King Kong versus Godzilla: US and Chinese Central Banks Go to War over Trade

Tariffs are a mistaken policy---unless you find a trading partner who's even dumber than you are and is willing to foot the bill for you. President Trump may have done that. The strengthening dollar suggests a deflationary effect of the tariffs arising from Chinese dollar purchases. The dollar gets stronger, Americans can buy more; the yuan renminbi gets weaker, the Chinese can buy less but sell more. American goods will be harder to sell, but Americans will be richer and have more money to spend. If this pattern continues, some of the effects of Fed monetary policy--reduced interest rates--will be counteracted. The stock market may be in for a roller coaster as Chinese and Fed manipulation--King Kong versus Godzilla--battle it out. Americans may at least temporarily benefit. In the long term, we would have been much better off without the manipulation, without the Fed, and with a market-based system free of central bankers and Wall Street subsidization.

I have temporarily reduced my gold holdings on the chance that dollar strengthening continues and gold continues to fall. A few days ago $1240 was a technical resistance point. Gold is now down to $1217, and it looks like the drop will continue.  I suspect that the collapse in the commodity sector will continue down to the point where the Chinese stop subsidizing the dollar, probably when the dollar rises another five to ten percent. 

Trade War May Pressure New Bottom in Gold

President Trump's escalating trade war appears to be affecting gold prices, which respond to a stronger dollar.  The tariffs will make Chinese goods more expensive, but the Chinese can make their goods cheaper by making their currency cheaper to offset the effects of the tariffs.  There are many ways the Chinese can do this:  The yuan is pegged to the dollar, so they can lower the peg.  This is easy to do because the Chinese owe at least a trillion dollars in loans to the US, and they hold trillions in dollars and dollar-denominated loans that they’ve made to the US government. If they purchase dollars, the dollar will strengthen, and Chinese goods will become cheaper, offsetting the tariffs.  

In turn, the price of gold is affected by the dollar. A stronger dollar means cheaper gold. That correlation has held this week. 

In light of today’s White House threats of an additional $200 billion in tariffs,  the S&P 500 fell almost one percent and gold fell back to $1244, a fall of about $10.  The yuan renminbi-to-dollar exchange rate has fallen over the past couple of days to $0.1497, the lowest level this year.   

 It will be seen whether gold can hold a technical $1240 inflection point.  If not, there may be a good way down as the Sino-American trade-and-currency war escalates. That might provide a good entry point for gold, perhaps below the $1,000 mark.

Hope is not prediction, though.

Gold and VIX Fall in Response to Trump Tariffs

Gold broke down on Friday, falling to 1279 from about 1300.  Some technicians were calling 1280 critical support. What puzzles me is that it fell on the same day that Trump announced $50 billion in new tariffs and China announced $50 billion in response.  Tariffs are disastrous; trade wars are worse.   I would have thought this news would spike gold, but it had a reverse effect. 

I looked at the VIX, the one-month forward volatility indicator, and it fell by 1.16% in response to the announcement of a trade war.  What? The announcement of a trade war led to less volatility? Sometimes the announcement of news causes a reverse result when insiders have been trading in anticipation of the announcement. Then, they sell on the news.  That may have happened here, but it still seems strange. Another possibility is that Mario Draghi, head of the European Central Bank, made dovish remarks about ECB interest rate policy, causing the euro to fall against the dollar. This has short-term bearish implications for gold, which often goes in the opposite direction to the dollar. Low European interest rates may fuel demand for US stocks.

Whatever the reason, the decline in gold and the VIX both suggest a market sentiment that risk in the dollar and in financial markets are falling despite a trade war with one of the largest holder of dollars.  As I've previously blogged, the massive monetary expansion of the Bush and Obama years may have created a lengthy bear market in commodities. Lower interest rates means more funds are available for exploration, which means lower commodity prices. Eventually, the pendulum swings the other way as falling prices cause miners to go bankrupt.  Then, there is an explosion to the upside, as gold experienced in the 1970s and 2000s.

Still, a bloated stock market, a high dollar, significant Chinese dollar holdings, and the announcement of a trade war don't support a strong dollar, rising stock market scenario.  I'm puzzling over the apparent decline in volatility in response to the trade war news. Is the trade war a ploy or fake news of some sort?  It was announced on the heels of positive news about North Korea, which should have helped improve Sino-US relations.

If the VIX falls much more, it might be sensible to buy it in case of a sharp market fall at some point. I've made the decision to buy gold when it falls, even if that means to $200.