Is Trump bad news for gold after all?

Is Trump bad news for gold after all?

“Unexpected” is an understatement when describing the outcome of the US presidential elections. Trump’s win defied all odds, rattled markets and shook social media. Clinton had maintained a steady lead for months in almost every national poll and early voters’ count. The media was confidently pushing this narrative, doubling down on their numbers projecting a clear Hillary win. However, to the elites’ great dismay, Trump came, he saw and he conquered: the presidency, Congress with its two chambers and the governors’ race.

These results delivered a major blow to the establishment that Trump fought hard against in this long and fierce campaign. The markets, having also placed their bets with Clinton, were caught off guard as well. On election day at midnight, futures for the benchmark S&P 500 and Dow Jones Industrial Average indexes fell by over 4% as the Trump victory became more likely. Meanwhile, gold prices surged by nearly 5% to a 6-week high of USD 1337.40/oz before the election results were final. Traders went for the safe-haven asset, believing that a Trump administration would lead to political uncertainty. But then everything changed: Stock markets not only recovered, they reached new record-highs in what became known as the “Trump rally”. Conversely, gold prices went in the other direction, and by the end of the year had dropped 16% from its peak last summer.

Does that mean that gold is in a bear market? We argue this is temporary and that a Trump administration is actually good news for gold! In fact, we see this moment as a unique opportunity to buy at these low levels, before the market euphoria ends, and the very real, fundamental problems of our economic system resurface once again. In this article, we outline the reasoning behind our optimism.

Why the markets got it all wrong: fake news and false narratives 

Trump was right: it was indeed a rigged election, at least in the sense that the media played an instrumental role in manipulating voters and investors through sheer fear mongering and blind panic. The closer we got to election day, the more frequent and shocking were the “news” bombshells against Trump. Meanwhile, oddly enough, Clinton managed to overcome the scandals of the Benghazi attacks, her 30,000+ deleted emails and even the FBI investigation.

Overall, 2016 was a year which clearly proved the media to be unworthy of the public’s trust. Margins of error are to be expected in opinion polls – they are not fortunetellers, after all. But how can we explain the total failure to project the clear outcomes of the US, Brexit vote, or the recent Italian referendum? Was the media that ‘oblivious’ to the public will? Or could it be that they have been manipulating the polls to promote their own preferred candidate/policy direction? This has led many to feel that the polls have not been used to reflect the popular view, but instead to influence it. As a result, the credibility of the mainstream media now stands at its lowest point in recent memory.

Post-election: turnaround in investor sentiment 

Trump’s conciliatory victory speech and his promises of income and corporate tax cuts, infrastructure spending, decentralization, helped push US stock prices higher, strengthened the USD and boosted bonds. However, with a rampant USD, investors turned away from gold, with prices sinking to USD 1184/oz on November 24th, the lowest in 9 months.

The promise of increased spending by the US government has driven up inflation expectations that have led to higher yields on treasuries, as illustrated in the chart below. Treasury yields dived briefly on election night before catching up over the following weeks.

10-Year Treasury Yield
Source: Business Insider, Bloomberg

Is Trump the new Reagan?

Many have drawn comparisons between Trump and Reagan, suggesting that Trump’s presidency will be revisiting the Reagan years and his strategy. It is an interesting comparison, for sure. Both are strongly related to the entertainment industry, and they share the same “principles” when it comes to the economy: lower taxes and more government spending, particularly on infrastructure and defense. When it comes to the role of government, both want less regulation. In Reagan’s inaugural address, he said: “Government is not the solution to our problem, government is the problem.”

On the surface, it seems plausible that Trump will try to implement Reagan’s formula, but he will be operating under drastically different circumstances. When Reagan took office, interest rates were almost 20%, annual inflation was above 10%, and the economy was struggling with 1.4% real GDP growth and unemployment levels close to 8%.

Today, the Fed projects a mere 1.9% GDP growth, which is almost the same as back then and unemployment is not all that better at 4.7%. But because we are rather skeptical of official numbers and the incentive of state institutions to keep these numbers in check, we referred to Shadowstats, which uses the calculation methodology employed in the 1980s. It in fact shows that unemployment is a staggering 22.7% in December 2016! Ultimately, Trump’s inheritance of near zero interest and inflation rates puts him at a sharply contrasting position.

