended its two-currency system in January 1994. Gold prices responded in typical fashion, rising to a three-week high as skittish investors rushed to the safe haven. (Source: Financial Times, last accessed August 11, 2015.)
But what does a financial policy decision in Beijing have to do with the price of gold? Quite a bit, as it turns out.
Gold’s price movement is predictable, and underscores the importance of precious metals in moments of financial crisis. Rather than being the junk commodity many analysts have been referring to as such for months now, the safe haven’s psychological importance cannot be overstated. Commodity prices however retreated, as investors are afraid Chinese consumers will now have reduced buying power to buy raw materials.
The move by China has raised the prospect of a currency war, in which countries desire weaker exchange rates vis-à-vis rivals in order to keep their exports competitive. One doesn’t have to look far to realize why.
China’s economy slowed to seven percent in the first quarter of 2015, the slowest growth rate in six years, while data released this weekend shows that exports declined by 8.3% year-over-year in July. (Source: Washington Post, last accessed August 11, 2015.)
And this is only the beginning. Some analysts have pointed out that a 1.9% devaluation is hardly enough to jump-start China’s limping exports, and that more such moves are on the way. (Source: Bloomberg, last accessed August 11, 2015.) We may likely be facing new rounds of currency devaluations, as export countries large and small begin slashing the value of their money to remain competitive. (Source: CNN, last accessed August 11, 2015.)
You might be asking yourself why this development would have anything to do with gold.
Gold does not earn interest or pay returns like other investment assets such as equities and bonds, and is generally shunned for this reason in a bull market. But when financial markets are threatened as they are today, its appeal as a stable place to park your wealth soars.
Sound far-fetched? The numbers don’t lie.
Gold for December delivery rose by approximately 1.4%, or $1,119.10 per ounce. This is the highest price since July 20, and was climbing the COMEX at $1,109.50 by 7:24 a.m. in New York. (Source: Bloomberg, last accessed August 11, 2015.) The price of the yellow metal is up a fourth day in its longest run since May 2015. The volume of futures traded was more than double the average for the last one hundred days. Gold bullion for immediate delivery on the spot markets rose by half a percent to $1,109.93 an ounce.
Translation: Investors are afraid, and they are looking to park their money in the one place where it can’t disappear in the event of a crisis.
The Middle Kingdom’s decision to devalue its currency, perhaps as the first in a series of similar steps, will put positive pressure on gold price growth. (Source: Globe and Mail, last accessed August 11, 2015.) When you combine a looming currency war with slumping growth in Europe and Asia, a global energy sector hitting new lows, and the threat of a Greek exit from the European Union, it’s no wonder that people are scrambling to transfer their wealth into gold.
If we are truly standing at the edge of the financial abyss, gold will be the life preserver everyone is reaching for. Where the gold price will go from there may not be certain, but if history is any indication, it will likely skyrocket.