By: Steve Smith
Tough talk from politicians, from Theresa May’s speech laying out the path for a ‘hard Brexit’ to Trump tweets threatening higher border tariffs, is starting to seep into market psychology. The initial responses to these pivots in policy were quick knee-jerks, then stocks and bonds resumed the rallies as all was status quo A-OK.
But it’s becoming clear that some of the fears surrounding these shifts in trade policy and populism are driving people to find alternative stores of wealth. Loom at the way bitcoin soared some 35% in past four weeks to cross the $1000 per dollar level for the first time in three years.
As perceptions are shifting toward a reality if, for better or worse, we do get protectionist border tariffs and a realignment of strategic allies, the transition will cause short term dislocation (AKA volatility). Something the initial expectations Trump’s win has not generated in a meaningful way. Despite all the tweets and daily blips the VIX stands at 11.25. A multi-year low. Full stop.
And this morning we continue to see things get shrugged off. Last night following May’s speech the British Pound was pounded and stocks fell, including in the U.S., which had the Dow down over 100 points. But as we approach the opening the currencies have reversed and stocks are only fractionally lower. The one item still clinging to the chaos is Gold.
This morning gold and GLD broke through and very important resistance at the $115 level. It may indicate a significant trend reversal.
1. Inflationary U.S. and Chinese policies will result in speculative fund flows into gold.
President-elect Donald Trump’s plans to cut taxes is estimated to add $7.2 trillion to the federal debt in the first decade and as much as $20.9 trillion by 2036, on top of the $19 trillion outstanding today. Even in the absence of such additional spending (Congress has never been able to implement a “revenue-neutral” tax cut in the modern era), the U.S. federal debt is still expected to increase from 77% of U.S. GDP at year-end 2016 to 86%, or about $23 trillion, over the next decade, driven by entitlement spending such as Social Security and Medicare/Medicaid. Higher fiscal spending amid a tight labor market and rising wages invariably leads to higher inflation.
Similarly, the ongoing fiscal stimulus and a surging housing market has led to significant credit creation in China. The most recent surge in housing prices began in April 2015 as Chinese stock prices were tracing out a peak; a similar peak is being traced out in the Chinese housing market today as regulators institute macroprudential policies to prick the Chinese housing bubble. Chinese speculators are now turning to the commodities market to hedge the depreciation in their Chinese yuan-denominated assets. Over the past three months, zinc and copper prices, for example, have risen by 20% and 25%, respectively, driven by Chinese buying. Finally, gold futures turnover in China has risen to about 25% of that on the Chicago Mercantile Exchange, suggesting that precious metals pricing power is increasingly shifting to Chinese hedge funds and traders.
2. Speculative inflows into the SPDR Gold Trust(GLD) have capitulated, suggesting a good entry point.
In the month leading into, and in the immediate aftermath, of the June 23 Brexit vote, the SPDR Gold Trust’s holdings increased by 3.7 million ounces, or 13%, to a total of 31.6 million ounces, as retail investors scrambled into gold over fears of a potential breakup of the European Union. Since then, the ETF’s holdings have declined by 4.1 million ounces to a total of 27.5 million ounces, a seven-month low. This means much of the Brexit-related “hot money” has gotten out and capitulated on gold. From a contrarian and trading standpoint, today’s price of $1,150 an ounce is thus a good entry point.
In fact last week saw the first inflows into GLD in 44 days since the election.
3. Chinese and Indian jewelry demand will recover in 2017.
According to the World Gold Council, global jewelry demand, which makes up half of annual gold demand, was down 21% year-over-year in the third quarter. This was driven by an unprecedented decline in jewelry demand in the world’s two largest markets, China and India (which collectively account for 60% of global jewelry demand), where jewelry consumption was down 27% and 41%, respectively, year-over-year. Jewelry demand is expected to hit a seven-year low in China, and a 13-year low in India.
This year’s unprecedented weakness of the Chinese and Indian jewelry markets was due to a confluence of factors that will not repeat themselves in 2017. These include: 1. a loss of Chinese consumer confidence; 2. Chinese gold import curbs designed to restrict capital flight; 3. a tax hike on Indian gold imports earlier this year; 4. a cash crisis in India as the country’s government outlawed the use of large-denomination notes. With the recent correction in gold prices, I expect both Chinese and Indian consumers to step up their jewelry purchases in 2017. Already, a large Hong Kong-based retailer, Wo Shing Goldsmith, is reporting a 20%-25% rise in gold jewelry sales over the past month.
All told, we are seeing a sentiment shift followed up by action in terms of money flow. This could be the dawning of a new golden era. For chaos.