- FX regime shift in China has supported precious metal prices…
- …mainly because of US dollar weakness
- But this development has not altered our outlook for precious metal prices…
- …because we still expect higher US rates and stronger USD to trigger position liquidation
FX regime shift in China…
The People’s Bank of China (PBOC) has recently shifted its daily yuan reference rate pricing mechanism to better reflect market forces. As a result, the yuan weakened by around 3.5%. This surprised financial markets.
…and gold strengthened on deterioration in sentiment…
The FX regime shift in China has supported gold prices. Financial markets appear to be concerned about the motivation behind this decision. They fear that the Chinese economy may be weaker than currently is anticipated. This has resulted in deterioration in market sentiment, which has been reflected by lower US Treasury and Bund yields and weakness in equity markets. Gold prices have received some support because of this.
…and more importantly a weaker US dollar
This FX regime shift has negatively impacted the US dollar. There are two reasons for this. First, as recent episodes of deterioration in investor sentiment have shown, the US dollar is negatively affected because it is mainly driven by cyclical forces such as the state of the US economy and Fed rate hike expectations. Second, financial markets have slightly scaled back expectations about a possible rate hike in September because of concerns about China. We do not share this view. Chinese authorities are working hard to support the economy, which is logical. A weaker US dollar has supported gold prices.
Weaker US dollar overrules China growth worries
The other precious metals have done relatively well so far this week. Since Monday they have outperformed the US dollar by 1-2%. If financial markets were really concerned about a Chinese hard landing, these precious metals should have moved much lower. Weakness in the US dollar versus most major currencies appears to have outweighed the effects of worries about the demand outlook.
The recent developments have not altered our outlook for precious metal prices. For a start, we expect the Fed to start raising rates in September driven by a strong economy. This should support the US dollar across the board. The prospect of higher US interest rates and a stronger US dollar is a major headwind for precious metals prices. It is likely that in such an environment investors will liquidate speculative positions in precious metals. Gold prices will be the most negatively affected in our view. Silver prices remain closely tied to gold’s fate in the near-term. The negative spillover effect of lower gold prices on other precious metal prices signals that investor liquidation has further to go. This implies that price weakness in cyclical precious metals has further to go as well. We expect a recovery in cyclical precious metals’ prices to arrive later.