Yuan/Dollar unpegging to SDR to PBOC’s Gold – the relationships are becoming interesting

In a move to further internationalise the use of its currency in global trade, China appears to be seeking to have the yuan included in the basket of currencies that make up the IMF’s Special Drawing Right.  Currently the US Dollar, the Euro, The British Pound Sterling and the Japanese yen in varying percentages form the current SDR basket, but this is due for review this year with initial meetings to be held next month and a final decision on any changes to the basket should be made by October.

Why is all this suddenly seen as so significant?  China has already had some considerable success in internationalising the use of the yuan through bilateral deals but the general consensus is that it would like it to be recognised as A global reserve currency.  Perhaps not THE global reserve currency – yet – but to rank alongside the dollar in particular given it sees that the U.S. has gained huge advantages over the years from its position as being the de facto global reserve unit of trade.  Thus China sees its inclusion in the SDR currency basket as being a key factor en route to this ultimate goal.

But – and it would seem to be a big but – currently the yuan is directly pegged to the U.S. dollar in the global exchange rate system.  Given the SDR make-up is designed to balance out upwards and downwards movements in the currencies which make it up, to have two significant currencies in its composition which are effectively tied directly to one another would seem to defeat the balance objective.  While there is little doubt that China, as the world’s second biggest economy by GDP – or the largest based on purchasing power parity (PPP) – should be included, can this decision be reached while it is still dollar pegged?  We feel that this would be seen as an insuperable objection.

This brings us down to the question as to how important inclusion in the SDR is to China.  Is it sufficiently so for the Chinese to drop the dollar peg and probably allow the yuan to rise  accordingly (much as the Swiss Franc did against the Euro when it dropped its peg to the pan European unit)?  Remember the shock the Swiss decision had on the gold market, albeit a relatively shortlived one.  But the dropping of the Yuan peg to the US Dollar could have far greater ramifications in global financial markets.

This could be further exacerbated by a possible revisiting of the Chinese gold reserve figure.  there has been enormous speculation in the West that Chinese gold reserves are in fact far greater than the 1,054 tonnes it has reported to the IMF for the past six years and that it would further enhance the yuan’s standing if these were shown to be far greater than they appeat to be officially now.  Even the more conservative estimates suggest China may announce that its gold reserves are in fact some 2,500 tonnes greater than the currently reported level would suggest, moving it up to second place in global gold holding rankings.  Others suggest the level could even be far higher.  Thus a twin announcement of the unpegging of the yuan to the dollar and a substantial uprating of Chinese gold reserves could give the gold price an enormous fillip – and one which those who appear to have been playing the futures market to keep the gold price under control could not counter – unless of course it is China itself which has been keeping the gold price subdued so it can continue to purchase the yellow metal at low prices!  These theories would seem to have no end!

If indeed its true gold reserves have reached a level with which China feels comfortable, it would have the power to drive the price higher, which it might consider  doing for internal market reasons, given the amount of gold believed to be held by its citizenry, while its own incentive for perhaps keeping the price down while it was in purchasing mode, would have fallen away.  More speculative theory!

But theory or no, the feeling is that all this is driving towards the key inflection point and it is the Chinese desire to have the yuan a part of the SDR which is the vital element.  And if this is so these decisions and changes could all occur within the next few months.  If any of these should happen then gold would almost certainly benefit positively – and if all three take place over a short period of time then the sky could be the limit as far as gold price is concerned.  This would tie in nicely with the Elliott Wave forecasting suggesting a massive precious metals price surge is due (See: Elliott Wave analysis: Gold and silver now in major long term uptrend).

It is all very well theorising in this manner, but with gold’s downside seen by virtually all as extremely limited at current levels, then perhaps some credence in the possibility of these events occurring might colour one’s investment policies with little risk involved.