Hardly a few weeks have passed since the onset of the Trump presidency and investors have already formed a narrative as to how different markets will fare in this new era. As a gold bull who thinks 2011-15 was a cyclical bear market within a secular bull market for gold, here’s my take on the Trump narrative and its flaws. I also lay out the case for why all this is bullish for gold.
The Trump-ian investor’s logic:
- Trump is going to be protectionist – higher inflation, higher bond yields
- Trump is going to increase infrastructure spending – higher deficits, higher bond yields. Also, higher commodity prices due to the additional demand for commodities
- Trump is going to be more business-friendly and repeal onerous regulations. Companies will be incentivized to repatriate offshore earnings and invest in America – higher stock prices
- The Fed is going to hike rates to curb the expected increase in inflation – higher USD
Higher bond yields, higher stock prices, higher commodity prices and higher USD. This is the narrative, but as I am about to show, this conflicts with reality.
The Trump-ian Cognitive Dissonance:
- Stocks: Rising bond yields imply a higher discount rate. The previous stock market rally was justified based on zero interest rates. Now, with higher discount rates, stocks will still rally because… Trump. Stocks are certificates of ownership in businesses. Businesses produce in order to sell to consumers at a profit, which flows to shareholders. Rising price inflation means rising costs, and higher prices mean lower sales. Businesses will get squeezed at both ends, which is not good for their profits or share prices.
- The USD: The lemmings on Wall Street parrot that higher interest rates are good for the dollar. The Selic Rate sits at 13%, so why not buy the Brazilian Real by the boatload then? The interest rate differential is still 7.5 times greater even assuming 3 additional rate hikes in 2017. The Russian Ruble offers a 10% interest rate as well. That’s another currency that should be bought based on this logic. The USD was in a bear market in mid-2000s even as the Fed was hiking rates. Bull and bear markets are based on fundamentals – in the long run, currencies tend toward purchasing power parity as arbitrage works its way into the supply and demand for the currency. Buying dollars because interest rates are going up is first level thinking, and there is an inherent flaw in expecting both higher USD and higher commodity prices.
- Commodities: Commodities are bought and sold in USD. Rising commodity prices imply a fall in the purchasing power of the dollar, while falling commodity prices imply a rise in purchasing power of the dollar. But Trumpians say both commodities and the dollar will rally. Granted, the USD can rally in the forex market while commodities can rise against the USD. That would imply that while the USD is depreciating in value, other currencies are depreciating even further and faster. Is there any evidence of this? The spread between US 10-year yield and German 10-year yield is over 2%. If the expectation is for the USD to strengthen against the euro, the spread should be close to zero or in favour of US treasuries, but the gap has only been widening. The only evidence we have, the price, argues against the higher USD thesis. If anything, it makes the case for dollar weakness, which would be consistent with higher commodity prices.
- Stock and commodity cycles are typically negatively correlated. Intuitively, that’s not hard to understand. Stocks do well in a stable environment where investors are confident about growth in future cash flows, well into the future. Commodities do well during times of high inflation, when the environment is anything but stable. The Trump administration is going to be a stable, business-friendly environment for stocks, while all that inflation eating away at the purchasing power of the dollar will boost commodities and strengthen the USD in the process.
Good luck figuring that one out!
Trump as the ‘CEO of the economy’ faces two hard choices: either end the artificial boom brought about by the Fed and get the economy back on the path of a healthy recovery, or continue to feed the boom and hope to kick the can down the road even further.
Trump’s election was brought about by the anger of the populace at their straits, the source of which can directly be placed at the monetary machinations of the Fed in response to the 2008 crisis. Eight years of depriving savers of interest income, destroying pension funds with zero rates, increasing the price of assets with thin-air money and destroying capital by arbitrarily picking winners and losers via the lending policies of the commercial banking system is what has led to the Trump phenomenon. If Trump disrupts this status quo positively, expect malinvestments to get liquidated and a steep (but short) depression. Capital will be sucked out of zombie enterprises and deployed where it actually produces returns in an unfettered market. The economy will be healthy and it would be time to buy stocks based on Graham-Dodd principles of value investing, while ending the bull market in gold.
But that would mean a vastly reduced role for the Federal Reserve, a shrinking financial sector with Wall Street becoming a backwater, the imploding of the US (sovereign, corporate and personal) debt bubble (let’s not forget that he wants to renegotiate the debt and has a track record on that front), the collapse of Social Security and pension funds, bank failures… a wiping out of all the fractional reserve banking caused distortions in the marketplace.
In a nutshell, a scenario that has a very low likelihood of happening given how entrenched fascism is in the US.
Instead, I argue that we are going to continue the slow march towards a crack-up boom, with some liquidation of malinvestments here and there (as has already happened in the oil patch), some controlled collapses, half-hearted Fed attempts to end the boom while trying to postpone the bust, more capital controls, protectionist tariffs and trade barriers, and a slow but sure destruction of capital and shortening of the capital structure. In such a scenario, gold is a must own asset for any portfolio. While the Trumpians have foolishly shorted/abandoned gold thinking they have the next 4 years all figured out, I’ll be speculating on higher gold prices for the foreseeable future with a solid allocation to the gold miners and explorers.