May 18, 2007
Gold Game Evolves As China Continues To Play Ball
By Brady Willet

A day after Asia's richest man warned that Chinese stocks ‘must be a bubble’, The People’s Bank of China raised interest rates, increased reserve requirements, and widened the Yuan’s trading band. As Bloomberg noted, the currency shift comes before an important U.S./China meeting next week and may have been timed to “appease U.S. lawmakers who say the Yuan is kept artificially weak”.  As for the rate hike and reserve changes, these actions were likely announced today so that investors would have the weekend to calmly absorb the news, or in the case of those heavily leveraged enough time to try and round up more funds. Needless to say the action in China’s equity markets could turn more interesting next week.

With the financial markets seemingly on autopilot for a few weeks now, it is tempting to contend that developments out of China will have a jarring impact on investor sentiment.  This is exactly what many analysts did when China first moved to “a managed floating exchange rate regime” on July 21, 2005 – or when there was building talk of a pending USD crisis, skyrocketing gold, and/or the onset of global rebalancing. Few could have imagined back then that things (with regards to currency volatility and financial market risk taking), would go so smoothly in the future.

But what should be remembered is that as China started to move towards a more freely floating currency in 2005 certain markets did respond.  Specifically, gold embarked upon a massive move higher in late 2005: a move that outpaced the coinciding downward move in USD.  Do today’s developments out of China presage another move higher in gold?



In a word, No...

Song Doesn’t Remain The Same For Gold

Against the backdrop of ‘endgame’ calls in July 2005, the following statement seemed applicable at the time:

That China is playing along and revaluing is positive but not great news for the price of gold.   Do You Remember July 21, 2005?

Ironically, the most applicable statement today may be the exact opposite:

That China continues to play along and revalue is negative but not dire news for the price of gold. 

Don’t get me wrong, with precious metals already in correction mode the price of gold could rally or fall independently of today’s announcement (after all, there is little to suggest that over the long-term USD hegemony will be more severely tested and when this happens precious metals will be the place to be). Nevertheless, what the last few years have proven is that the financial world not only still puts its trust in USD, but that China is willing to play ball with U.S. policy makers calling for change. These developments reinforce the expectation that changes in the FX markets could arrive in an orderly manner.  Thus, with gold perched near historic highs and currency regime change arriving slowly, how does a widely welcomed trading band tweaking in China spell good news for gold?  It doesn’t.

As for the tightening measures, if such moves are not absorbed smoothly by market participants and/or the Chinese economy, commodity prices - which are guided by the blurry perception/reality of unrelenting Chinese demand - could be in jeopardy of a correction. And as the selloff in late February highlighted, any negative developments in China’s financial markets serve to drain liquidity out of the system – potentially bad news for gold.

At the risk of listing off too many speculations, remember that Chinese investors have the weekend to absorb today’s announcements and that repeated calls for a meltdown in China’s financial markets have proven not only to be wrong, but wildly so. Much like in July 2005, it may be premature to mesh longer-term biases with policy developments in China. 


Incidentally, and to close with some context, despite some dollar doomsayers suggesting that China/Yuan domination will come at the expense of USD, the USD index is actually up since the first day of trading in 2005.

Members Home