Gold and U.S. equity futures are rising this morning based on continued Sino-U.S. trade optimism, as well as a tentative shutdown avoidance deal that may include some sort of border security.
On December 26, gold and e-mini futures had a 20-day correlation of -.91 (near inverse), but the 20-day correlation has tightened considerably to .72. Last time we saw this in December 2017 as emerging markets became unhinged, seeing the correlation move from -.78 to .90.
It is slightly unnerving because there is virtually no volume in either gold or e-mini futures, and when global equities began to underperform stemming from EM weakness, gold did not rise but declined over 10 percent.
Gold has been trading within a tight range after the PBOC announced liquidity measures for the Chinese Lunar New Year, but since the New Year holiday comes to a close, $30B in liquidity was drained via reverse repos and gold began trading higher.
Why did gold, equities and the yuan rebound from the depths of December? The aggressive repricing of the yuan by the PBOC.
In January, subscribers received "Does China Need a Stronger Yuan?" which outlined that even though China may want to boost secondary industries, such as manufacturing but capital flows are the life blood of China:
Yuan strength is important, domestically. The strength of the yuan outright dictates the flow of capital into China and throughout the emerging markets. From 2016 to 2018, China had seen massive foreign inflows into their asset base and it has helped prop the yuan up.
However, the abhorrent performance of Chinese and emerging market equities is going to risk significant outflows. This could dramatic impact China's weakening economy and further hit the yuan.
What the PBOC has done - masterfully - is strengthen the yuan into the illiquid Chinese New Year while increasing liquidity measures which drove capital into China, and gold benefited.
Gold (gold); FXI (orange); CNYUSD (bottom pane)
In January, we saw a record flow into of $8.6B emerging market local currency fixed income with $9B into Chinese equities.
The problem is whether or not these measures will wake the Chinese economy up. If not, the link between gold, the yuan and equities may continue but to the downside.
The yuan is already beginning to weaken against the dollar, and that's weakening gold as expected. China equity bull may get trapped in their consensus position.