Monday, 6 August 2018

Correlation Between Chinese Yuan and Gold

The King Dollar was used to be backed by gold until Nixon took the Gold Standard off in 1971 to finance the Vietnam War. This is also known as the Nixon Shock.

And for those who don't like the idea of a fiat currency (dollar bills not backed by commodity like gold, except the full faith in the government) would point to gold as a form of protection. In a sense, by owing some gold you hedge your fiat currency against devaluation (because of inflation).

Anyway, when i heard somebody said awhile ago (about 2 years if memory serves) that China was planning to back Yuan with gold as a way of displacing the fiat currency of the King Dollar, i scoffed it as some silly conspiracy theory.

But then because my mate hadn't shown me any data (preferably in the form of a chart) to back up that claim.

And a few days ago, somebody (else) mentioned that subject again, and so i thought i should give that this theory the benefit of the doubt, and dug a little deeper to see if there's any detectable pattern between gold and Chinese Yuan. The chart made me sit up and pay attention.

This is the chart i looked at by putting 2 charts - gold futures (GC) and Chinese Yuan (CNYUSD) - side by side (well, up and down). Before 2017, there's little correlation between them. In fact, in the 1st 10 months of 2016, they trended in the opposite direction. (So if i looked at the same charts back then 2 years ago when my friend told me about the Chinese plan for gold back Yuan, i wouldn't see any correlation in the chart).

Chinese Yuan (top chart) Vs Gold futures (bottom chart)
Chinese Yuan (top chart) Vs Gold futures (bottom chart)
(Click image to enlarge)

So i decided to have a closer look at them in the last 2 years period. I combine the 2 curves in 1 chart for easy comparison (I divided the gold curve by 10 so that they're in a comparable scale. This is perfectly ok as we're only looking at trend, not actual magnitude).

Gold (candle chart) Vs Chinese Yuan (orange line curve)
Gold (candle chart) Vs Chinese Yuan (orange line curve)
(Click image to enlarge)


It's hard to ignore their strong correlation. In fact, i haven't come across such strong correlation between 2 very different assets over a 2 years period with such close correlation EVER.

Euro (EURUSD) is known to have a good correlation with gold, and so i make similar comparison between EURUSD and gold. While it has good correlation with gold, it has broken down since June this year while the correlation between CNYUSD and gold has strengthened.

Gold (candle chart) Vs Euro (orange line curve)
Gold (candle chart) Vs Euro (orange line curve)
(Click image to enlarge)
This recent strong (last 2 years) correlation between gold and Chinese Yuan does lend support to the theory because Chinese Yuan got included into the SDR (Special Drawing Right) on 1st Oct 2016. So it's more reasonable to think that Chinese government would only start to peg their currency to gold as an expression of their commitment to the gold standard.

I don't know if this is proof of the theory or this is nothing more than a coincidence (which is very difficult to swallow as the correlation is strong and spans over 2+ years).

The bottom line is that from now on, instead of (or in addition to) only look at Euro when study a gold chart, one should look at the chart of Chinese Yuan as well to gain further insight.

The idea that despite being the smallest of the 5 in the basket of currencies, Chinese Yuan now has stronger correlation  with gold than the Euro, which has the largest percentage or the most dominant in the basket. So symbolically, at least, that Yuan is now a more important currency than Euro. Perhaps, one day dethrone the King Dollar. So the theory goes.

All this is just my speculation. I don't think anyone outside Chinese government really knows what's going on here. But i don't need to know the why to trade, except that now i should look at the CNYUSD (in addition to EURUSD) chart for further insight if i want to trade gold.




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