Page 2 of 2 China's other bull is
solid gold By Adam Hamilton
bull
paced the dollar gold bull one-for-one. Their
charts to that point are indeed perfectly
interchangeable. And since we American contrarians
earned fortunes in the first four years of this
gold bull and were quite satisfied, I have no
reason to believe Chinese investors didn't feel
the same.
Having tracked gold in major
world currencies for years, I did know that the
Chinese gold bull looked just like the US one
before July, 2005. But what I hadn't realized yet
really startled me. The
greatest upleg of this entire
gold bull started in July, 2005. It's the one that
ended in May 2006 and led to enormous realized
gains for prudent contrarians.
Well, in US
dollar terms gold bottomed about a week before the
strict yuan-dollar peg was loosened. Then it
meandered lazily near lows for a couple weeks, in
the midst of which the yuan news broke. Then gold
really started climbing higher in earnest about a
week after the yuan news. It is a strange
coincidence that the most powerful gold upleg of
this entire bull market launched virtually
simultaneously with the Chinese effectively
severing their longstanding dollar peg!
I
really don't know what to make of this yet. My gut
feeling is I suspect it is indeed pure
coincidence. I was already very bullish on gold
the week before the announcement for reasons that
had absolutely nothing to do with China.
Correlation does not necessarily imply causation.
This being said, the more years I study
the markets the more I respect their underlying
complexities. Often relationships exist between
disparate markets that are not readily apparent.
One key example is today's Tortilla Crisis in
Mexico.
Corn tortillas are a crucial
staple food for at least 50m poor Mexicans. But
due to Americans burning corn to fuel our cars
thanks to the ethanol craze, corn prices have
soared. This is pricing corn tortillas out of the
reach of most poor Mexicans. It is such a big
issue the Mexican government fears widespread
civil unrest. Who would have thought that American
ethanol could lead to a potential Mexican
revolution?
My point here is even though
it seems improbable that the severing of the
yuan/dollar peg had anything to do with global
gold supply and demand in July, 2005, we can't
rule it out emphatically. Perhaps the US dollar
sold off on the quasi-floating yuan and gold
caught a bid because of it. Perhaps the newly
rising yuan inspired enough confidence in the
Chinese populace to increase its gold investment
demand. That could have driven gold's initial
spike off its lows which then enticed global
investors. All I know for sure is that the
coincidental timing here, within one week, is very
intriguing.
Since the peg was loosened,
the yuan has been climbing. Indeed this year its
climb has accelerated considerably as the red line
above shows. The rising yuan means that gold is
getting relatively less expensive for Chinese
investors. In the forex-implied sense, it takes
fewer yuan to buy a dollar and hence fewer yuan to
buy enough dollars necessary to buy an ounce of
gold. Of course the Chinese don't have to actually
buy dollars first to buy gold, but due to the
dollar's dominance of the world gold market this
is how Chinese gold pricing effectively works.
Hence the Chinese gold bull looks more
subdued than the dollar's since July, 2005. The
higher the yuan climbs, the more it moderates
gold's gains in dollar terms. This is readily
evident above in the blue yuan-gold line. This is
a double-edged sword for Chinese gold demand. With
a rising currency the Chinese can afford to buy
more gold, but with this same yuan rise nullifying
some of gold's dollar gains the yuan-gold
incentives to buy aren't as compelling as dollar
gold's. Nothing begets buying like higher prices,
and the strengthening yuan moderates those for
yuan gold.
But overall in a strategic
sense, the China gold bull looks very much like
the American gold bull. Yuan gold is up 172% at
best compared to 181% at best for dollar gold. And
despite the rising yuan in the last couple years
eroding some of the raw gold gains in dollar
terms, the yuan gold performance since the dollar
peg was dropped has still been excellent in an
absolute sense. The secular gold bull is alive and
well in China!
Back to my original impetus
for this thread of research, do Chinese investors
fleeing Chinese stock-market weakness have good
technical reasons to buy gold today? The answer is
definitely yes. The China gold technicals really
look quite bullish now and I would not hesitate to
throw long gold if I was in China.
Note
that yuan gold has carved a series of higher lows
and higher highs since early October, a textbook
young upleg. At best in May it was up 21% since
its October lows, definitely not a number to scoff
at. Other than the recent weakness spawned by
central bank gold-selling fears out of the West,
yuan gold has remained within a nice uptrend
channel for eight months now. Thus gold is already
showing consistent strength and laying the
foundation for its next sharp run higher.
Another bullish factor evident in yuan
gold is its long consolidation. For about a year
now, yuan gold has largely oscillated around 5,000
yuan per ounce. In bull markets there is
tremendous fundamental supply-and-demand pressure
for a price to rise, so when a price consolidates
sideways for an entire year big forces build
behind it. These consolidations reflect poor
sentiment. But eventually some catalyst emerges
that dispels this sentiment and a price soars
heavenwards as fundamentals aggressively reassert
themselves. The longer the consolidation, the
higher the odds of a big surge up once this
happens.
So totally independent of
stock-market considerations, yuan gold looks very
bullish today for a variety of reasons. Chinese
investors should have no problem buying gold if
they believe the metal's global fundamentals
remain bullish. And to have gold near technical
lows is a huge boon for China's stock-market
investors. As they start to get scared some will
certainly flock to the stability of gold. And
doing this when gold is technically cheap is far
better than doing it when gold is technically
dear.
Provocatively, yuan gold is only
about 11% below its all-time highs today. A surge
in Chinese gold demand, regardless of whether it
is driven by gold's own fundamental merits or
fears of falling stocks, could drive yuan gold
above last May's 5,764 yuan level in relatively
short order. And since there is nothing like new
highs to generate interest, even more Chinese will
follow the early investors in after new highs are
hit.
In the stock-market history of the
Western world, speculators tend to flock to gold
when panics and collapses set in. Sometimes gold
falls initially when people are scared enough to
sell everything indiscriminately, but very soon
rationality starts returning to some and they
start buying gold. This leads to a rising gold
price, which attracts the interest of even more
buyers. And soon gold is powering higher despite a
major stock-market downleg.
And with the
great Chinese love for gold going back thousands
of years, I suspect the Chinese investors will
have an even stronger urge to buy gold when stocks
crumble around them than we do in the West. Gold
is the ultimate store of wealth and a safe haven
in any financial-market storm, and the Chinese
probably instinctively realize this to a far
greater degree than we ever will in the West. Odds
are a major Chinese stock selloff would lead to a
surge in gold demand out of China.
Adam Hamilton, CPA.
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