The gold price reaction in the wake of the Trump presidential victory has been bewildering. The so-called expert consensus that predicted a price surge to $1500 in a post-Trump world has evaporated and now been replaced with dire price predictions of a fall to $1,050.
Markets have responded to the Trump victory in several ways that seem contradictory. Base metals and the dollar index are firmly higher based on inflationary expectations, whilst gold and oil have fallen based on deflationary expectations.
In my view, the systemic risks that existed prior to the presidential election have not suddenly vanished. Most important amongst these is a massive US bond-market bubble, followed by US equity valuations that are at historically-extreme levels.
A strengthening dollar is negative for exports. To put things into perspective, the dollar index was around 80 in July 2014 and surged to 100 by March 2015. The dollar strength has sustained thereafter with the index currently at 100.8.
Once Trump assumes power, there is likely to be a focus on ensuring that the dollar trends lower. It would not be surprising to see stimulus that is targeted towards encouraging manufacturing-driven growth. Overall, the current dollar level is not ideal for exports growth and that is likely to change in the coming years.
A very strong dollar is indeed deflationary, as are weak emerging-market currencies. According to Jonathan Lewis of Fiera Capital, “The strong dollar is destabilizing for markets, for foreign assets, for emerging market nations that pay back their debt in dollars…” (WSJ, “Dollar’s Rapid Gain Triggers Angst in Emerging Markets,” Nov. 19).
Simultaneously, bonds are weak based on expectations of rising deficit spending and inflation. Higher bond yields would seem to undermine the idea of higher stock prices, especially with valuations near all-time highs (perhaps second only to levels seen during the dot-com bubble).
Despite the initial euphoria, in my view the reality is that there is underlying uncertainty related to Donald Trump – and until a clearer picture emerges, there is likely to be economic weakness over the coming quarters.
The Trump victory has triggered a frenzied repositioning across asset classes. Jumping to conclusions, investors seem to have been caught up in a highly speculative and emotional game of musical chairs. Gold has been a significant loser so far as the graphic below clearly indicates.
What’s contradictory though is the fact that we’ve witnessed record COMEX gold volumes of around 2 million contracts (or 6,200 tons) – which equates to two years’ of global mine production! This fact alone highlights the absurd disconnect between synthetic paper instruments and the real assets they represent.
What one can say with absolute certainty is that relatively little physical gold changed hands to explain this price swing. While the gold ETF (GLD) did shed approximately 600,000 ounces during the week (17 tonnes), this is a far cry from the 6,200 tonnes of synthetic that was dumped. My views is that the recent wild price gyrations are little more than just that.
Since 2000, gold has been the top-performing asset class, winning out over both equities and bonds by a wide margin, as the graphic below clearly demonstrates.
The common thread driving gold higher for the past 17 years has been radical monetary policy, which seems immune to politics and rests on an unshakeable bipartisan consensus to avoid the economic and political pain that would be required to undo nearly five decades of bad public policy. There seem to be too many unknowns to discard the protection afforded by gold.
The Fed’s great monetary experiment involved quantitative easing (bond buying) and near-zero interest rates in order to lift financial assets, which in turn would lift the real economy. The reality is however that while stocks and speculative assets like junk bonds and commercial real estate have soared, the real economy hasn’t.
Keeping rates low for several quarters is a justifiable and useful monetary tool – however it is very different from keeping them there for years, as it inevitably punishes savers and forces investors to take greater risks in order to generate a return on their investment. The Fed’s easy money policies have therefore distorted market prices and encouraged destabilizing financial speculation.
Let’s also address the issue of interest rates. I believe that the outlook for gold will remain bullish, as long as real interest rates remain negative. As the chart below shows, the real interest rate has been in negative territory since 2008 and is likely to remain in negative territory over the coming years as well.
As we’ve previously discussed, it’s not about rising rates per se – it’s all about the underlying real interest rate (i.e. the interest rate after accounting for inflation). And even if we several consecutive rate rises (unlikely, given we’ve only seen one since the GFC and especially taking into account the enormous level of debt inherent within the US economy that has to be serviced), the real interest rate will still remain negative.
Central bankers still view gold as a sound investment, as evidenced by the fact that they have been net buyers for the last seven quarters. China and Russia will likely continue to aggressively purchase gold, China’s gold holdings still representing just 5% of its total reserves.
Gold has been battered over the recent past; however there is little reason to panic for medium to long-term investors. The recent correction in gold is a buying opportunity with several triggers for upside on the horizon. Real interest rates will remain negative in the years to come even if an interest rate hike is seen in December 2016. Accordingly, we maintain confidence in our base-case gold price target range for the yellow metal during 2017 of between $1200 and $1500/oz.