Bubbly Gold: An Alternative Hypothesis?25 August, 2011, 0:33. Posted by Zarathustra
Tags: Chinese Yuan, Gold
Gold is something you can’t really value in monetary terms, as a result, I have never had any idea why and how gold should be priced at US$xyz (plug any numbers you like). And I have absolutely no love towards the idea that it is about debasement of fiat currency, simply because there is something really wrong semantically about this idea: if fiat currency is backed by nothing, what are you talking about when you say that fiat currency is being “debased”? Also, if gold is an inflation hedge, inflation in the United States is no where near the highs in 1970s.
If gold is an inflation hedge and/or hedge against debasement, these are something you can’t really explain. According to the Financial Times, Japanese people are now selling their gold because gold has been rising like crazy in Japanese Yen term. There is something wrong here. First of all, Japan has been in a deflation for I-don’t-know-how-many-years, so if gold is an inflation hedge, it does not make a whole lot of sense for gold to be making new highs in I-don’t-know-how-many-years in Japanese Yen term. Secondly, if gold is a hedge against so-called “debasement”, why should Japanese people be selling gold instead of buying? So they are not afraid of quantitative easing by the Bank of Japan?
Cullen Roche discussed about gold last week. He also pointed out that Gold now has very little to do with inflation in the United States. Instead he pointed to inflation in China and wages in China and India. It is true that these two countries are now the big drivers for gold demand, so it would be interesting to look into it further, and make some new hypotheses for further testing in the future.
Confining my discussion on gold and China, let’s start with some data-mining which by no means claim any relationship between anything, here’s the chart of year-on-year change in gold price in US$ term and year-on-year inflation in China. As we can see, there is some relationship, but it isn’t very tight.
Now this bit of data-mining is interesting. When we look at gold and the exchange rate for Chinese Yuan, surprise surprise…
There are something rather interesting here, although the reason for the existence of such relationship between them is not quite so clear. When gold did nothing, Chinese Yuan was doing absolutely nothing against the US dollar. When Chinese Yuan first start appreciated, the bull market has gathered pace for gold. Of course, while they both appreciated against the US dollar, the paces of the appreciation are very different.
And here is the interesting bit, zooming into the period since 2007:
Gold made new high in early 2008 as the financial crisis escalated. It did not reach that level until more than a year and a half later. Curiously, Chinese Yuan stopped moving against the US dollar in the middle of 2008 until almost 2 years later.
It is difficult to make sense of this relationship (if there is really any that can make any sense). You don’t see that tight relationship in Indian Rupee, so that’s interesting. Even more curious is that the movement of gold seems to be leading the movement of Chinese Yuan, and it is clearly now getting way ahead.
The reason is not clear. What I would speculate here is that Chinese policy makers allow the currency to appreciate whenever they think the economic growth is strong and inflation become more of a concern, and as it stopped appreciating during the financial crisis, we can infer that policy makers were having less confident on growth and inflation is no longer a problem. As growth and inflation picked up, the currency started appreciating again. Bizarrely, gold has been anticipating those policy manoeuvres.
So what would be a sensible alternative hypothesis for such observation?