One week before the presidential inauguration, I asked Janet Mirasola for her opinion on gold price. The New York Managing Director of Sucden Futures Inc. replied, “Gold is a currency and will be held back by the strength of the dollar as Trump begins to come through on fiscal policy promises.”
The Chinese return from Lunar New Year holiday and President Trump makes his first official impacts on policy. It is mid-February and global market participants scramble to divine what lies ahead for 2017. Mirasola’s forecast is a good starting point – she’s been spot on before but we are exploring a new level in the mine.
Here’s my argument for why gold should surprise to the upside in 2017.
Strong dollar hits a speed bump
To date, the U.S. dollar has proved a good proxy for how the world reacts to the initiatives and policies of the new administration. In the new market parlance, “Trump-o-nomics” is a mix of pro-growth and protectionist measures that proponents claim will provide a sustainable economic benefit domestically. Through new negotiations with trade partners, they also expect these policies to promote global growth and prosperity – even with an “America first” priority. After the November election, world stock and commodity markets reacted very positively to this message. The U.S. dollar strengthened dramatically and gold took a nose dive.
In this context, “U.S. dollar” refers to a currency index and not an actual greenback. The classic is the U.S. Dollar Index denoted “.DXY” and nicknamed the “Dixie.” It is a measure of the value of the United States dollar relative to a basket of foreign currencies. The basket includes the euro, Japanese yen, British pound sterling, Canadian dollar, Swedish krona and Swiss franc. It reflects an older mix of U.S. trading partners and has since been joined by broader indexes that include newer trading partners such as China, Mexico and Brazil.
Nonetheless, just like the enduring charm of a ’57 Chevy, the Dixie has survived as an important currency value benchmark. A reason beyond sentiment is that more than 70 percent of its weighting favors the euro and yen. These two major reserve currencies remain a reliable tell on what’s up in developed world economies.
The first chart shows the reaction of gold and the dollar (i.e. .DXY) during and beyond the transition period following the U.S. election — gold falls and the U.S. dollar rises during presidential transition.
There is nothing unusual about dollarized commodities moving in opposition to a U.S. dollar index. The extraordinary post-election characteristic for gold was the magnitude of divergence. It caught many market analysts off guard, including yours truly, to see the yellow metal fall from a $1,281 perch on polling day to sub-$1,200 for Thanksgiving. The bottom for Comex gold occurred Dec. 15 at $1,127.2 per ounce – a 12 percent correction. On the flip-side, the dollar steadily grew in value peaking Jan. 3 to a 14-year high – a 5 percent bounce.
The President Trump economic agenda of deregulation, tax reform and a $1 trillion fiscal spending package creates expectations for strong economic growth, higher inflation and higher interest rates – outcomes supportive of a stronger dollar. If interest rates in turn rise faster than inflation expectations, the yellow metal could face a very negative environment.
However, a stronger dollar also puts U.S companies that sell products and services abroad at a disadvantage—a potential detriment to domestic growth. President-elect Trump warned Jan. 17 that “Our companies can’t compete with them [foreign companies] now because our currency is too strong. And it’s killing us.” This was followed Jan. 31 by comments from his top trade advisor, Peter Navarro, that the euro is “grossly undervalued.” The administration talked down the dollar creating a descent from the early-January peak called by Kitco News commentator Kira Brecht the “Trump top.”
In the meantime, gold rallied solidly higher from its bottom with emerging concerns and uncertainties about 1) the timing and specifics of the economic plan and, 2) the fear of possible trade wars and other global backlash to protectionist portions of the new policies. The yellow metal was further boosted by the January reversal of the dollar.
From December to early-February gold had an unusually high correlation with the euro and Japanese yen. On days when the net effect of new administration policies was viewed favorably, the dollar index grew stronger as its major components, euro and yen, grew weaker. Along for the ride, gold grew weaker too. On less favorable days, the dollar weakened and the trio strengthened. In all this flux, the value of the euro in terms of yen remained surprisingly constant. This suggests that regional, national and central bank influences were mostly absent for the two currencies over this period. The euro, yen and gold all marched in lockstep to evolving perceptions of Trump-o-nomics.
By the second week in February, concerns about upcoming elections in Europe surfaced weakening the euro currency and restoring investor interest in gold and the yen. But on Feb. 9, President Trump announced a “phenomenal” tax plan coming within weeks—the euro and yen fell, the dollar rallied and domestic stock markets made new highs. After an initial drop, gold rallied to dance in step with Dixie (note gold & green arrows on the chart).
Is the yellow metal departing the currency crowd for a more traditional safe haven and commodity role? A look at the copper story provides a clue.
Infrastructure expectations boost metals
The bottom is finally in the rearview mirror for industrial-metals and that’s great news. For example, copper has enjoyed a 36 percent rise in price over the last 12 months. The Bloomberg Commodity Index (BCOM), including everything from animals that oink to metals that shine, is up over 20 percent. For metals the reasons include increased global infrastructure spending, Chinese attempts to cut excess capacity and the closure of some large mines. A significant portion of the rally has come after the election of Donald Trump with his promise of massive infrastructure spending in the U.S.
The second chart shows the same post-election time period for Comex copper and the BCOM index — copper and commodities rally during presidential transition.
Comex copper wasn’t held back by the rise in the post-election dollar. In ten days, it launched an intraday “moonshot” above the key $2.75 per pound-level to bounce 16 percent. Although the red metal pulled back in December, it was clear the propulsion of infrastructure expectations overcame the drag of a stronger denominating currency. After the “phenomenal” tax plan remarks, the red metal rebounded to close at $2.77 by Feb. 10. This is very impressive since it occurred after Lunar New Year holiday – returning Chinese metal traders thumbs up for Trump-o-nomics.
Despite dollar headwinds, the broader Bloomberg index also rose over the same period by a respectable 6.5 percent.
e than just a dollar story
The strong U.S. dollar era began in October 2014 with the divergence of monetary policy between the U.S. and other developed nations. – the Federal Reserve started to tighten while other central banks experimented in increasingly experimental and risky accommodations. As I explained in the Winter Edition of the Mining Quarterly, gold ratios relative to key global commodities like copper and oil sky rocketed to historically high and unsustainable levels in 2016.
By last October there were signs of market rebalancing and those continue to date. The gold-to-copper ratio is now comfortably in a range of historical values. This trend should continue as major economies slowly shift from monetary to fiscal stimulus (like infrastructure spending). Gold will experience lift from rising commodity prices as suggested by a 2017 comparison of the two charts. The “Trump top” is likely to hold if the new administration can keep the dollar in check as pro-growth policies of tax cuts and business deregulation become reality.
Rising inflation pressures will also provide buoyancy for gold in 2017. The increase in oil prices, tighter labor markets and the possibility of restrictive trade barriers will put upward pressure on consumer prices. Gold is an effective inflation hedge if inflation expectations rise faster than interest rates – a possibility if the pro-growth policies take longer to result in real economic growth. The Fed may also be hesitant to raise their benchmark rate too quickly in a political environment that favors a weaker currency.
Finally, heightened geopolitical risks could very well return more investors to gold as a safe haven. On the near horizon are plenty of risks to European stability in the implementation of “Brexit” and upcoming elections in the Netherlands, France and Germany. For example, a National Front victory in France greatly increases the chance that country will leave the European Union. A euro currency in peril could easily send gold to $1,400 per ounce territory.
For these reasons, I believe the low for gold is in and average gold price for 2017 should print above $1,200 per ounce. If current trends continue, 2017 should a shiny year.
Gold ain’t just whistling Dixie.