The Debasement Trade: Watch China

Following on from yesterday, let’s examine the “how long?” aspect of the debasement trade.

I reckon it all hinges on China.

So, on my read of what’s happening in that country, the gold leg of this trade is exactly that, a trade.

The US, we know, has various financial engineering plays on the table around squeezing China.

Long-term, though, the US will also have to fight pressure building in its own financial system around its money printing.

It’s the medium-term picture that remains clouded.

And I think it remains a solid long-term investment because we know governments want to inflate their way out of a mountain of debt.

It also turns out, the same levers that are animating golds short-term appeal, also animate its long-term appeal.

Now this may get a bit wonky, but I’ve got a series of charts to show you to paint a picture of the connection between gold, oil, US bonds and China’s role in the gold market.

Debasement trade comeback 
— here’s the context…

Since the debasement trade (gold + BTC) took hold at the start of this month, The US Dollar Index [DXY] and the USD price of gold [XAUUSD] read as a close inverse:

Source: TradingView

[Click to open in a new window]

Gold has gone the other way, climbing from around US$4,000 an ounce to roughly US$4,650.

Dollar index down, gold up.

But we know the Iran kerfuffle is hurting the US on inflation, and oil is a big part of that.

Now for the second piece of the puzzle, which is the West Texas Intermediate [WTI] price — this is the US oil price benchmark:

Source: TradingView

[Click to open in a new window]

West Texas Intermediate crude is currently trading below US$81 a barrel after dropping about 6% across three sessions.

I’ve long maintained to our fellow editors at Fat Tail Investment Research that I only care about WTI…

Brent (EU oil) is meaningless, because Europe doesn’t get to make any decisions in this conflict.

And if WTI is falling, that gives the financial engineers in the US (Warsh, Bessent) the extra ammo they need to do what they and the market ultimately wants to see…

Sweet, sweet rate cuts.

The current Iran talk is around Iran and Oman creating a temporary shipping corridor through the Strait of Hormuz, with a permanent route on the table inside 30 to 60 days.

So traders have started pricing in a peace deal that arrives sooner than expected.

Bear in mind, crude is still up more than ~40% this year.

Now for how WTI fits into the DXY, XAUUSD and bond scheme of things…

Cheaper oil is the permission slip

Energy prices flow through headline inflation faster than almost anything else.

Meanwhile a crude price that falls away in late August gives the US Federal Reserve cover it did not have in July.

Kevin Warsh, the US Fed Chair, speaks at Jackson Hole in Wyoming on Friday US time.

He does not need to promise anything; just a few dovish flutters of speech would do.

Trump, Warsh, and Bessent all want lower rates — cheaper oil lets them angle at that outcome.

And that’s the whole game for gold at the moment.

This is not a mainstream view.

Bloomberg and the larger financial press cohort would have you believe the US have lost control of the bond market and financial ruin is in the offing.

I think a bit differently – namely the lower oil price is giving the US more room to manoeuvre than many think.

And that means more cheap money.

Because cheap money is the usual lever that gets pulled.

Which means a metal that pays you nothing starts to look a lot better when the return on cash is heading lower.

Fixing the problems, or are 
they fixing the market?

Double entendre intended — I reckon what we’re seeing in the US is avant-garde, highbrow financial engineering at scale.

Suddenly, everyone wants to learn about bonds — the foundation of fixed income and the whole guts of the global financial system.

Now, Treasury Secretary Scott Bessent announced last week that he would at least double the US government’s buybacks of longer-dated bonds.

CNBC then reported the department could fund those purchases out of the Treasury General Account, which is the cash pile it keeps parked at the Fed.

There has been a Japanese yen intervention on top of that.

US hedge fund luminary Stanley Druckenmiller has called the bond buying a mistake.

Plenty of traders disagree and have simply stopped fighting what they now call the “Bessent put”.

Options on bond spreads are a bit arcane and niche though, just know that the US is trying to squeeze China with both its geopolitical plays in Iran and in the global financial system.

And if they are getting their way in the bond market, that flows through to rates and thus gold…

So this is why China is so crucial for 
the gold trade (and investment)

I reckon China is the piece that decides how long this gold run lasts.

The People’s Bank of China added 19.9 tonnes of gold in July, its biggest monthly purchase since October 2023.

That was the 21st consecutive month of reported buying.

Chinese households are doing something similar in their own way.

Bar and coin demand jumped more than 28% in the first half of the year to 339 tonnes, while jewellery buying fell almost 34%.

That shift matters more than the headline consumption number.

Jewellery demand generally dies when prices rise, and investment demand often feeds on a climbing price.

Estimates put gold at around 1% of Chinese household assets.

A small move in that number moves the world gold price.

And when China gets squeezed, they buy gold as a financial asset.

The Iran conflict was always a US play to squeeze China’s economy through the energy market.

Venezuela and Maduro earlier this year fits the same pattern.

Every fresh squeeze on Chinese growth pushes more mainland money toward the one asset sitting outside the domestic credit system.

So watch the mainland gold ETF flows and the monthly PBOC reserve disclosures for gold — they matter more to me than short-term fluctuations in the USD priced gold.

And what about Bitcoin?

It’s quite safe to say that it still trades like a risk asset.

When stocks wobble, Bitcoin wobbles harder.

It may earn its place beside gold eventually, and I suspect it will.

But that day has not arrived yet.

I would watch closely for a divergence between gold and bitcoin in the coming months.

But what to do?

Well done to the dip buyers.

But also, be sensible.

Taking some profit along the way when a gold position runs hard is one way to stay in the game long enough to see the rest of this play out.

Long-term, the debasement investment should be fine.

The world has an enormous pile of debt to refinance over the next three to five years, at rates well above what borrowers locked in a decade ago.

Governments will meddle and try to inflate their way through it, quietly, over years.

That is the debasement investment thesis in a nutshell.

The next two to three months are just the trade.

And if you are a gold aficionado, definitely pay attention to China’s economy and financial system.

It will give you a much better read on things, especially when the US financial engineers start running plays.