Threat of a Chinese Housing Collapse Revives Gold's Run

Spot Gold - $1,195.65 // $9.50 // 0.80%

Where risk appetite stalls, gold more often than not finds itself in demand. That is the situation the metal would find itself in today. Though US equities were in the green on Wednesday, there was little momentum to speak of to suggest that the underlying current of confidence was supportive of a meaningful and lasting advance following Monday's prominent breakout. And, once again, the source of volatility for gold was China. Just Tuesday, news that China (the second largest buyer of the precious metal in the world) was opening its commodity trading to foreign banks and streamlining the import and export of the raw material helped boost expectations of demand. Wednesday, the bullish news' influence would come via the more common root of gold strength: uncertainty in speculative and financial conditions. According to an unnamed Chinese official, the country's primary banking regulator had instructed lenders to perform stress tests on their exposure with a worst-case-scenario that assumed a 60 percent decline in residential housing prices. This doubled the drawdown that was used in last year's stress test and clearly points out a concern over the future of the nation's economic and financial future.

That being said, gold investors' interest in this news does not run the normal lines of the risk appetite / risk aversion. The threat that one of the best performing economies through the Great Recession is on the verge of its own crisis bodes poorly for the rest of the world. With economic activity leveling off and stimulus being withdrawn amongst advanced economies, there is a growing probability that we are heading for another global slump. It is this uncertainty that justifies gold prices at or near record highs; and with Europe's troubles out of the spotlight (a Portuguese bond auction Wednesday met lower yields and rising demand), a clear catalyst is needed to push gold back above $1,200/oz and keep it there. Taking stock of the futures market for clues to speculative interests, the December Comex contract (the most liquid at this point) reported its first increase in volume in five days (97,635 contracts). At the same time, aggregate (a composite of interest in all live futures contracts) volume dropped to its lowest level this year and open interest slipped to its lowest level since April 22.

Spot Silver - $18.31 // -$0.08 // -0.41%

Silver ended the US session in the red for the first time in five days - but it could be argued that the metal has seen little to no progress in the past 48 hours. A high level of intraday volatility helps to confirm the technical relevance of $18.50 as meaningful, short-term resistance; and a breakout will likely hold off until there is a clear fundamental catalyst. As it stands, risk appetite is not hearty enough to encourage such a breakout; and the influence of gold and dollar correlations doesn't provide better guidance.

Spot Gold Chart (Daily)

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Crude Oil (LS NYMEX) - $82.42 // -$0.13 // -0.16%

Energy traders were not lacking for fundamental fodder upon which they could determine their positioning and conviction. However, as it would happen, there were two diametrically opposing brands of event risk that would lead the commodity to trade relatively unchanged for the day. In fact, the modest contraction through the aftermarket hours of the US session led the NYMEX crude contract to its first loss in five days - breaking the most impressive run in months. Preventing a hard reversal Wednesday, the supply-and-demand balance was bolstered by the positive release of the US ISM non-manufacturing survey. Helping to offset Tuesday's unfavorable personal spending and income data for June, the service sector activity gauge unexpectedly rose for its July reading. While the performance of this particular indicator may not have as direct a link to energy demand as its factory counterpart, service-based output accounts for an estimated 90 percent of output from the business sector - the demand component should thereby not be underestimated.

If this particular indicator were the only fundamental update for the day, oil may have been able to sustain its advance. Yet, there was plenty of event risk that would more than offset this single economic release. From a macro perspective, the news that China's banking regulator was setting a worst-case-scenario stress test for lenders at a 60 percent drop in housing prices was enough to undermine expectations for energy consumption for the world's largest crude user. Another detrimental product of this news was the negative impact it would have on risk appetite trends. China's economic and financial performance is the foundation of global investor confidence. With equities struggling to regain momentum, crude would naturally find it difficult to climb.

From demand to supply; Wednesday's US Department of Energy inventory readings would seem to impress at first blush; but in reality, the data is disappointing. As a headline reading, crude oil inventories dropped 2.78 million barrels (0.8 percent) to seemingly tilt the balance. That being said, the glut in holdings will take more than just this decrease to offset. What's more, the 729,000 barrel increase in gas stockpiles drove overall holdings to its highest level in over 20 years for this specific period (the end of July). This further curbs downstream demand for refined petroleum products. Speculators should take note that the 20-day average (one-month) of aggregate futures volume and open interest dropped to its lowest level since January. This despite the climb in price...

Crude Futures Chart (Daily)

John Kicklighter is strategist with DailyFX.com.

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