Why gold dropped on the headline about China halting reserves buying?

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Gold sold off on the headline that China halted reserves buying after an 18-month stretch. In my opinion, this has a lot more to do with the prevailing market narrative than a real fundamental reason. In fact, we’ve been hearing lots of talk about gold surging because of China and Russia buying, so the risk of that flow stopping triggered a negative reaction.

I would also point out that the selloff could have been exacerbated by algos and the price is now near the lower bound of the average daily range. Generally, the price doesn’t extend much beyond these levels unless there’s a very strong catalyst. Therefore, this might be a good opportunity for dip-buyers to fade the reaction.

In the bigger picture, gold is inversely correlated with real yields as it “competes” with bonds. The opportunity cost of holding gold rises when real yields rise and falls when real yields fall. Therefore, the inverse relationship. You can see it in the chart below.

In the past two years people pointed out to the decoupling of the correlation, but they never really decoupled. It’s the magnitude that changed. In fact, when real yields have been rising, gold has been falling much less, and when real yields have been falling, gold has been rising much faster.

I’ve never really bought the narrative that gold has been rising due to China. If you look at the chart below which shows China’s gold reserves vs. gold, you will notice that gold has been rising in the past without China buying, and has been falling with China buying a lot. The main reason for the change in the magnitude might be related to the US fiscal profligacy.

This article was written by Giuseppe Dellamotta at www.forexlive.com.

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