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Mr. Chirag Mehta`s views on Chinese Yuan depreciation and Gold

Posted On Thursday, Aug 13, 2015

The People`s Bank of China (PBOC) weakened its currency dramatically for two consecutive days. The official comments are - China is not waging a currency war; merely fixing a discrepancy. The central parity rate revision was designed to make the Yuan more market-driven and in line with market expectations.

Given the depreciation in many of the developing markets and exporting nations, China has also joined the currency wars in a bid to protect its exports and provide some relief to the slowing economy and thereby provides itself sometime to smoothen out the economic restructuring.

That`s bad news for carry traders (those who deal in currencies), drawn to the Chinese Yuan (CNY) by its stability. If this devaluation runs further and marks the beginning of an ongoing and persistent depreciation of the CNY versus the USD, it could spell disaster for carry (currency) trades and in turn could potentially scare financial markets. The embedded USD short position within the carry trades will begin to result in losses and margin calls as the USD appreciates versus the CNY, thus forcing investors to liquidate some of their positions. These trades, which took years to amass, could unwind abruptly and exert an influence of historic magnitude on markets and economies.

On a broader level, the devaluation signals PBOC`s eagerness to join the global currency wars. With the competitive devaluation by various central banks gaining momentum amidst slowing global trade flows, the latest CNY devaluation could be seen as likely to force other central banks to consider similar measures before long.

Gold markets have been positive since the news flashed about the depreciation of the Yuan. Currency wars have always helped boost gold price as gold is still been seen as a monetary asset. This depreciation and the impact it can have on carry trades has sparked off a wave of risk aversion as signaled by the decline in equity markets. Also, there is also a possibility that US Fed may delay raising rate if the volatility in asset markets continues to be high. Any move higher in gold price can be exaggerated and furthered on account of the buildup in short positions in gold. The Yuan depreciation story can also reignite demand for gold from Chinese buyers.

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