Gold Price Could Gain From Stronger Yuan

If Beijing allowed the yuan to appreciate in value, demand could rise for dollar-backed commodities like gold.
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NEW YORK (TheStreet) -- A stronger yuan could increase Chinese gold demand and help push the gold price past its $1,227 high.

China might revalue its currency, known as the yuan or renminbi, after a recent meeting between

U.S. Treasury Secretary Timothy Geithner

and Chinese Vice Premier Wang Qishan. China historically has tethered its currency to the

U.S. dollar

to produce good exchange rates that support low-priced exports. If Beijing did allow the Chinese currency to appreciate in value, not only would the U.S. be able to export its goods to China at a cheaper rate but demand could rise for dollar-backed commodities like gold.

The

Chinese currency

could appreciate by 3% this year after which the yuan's value would be dictated by supply and demand in the open market. Some analysts argue that the yuan is undervalued by as much as 40%.

A stronger yuan could support higher gold prices as the precious metal becomes cheaper to buy. According to the

Associated Press

, China let the yuan appreciate almost 20% between 2005 and 2008 during which gold prices touched $1,000 an ounce for the first time.

Gold demand in China has steadily strengthened since 1992 accounting for 11% of global gold demand in 2009. The World Gold Council sees demand doubling in the next 10 years from $14 billion to $29 billion and analysts think a stronger yuan could be a catalyst. Juan Carlos Artigas, investment research manager at the World Gold Council, says that "holding other things constant, if the yuan appreciates against the dollar, gold becomes more attractive for the Chinese consumer as the price of gold in RMB

terms falls."

Gold is a dollar-denominated asset and typically trades inversely to the U.S. currency. As the U.S. dollar slips, gold becomes cheaper to buy in other currencies and gold prices rise. Other currency appreciation scenarios have yielded stronger gold demand. "If you follow the Indian market like I do whenever the rupee appreciates Indian gold demand accelerates because obviously it's cheaper ... The

Chinese government itself has been encouraging the citizenry to buy gold and silver and if the yuan rises I suspect that will facilitate the buying of more gold and silver,"says John Embry, chief investment strategist of Sprott Asset Management.

If the yuan does appreciate significantly in 2010, the upside for gold prices is long term. Frank Holmes, CEO of U.S. Global Investors, argues that "historically you get a short bleep and then

prices find an equilibrium and then it takes time before

price rises

again." Holmes has a $1,300-$1,500 price target for gold and might re-adjust it higher for rapid yuan appreciation. "As long as the government has policies for infrastructure spending, for job creation then I would say yes this is very bullish for all the commodities."

Not all analysts agree, however. Jon Nadler, senior analyst at Kitco.com, argues that currency appreciation is only neutral for the gold price. "A 3% revalued upward yuan does not imply a weaker dollar." And even if it did Nadler thinks gold's inverse correlation to the U.S. dollar is marginal.

As gold prices hit a record high of $1,226 an ounce the paper currency moved towards its all-time low of $71.40. But over the past two years, as this chart indicates, there have been times where gold prices have made new highs despite dollar strength.

On a more macro level, a stronger yuan means that Chinese goods will cost more to sell in other countries. This shift could hurt overseas sales and stifle the disposable income of the fledging middle class, who are typically strong gold jewelry consumers. Currently China's per capita gold consumption level lags most other major gold buying countries.

Many analysts believe that gold consumption per capita will grow as the Chinese middle class keeps buying gold jewelry as gifts for holidays, weddings and celebrations. Any crimp in their disposal income could curb demand and weigh on prices.

Whether a bull or bear, analysts do agree that China's gold consumption is growing and will be a key factor in supporting a higher gold price. If China lets the yuan appreciate, gold prices will potentially be in for some long-term question marks and short-term volatility.

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Written by Alix Steel in New York

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Alix joined TheStreet.com TV in February 2007. Previously, she held positions in film and theater production, management, and legal administration. Alix has a degree in communications and theater from Northwestern University.