Yuan slide: A silver lining for gold?

Could hurt US exports, lower inflation and make Fed postpone rate hike decision



China, which for long has tightly managed the value of its currency, allowed it to weaken against the US dollar last week.

The People’s Bank of China has said that it would from now on give more weight to market factors while fixing the value of yuan.

The move seems to have been prompted by China wanting to strengthen its case for figuring in the SDR currency basket. The IMF will be reviewing the composition of Special Drawing Rights (SDR) currency basket before end-2015.

A weaker yuan is negative for the global commodities market especially for gold as it will make imports expensive for China. The country consumes about half the metals and a third of the gold that is produced globally. However, if the Chinese decide to accumulate gold because other asset classes, including equity and real estate, are plummeting, then demand for the yellow metal may receive fresh support.

Greater clarity on the direction of gold prices will emerge next month after the US Fed meeting (September 16-17). If the Fed decides to go ahead with a rate hike unmindful of the move by PBOC, gold prices may drop.

But, if it refrains from the decision, gold has scope for a relief rally. Here are some cues to trade gold this week.

Fed may wait and watch

The CME FedWatch Tool, which tracks market reactions on the Fed funds target rate, shows a 45 per cent chance for a rate hike in September, down from a better-than-50 per cent chance a week ago.

The US Federal Reserve may want to wait and watch how the commodity and currency markets react to PBOC’s move to partially ‘float’ the yuan. A cheaper yuan means Chinese exports will now be more competitive. The US is already seeing its exports hurt by the strong dollar. A rate hike now may only bolster the dollar further and crimp the US economy, as profits of its multinationals take a hit. In June, the US recorded a 3.6 per cent year-on-year drop in exports — the sixth month of decline — following lower demand for exported industrial equipment.

Further, a weaker yuan will make imports from China cheaper for the US too. Of the US’ total imports, about a fifth is from China. Inflation in the US was flat in June, up by just 0.1 per cent over last year, after being in the negative territory or at zero for five months. If the Fed goes ahead with a rate hike, it will only further push up dollar and lower inflation.

Dollar outlook

If the Fed turns dovish due to the above factors and holds interest rates in September, the dollar may weaken, and gold may gain. Last week, the US dollar index dropped by 1.07 per cent and closed at 96.5. However, its sharp rebound from it support at 95.92 is positive. If data releases in the US this week show an improvement in the economy, the dollar can edge up. This week, housing starts data is scheduled on Tuesday and on Wednesday the crucial consumer price index. Market expects CPI in July to have increased by 0.2 per cent, month-on-month. If, however, there is a disappointment, dollar may be hit, giving gold a leg up. FOMC minutes for the meeting held on July 29 will also be released on Wednesday. On Thursday, jobless claims and existing home sales data are scheduled.

Gold may crawl up

Gold closed the week at $1115/ounce, up 1.9 per cent. Given that it has held above $1100 levels despite a stronger dollar towards end of the week, some further gains can be seen this week. The next resistance is at $1136, which is the 38.3 per cent retracement of the move between May high ($1232) and July low ($1077). However, if it fails to move above $1136, it may test the support at $1113.

The MCX Gold futures contract closed at ₹25,768 last week, up 3.5 per cent buttressed by a weak rupee. This week, the contract may see further gains if the currency continues to weaken. But if rupee makes up for losses in the last week, all the currency related gains may vanish. On the downside, the first support for the contract is at ₹25,500 to the target of ₹25,000. Alternatively, if the contract moves higher, it may encounter its first resistance at ₹26,000 and the next at ₹26,500. MCX Silver also saw a sharp rally last week rising by 4.1 per cent to end at ₹35,429.

But, the black candle on Friday, raises doubts over strength of the rally. The contract needs to move past ₹35,500 levels to make further gains. Else, it can weaken to ₹34,600.

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