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Last Updated : Aug 17, 2015 07:14 PM IST | Source: Reuters

View: Is a cheaper yuan good or bad for gold?

It's possible to construct plausible-sounding arguments why the recent drama in China's financial markets could be both bullish and bearish for gold.

Gold investors are trying to work out whether the yuan's depreciation and the recent turmoil in Chinese equity markets is good, bad or indifferent for demand for the precious metal in the world's biggest buyer.

It's possible to construct plausible-sounding arguments why the recent drama in China's financial markets could be both bullish and bearish for gold.

At the heart of most of the arguments is a view on how Chinese consumers will respond to the recent developments but it seems this is largely guesswork on the part of analysts, as there are few precedents to serve as a guide to future behaviour.


One big question is whether the yuan's sudden 3 percent decline against the US dollar last week and the swings in equity valuations are likely to be important drivers of Chinese gold demand, or whether other factors with a lower media profile are at work.

Looking at the yuan depreciation first, and the important thing seems to be that the authorities are signalling the drop last week was a one-off move, not part of any sustained weakening.

Beijing may be trying to assuage fears of a global currency war, but taking the assurances at face value means that the yuan price of gold will have seen a one-off increase of about 6 percent.

The positive from this is that a 6 percent rise isn't enough by itself to crimp demand for the yellow metal, especially since Chinese prices are still about 13 percent below the high point so far in 2015 reached in early February.

This means there is very unlikely to be a drop in demand on the basis of rising prices, so the next question is whether demand can actually rise because of uncertainty over other asset classes and the need for a currency hedge.

If the yuan's decline does turn out to be a one-off adjustment, it's unlikely Chinese consumers will feel much need to boost their gold purchases as a hedge against a weakening currency.

At the margin gold demand may get a boost from some re-allocation of investments, especially when the equity volatility is thrown into the mix.

The wild gyrations in equities have seen the benchmark Shanghai Composite Index lose 23 percent of its value between the closing high this year on June 12 and Aug. 14.

However, it has rebounded 13 percent since the recent low on July 7 after authorities took measures to limit losses in a bid to restore market confidence.


Whether confidence has been restored enough to encourage investors to keep their exposure to equities remains to be seen, but even if money leaves equities, it doesn't necessarily mean it will flow to the safe haven of gold.

Initially, it's more likely that investors burned by equity losses will repair balance sheets and pay down debt.

Investors would also have to be convinced that gold has turned the corner and is set for a renewed bull period, and while the 3.7 percent gain in the spot price between Aug. 5 and Aug. 12 is a start, it's still a stretch to say gold is heading for a sustained rally.

What is known is that falling prices haven't sparked consumer interest in gold in China, with a World Gold Council (WGC) report last week showing a 23 percent drop in demand in the second quarter to 216.5 tonnes from the first quarter's 280.8 tonnes. Demand was also down 3 percent from the second quarter of 2014.

Overall, gold demand in the second quarter was the weakest in six years, driven by declines in both China and number two consumer India.

At the margin, it seems the yuan devaluation and equity volatility hold more positives for Chinese demand than negatives.

But any increased demand for gold from investors in China may be more than offset by the winding back of the use of gold to back domestic financing deals.

Efforts by the authorities to boost lending to stimulate the economy mean that credit is becoming more readily available and at lower rates, thus reducing the need for gold as security for loans.

The WGC said in a report last year that as much as 1,000 tonnes of gold may have been used for financing deals in China.

If this gold is released back into the market, it will cut the need for imports into China, which would be bearish for gold prices.

Once again, gold appears to be caught between competing and contradictory influences, especially with regard to Chinese demand.

This makes watching China's imports from Hong Kong, the main conduit for the precious metal into the mainland, key to seeing which way demand is going.

These have been trending lower in recent months, reaching a 10-month low in June, and this will have to reverse to convince anyone that Chinese gold demand is starting to rise again.

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First Published on Aug 17, 2015 02:53 pm
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