As for the debt levels, when Reagan took office, the federal debt was USD 994 billion. Today it has reached USD 20 trillion! This means that the federal debt was 20 times lower, with interest rates almost 20 times higher than today. The fundamentals here are completely different!

Despite the slow economy, the Reagan administration steered away from easy money policies like the ones we are seeing today

Reagan had much more room to maneuver with his fiscal plans with a 35% debt to GDP ratio: Interest rates and inflation were too high and had to be pulled down. The same went for taxes. When Reagan slashed marginal income tax rates by 23% in 1981, over three years, the top rate fell from 70% to 50%, while the bottom rate dropped from 14% to 11%. However, if Trump follows in Regan’s footsteps today, he could very well risk bankrupting the country.

Source: Federal Reserve

Trump’s nominee for Treasury, Steven Mnuchin, made a commitment that their tax reduction plan would be the largest “since Reagan’s”. But is this a realistic promise under the current conditions, with a debt overhang of over 100% of GDP? Even Reagan’s policies backfired: Within months of taking office, the US economy plunged into a recession and unemployment, which was already higher than it is now, soared. This created the conditions for a large stimulus to “restart” the economy.

In an interview with Reuters last September, Trump accused the Fed of creating a “false economy”, arguing that they are “keeping the rates down so that everything else doesn’t go down.” It seemed as if investors didn’t take note of that statement and instead feared the Fed would not pursue the much-anticipated rate hike in December if Trump won the elections. Instead, Janet Yellen effected the second-rate hike in a decade. It seems the Fed is more confident in the US economic performance or projecting it is, as Yellen argued that fiscal stimulus was no longer necessary to reach full employment.

The question now is: what will the Fed do with Trump’s plans for tax cuts and increased infrastructure spending? Some argue, that we could see more frequent rate hikes in the coming year, should Trump follow through with his plans. But if they proceed too fast, it could risk a recession. It appears that there will be tension between the independent Fed and the executive branch, as Trump and Yellen will go head to head.

Gold prospects under President Trump

We cannot expect that the Trump cabinet will turn things around overnight. Trump is inheriting a massive load of debt that comes as a result of years of irresponsible policies. To make “America great again”, he will have to start a real and frank debate about the politically incorrect consequences of the popular saying “there’s no such thing as a free lunch”.

Trump or not, the fundamental problems remain deep seeded in the US economy. “Draining the swamp” and “making America great again”, are easier said than done, as is effectively addressing the debt burden, dismantling the welfare state and reversing the effects of years of centralization of power and control. New policies or short-term patchwork solutions could yield some positive results and prolong market euphoria and wishful thinking. However, we highly doubt that they will suffice to keep the economic structure standing, when its very foundation is decayed.

This is why a serious investment into gold is for the long haul. Thus, you should look beyond the short-term speculations and projections of what a Trump cabinet and the Fed will do within the next year or two. It is clear that the conditions will not be favorable either way, and things appear increasingly dismal beyond those first two years.

Beyond the noise of the daily news cycle and short-term speculations, we believe that now is the time to buy and hold gold. With possible lows closer to USD1000/oz, now is an excellent buying opportunity. If you thought you missed the rally, think again – gold will inevitably pick up again. One shouldn’t panic over short-term, knee jerk market reactions. Instead, we should focus on the big picture and the fundamentals: the problems are still present (and only getting worse) and nothing has changed. We all know that the bust is bound to happen, and we know it will be tough. Therefore, we urge all investors to hold on to the time-tested store of value found in gold.

I truly believe that gold is the optimal solution to protect and preserve wealth for those with an investment horizon of 5-10 years. Gold price levels will eventually increase because we are at the end of a long-term debt cycle, which also means that a collapse of the system can happen at any time.

Therefore, a wise decision is to hold gold as “insurance”, and current events should provide even greater motivation to buy gold.  Reprinted with permission.  

Post a New Comment