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Gold suffers as irrationality Trumps reality

Joe Foster  |  20 Dec 2016Text size  Decrease  Increase  |  

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The markets have gone into fantasy mode since the US presidential election. US stocks reached new all-time highs, the US dollar has soared, copper has had a parabolic rise, and interest rates are up substantially--while gold has tumbled.

All of these strong moves indicate the market is pricing in a rosy scenario in which projected Trump tax cuts, infrastructure spending and regulatory reforms ignite robust economic growth that enables the Federal Reserve to normalise rates.

This outlook works against safe haven assets like gold and bonds. While we are hopeful for such an outcome, it will be very hard, if not impossible, to achieve in reality.

There are a number of obstacles that pose an imminent risk to the rosy scenario that is currently priced into markets, which are outlined below.

 

Extreme debt levels--Aggregate household, business, and government liabilities currently total 250 per cent of GDP. At such debt levels, servicing and/or reducing debt take priority over spending and investment. The 2016 fiscal deficit was US$523 billion, 2.9 per cent of GDP.

The total government deficit amounts to 77 per cent of GDP and the Congressional Budget Office (CBO) projects it will reach 85 per cent in 2026.

Estimates of the cost of the Trump tax plan range from US$3.5 trillion to US$6.2 trillion over 10 years, which would boost government debt-to-GDP to over 100 per cent, according to the Tax Policy Center.

Late cycle constraints--At more than seven years, this economic expansion is the fourth-longest since 1902. Pent-up demand for big-ticket items might be exhausted.

Trends in a number of leading indicators are following past late cycle trends. The risk of recession in the next four years appears to be increasing.

Fed tightening--Tightening policies are inherently designed to bring slower growth. Rising rates are also an impediment to the housing and automotive markets.

Infrastructure limitations--President-Elect Trump plans US$1 trillion of infrastructure spending over 10 years, however, we have already seen how little impact President Obama’s 10 year US$860 billion “shovel ready” infrastructure program launched in 2009 has had on the economy.

US dollar strength limits growth--As the US dollar strengthens, it becomes a drag on exports and industrial growth.

Fully valued stock market--The S&P 500 Index is up 229 per cent in a bull market that is over seven years old with lofty PE (price-to-earnings) valuations of 20-times.

The market response to the US election is, in our opinion, all based on expectations, not fundamentals. Markets have also lost sight of the potential risks that radical monetary policies globally pose to financial well-being. We believe that at some point sentiment will evolve to reflect these inherent risks.

 

We thought a Trump win would be positive for gold--and it was for about an hour, when gold rose US$50 per ounce as news outlets began to declare a winner. However, gold quickly reversed course.

Redemptions in gold bullion exchange traded products began the day after the election and continued through month-end. The selling pressure caused gold to fall below important technical levels. For the month, gold declined US$104.05 (8.2 per cent) to US$1,173.25 per ounce.

Gold stocks took their lead from gold bullion, as the NYSE Arca Gold Miners Index (GDX Index) dropped 14.9 per cent. For the year, gains have been trimmed to 10.5 per cent for gold bullion and 49.5 per cent for GDX Index.

While lower fourth quarter gold prices will likely put a dent in the profits of many mining firms, the industry remains in good health.

Third quarter results were positive, as Scotiabank’s universe of gold stocks reported production is 2 per cent ahead of expectations and all-in sustaining costs (AISC) came in 5 per cent lower than estimates.

The bear market forced the industry to reorganise around lower gold prices. With AISC averaging roughly US$900 per ounce, companies are well positioned to weather the current downdraft in gold prices.

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Joe Foster is the portfolio manager for VanEck's gold equities strategy. VanEck is a leading global provider of exchange-traded funds (ETFs). This is a financial news article to be used for non-commercial purposes and is not intended to provide personal financial advice to any person.

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