China: De-Dollarization Bid Continues amid Trade War

As the trade war rages on, China’s de-dollarization bid continues. The trade war is taking a toll on the US and Chinese economies. China seems to be more on the losing end. There’s a trade imbalance between the two countries. So far, the iShares China Large-Cap ETF (FXI) has gained just 4.2% this year as of Tuesday amid trade war tensions. The SPDR S&P 500 ETF (SPY) has gained 19.3% during the same period.

China’s de-dollarization continues

The US has much more maneuverability to target Chinese imports. Also, due to trade uncertainty and tariff structure, many US companies are moving their production away from China, which impacts the country.

US companies moving away from China

Recently, Google (GOOGL) decided to move its Pixel production from China to Vietnam. Other companies including Amazon (AMZN), Apple (AAPL), and Microsoft (MSFT) are also looking for alternate supply locations.

Escalating trade war

In August, the trade war escalated to a whole new level. President Trump announced tariffs on an additional $300 billion of Chinese goods. The Chinese central bank devalued the yuan to the lowest level in about a decade to offset some of the impacts from the tariffs. On August 23, China announced retaliatory tariffs on $75 billion worth of US products. However, the tensions calmed down at the beginning of September. Both sides decided to meet for trade talks in October.

China diversifies away from the dollar into gold

Due to rising trade tensions, China is trying to diversify away from the US dollar. China continues to pile into gold. Gold is a safe-haven asset and a hedge in times of uncertainty. In August, China added to its gold reserves for nine consecutive months. Bloomberg reported, citing People’s Bank of China, that China has added about 94 tons of gold to its reserves since December.

In addition to the trade war, there were makings of a currency war in August. After China devalued the yuan, the US labeled China as “currency manipulator.” President Trump has also been advocating a weaker US dollar to boost to the US economy. If the trade war escalates more, President Trump might try to manipulate the US dollar. If there’s a currency war, gold would probably be the winner.

US Treasury holdings fall

China’s holdings of US Treasuries (TLT) have been declining slowly but steadily. In August, Japan passed China as the largest holder of US Treasuries. According to a Reuters’ report in July, citing, the State Administration of Foreign Exchange, China’s US-denominated foreign exchange reserves in 2014 fell to 58% from 79% in 1995.

Russia’s de-dollarization continues 

The de-dollarization trend isn’t just visible in China’s foreign reserves. Russia has also been diversifying away from the US dollar. US sanctions are the main motivation behind Russia’s de-dollarization bid. A CNBC report said that Russia’s holdings of Treasury securities fell 84% between March and May. Based to figures released by Russia’s central bank, its gold holdings reached $109.5 billion—an increase of almost 42% from the holdings last year.

According to the World Gold Council, global central banks purchased 651.5 tons of gold—the second-highest total on record in 2018. Russia, Turkey, and Kazakhstan’s central banks were among the largest gold buyers.

Gold outperforms risk assets amid increased uncertainties

Gold has been outperforming risk assets lately due to continuing trade war tensions, geopolitical concerns, and the Fed’s lower rate outlook going forward. Currently, the price of gold bullion is close to a six-year high. Since the end of May, the SPDR Gold Shares (GLD), the largest gold-backed ETF, has gained 16%. The more leveraged bet on gold, the VanEck Vectors Gold Miners ETF (GDX) has risen about 35%. The gains are significantly higher compared to 6.4% and 7.4% gains seen by the S&P 500 and the Nasdaq Composite (QQQ) during the same period.

Read Trump, Trade War, Powell: More Upside for Gold Prices? for a more detailed discussion of gold’s price drivers.

Global central banks shift towards gold

Due to ongoing trade tensions and other geopolitical uncertainties, countries, particularly China and Russia, will likely keep piling into gold. According to Australia and New Zealand Banking Group, as reported by Kitco, “In the current environment, where uncertainty in emerging-market currencies is high, we see a good reason for countries like Russia, Turkey, Kazakhstan and China to continue to diversify their portfolios.”