Allow me to begin by offering an important caveat; my opinions and analysis are not necessarily the truth, I do my best to convey what I think is happening in markets and what is most likely to happen in the future. As Yogi Berra famously stated “it’s tough to make predictions, especially about the future.” Moreover, markets are always changing and in flux, therefore, an analysis today is unlikely to be the same a month from now, much less a year from now. I believe this caveat and a firm understanding that there is so much that we do not know and cannot know is more relevant today than ever before. After all, regardless of all the speculation Trump is a wild card and the implementation and specifics of most of his policy proposals remain unclear or entirely unknown.
Let me begin with the facts as best I can discern them. The Trump win was a surprise to most and judging by the futures markets initial response (S&P 500 futures -5% the night of the election) there was a lot of fear and uncertainty as to what a Trump Presidency will look like and how it will affect the economy. In an initial flight to safety rally gold futures rose to nearly $1340/oz before reversing lower and suffering the worst weekly decline in more than three years:
Gold (Weekly)
There seems to have been a consensus among prominent hedge fund managers shortly after it became apparent that Trump was going to win that the dip in equity futures represented a buying opportunity and as Carl Icahn stated Trump is “a positive for our economy, not a negative.” In an instant some very smart, shrewd guys decided that it was time to dump gold and buy stocks. And so it was. As is often the case among the hedge fund crowd a positive feedback cycle gets created and nobody wants to be caught on the wrong side of the move, which only serves to exacerbate short term market gyrations.
Regardless of the fact that I think Trump’s Presidency is likely to catalyze gold to new all-time highs last week’s candlestick cannot be ignored. Just when it looked like gold had regained its footing above $1300/oz a deluge of selling caught a huge contingent of investors wrong footed. The weekly candlestick encompasses a nearly 10% weekly range with the largest weekly trading volume on record. While the damage was significant I am not hitting the panic button on gold investments; the week ended with price near the largest volume-by-price bar of the last two years and also just above major support ($1200-$1210).
Why the big decline in gold? After all Trump brings a lot of things to the table which one would normally deem as being bullish for gold such as deficit spending (tax cuts with large infrastructure spending programs) and geopolitical uncertainty. However, the market appears to have focused on the prospect of rising inflation, more positive real yields, and tighter Fed monetary policy which will be necessary in order to prevent inflation from running rampant. Perhaps more importantly many hedge funds appear to have taken the emotional market response to Trump’s upset election win as an opportunity to liquidate gold positions. So far they look pretty smart but I would be willing to bet these same funds will be buying back those gold positions within a few months, if not a few weeks.
While the move up in real yields has been far from extraordinary, last week’s price action in precious metals is a strong indication that market participants believe yields are heading higher.
10-Year Real Treasury Yield
While the threat of a substantial increase in inflation is certainly very real the market may be underestimating the likelihood of two scenarios which could turn out to be bullish for gold in the long term:
- In one scenario inflation takes off resulting in damaging effects upon the real economy; high inflation and slow growth leads to a stagflationary economic environment similar to the environment which contributed to the 1970s gold bull market.
- In another scenario Trump’s economic policies (trade protectionism, smaller government, xenophobic immigration policies, etc.) could lead to weakening economic growth and foreign capital fleeing the US dollar and US investments creating a potentially perfect storm for gold.
For now optimism seems to be abundant. Even those who voted against Trump have decided to “give him a chance” and the changing of the guard is still more than two months away which allows for plenty of speculation that Trump will backpedal on some of his election promises. However, reality is likely to hit hard come the new year and gold investors are being given an opportunity to reload and/or add to positions at levels which some thought they might never see again.
From a technical standpoint US$1200 in gold and $20 on the GDX are about as important as any price levels could possibly be. A short term breach of these levels would certainly go a long way towards sending sentiment through the floor and shaking loose any remaining bullish ‘speculative froth,’ however, any protracted move below $1200 in gold or $20 in the GDX would raise more than a few eyebrows and call into question whether the 2016 rally was really a resumption of the long term bull market or simply a bear market rally in particularly convincing secular bull market ‘clothes.’
Trump doesn’t fix anything and the change he does bring is likely to be more destabilizing than anything we’ve seen in recent history. Damaging secular demographic trends aren’t changed by lower taxes for the rich or an infrastructure spending program. If you’re a long term gold bull nothing changed last week, in fact your conviction in the long term gold bull market should only be stronger.
That doesn’t mean the market won’t occasionally try to shake loose your conviction like it did last week, that’s what markets do. For a shorter term trader it would be reckless to simply go in and buy gold and mining shares after last week’s technical damage, however, a tremendous long term buying opportunity is likely to be weeks, not months away. The seeds of the next $1,000 rally in gold were planted last week.
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