Gold as safe haven in a Trump storm

Gold and gold mining stocks will benefit from the turbulence of the Trump presidency. And, analyst David Chapman writes in Investor’s Digest of Canada, the amount of new gold being found by gold mining exploration companies has plunged. Growing demand and lagging supply can only mean that the price of gold and gold mining stocks will go up.

Most would probably agree that Donald Trump was the top story of 2016. He appears to be headed that way in 2017 as well by beginning the year in confusion and upheaval—along with more rhetoric accompanied by President Trump’s flair for showmanship.

When someone dominates as Mr. Trump does, all other stories seem to get pushed to the sidelines. In the time since what many felt was his unexpected election, norms of decorum, policy and international relations have been swept aside.

Trump continues worrying rhetoric

Rather than temper his rhetoric, he has instead continued his diatribes, much to the delight of the millions who voted for him. If there was any thought that he might, following what many believe was the most divisive election in U.S. history, try to bring some healing, those hopes have been dashed with gloating tweets, continued attacks on those who might ‘diss’ him, and ongoing insults against opponents who don’t support him.

But it hasn’t stopped there. Mr. Trump has opened up fissures with China and with the U.S. intelligence community. He continues his desire for closer ties with Russia, one of the few things that makes sense, although that has appeared to be at odds with some of his own nominees for cabinet.

He attacks NATO as obsolete, is unconcerned if the EU breaks up, reiterates the desire for building a wall along the Mexican border, supports torture, desires to eliminate Obamacare (The Patient Protection and Affordable Care Act), and disregards climate change. He also wants to deregulate, particularly financial regulations that came about as a result of the 2008 financial crash.

Mr. Trump has a famously short attention span, which raises questions as to whether he is capable of focusing on complex matters. He has declined daily intelligence briefings, but apparently spent time looking at table settings for inauguration balls. He has left himself open to questions of ethics and conflicts of interest by setting his sons up to run his business empire without actually divesting himself.

He wants to “drain the swamp”, but promptly appointed a cabinet with a net worth of $14 billion—many of them billionaires.

His cabinet has been stacked with what can easily be described as Goldman Sachs executives, energy industry executives, entertainment industry executives, and former generals. Mr. Trump is the richest president in U.S. history, with no other president even remotely close.

The new president is considered an outsider (meaning outside the Washington Beltway) and is really the first one since Jimmy Carter, or possibly Ronald Reagan.

Both Bill Clinton and Barack Obama may have started out as outsiders but quickly became insiders. President Trump is entering the White House with the lowest approval rating of any of his predecessors and far below Mr. Obama’s approval rating on leaving.

Causes for the rise of Trump

According to historian Niall Ferguson, there are five conditions that give rise to a populist leader such as Mr. Trump.
    
These are: A backlash against a sharp rise in immigration of cultures different then the dominate culture; a rise in inequality (where today the top eight per cent own 85 per cent of global wealth); a perception of corruption at the top; a major financial crisis (2008 housing bubble); and, a demagogue to light the spark.

Those conditions were not only seen in the U.S., but in the EU as well. In Canada, those conditions do exist but to a lesser extent. They have the potential to grow in Asia as well, except Asia does not have the immigration issue.

Today, markets are not as driven by economics and market fundamentals as they once were. They are driven instead by political events—and in this case, by one man—Donald Trump—whose words and targets are often unpredictable.

When the president attacked global manufacturing stocks such as Boeing Co. (NYSE—BA), Lockheed Martin Corp. (NYSE—LMT) and Bayerische Motoren Werke AG (OTCMKTS—BAMXF), their stocks fell quickly, even as they recovered later.

Biotech and pharmaceutical stocks suffered when Mr. Trump declared they were “getting away with murder”. But others such as financial stocks, defence manufacturing stocks, metals and mining stocks benefited from thoughts of reduced financial regulation, while an increase in defence spending and infrastructure programs could further benefit metals and mining companies.

But what if Mr. Trump’s comments caused the stock market to crash? Of course, he is not the only politician that could cause market gyrations. Observe the collapse of the British pound because of the Brexit.

When U.K. Prime Minister Theresa May spoke on Jan. 17, 2017, about a hard Brexit, the British pound rebounded on expectations that the EU withdrawal might go well. But President Trump also spoke about the “strong U.S. dollar” and that sparked a 100 basis points drop in the US$ Index and conversely a $15-per-ounce jump in the price of gold. Both were a case of political comments sparking sharp moves in markets.

What Trump means for the stock market now

Comments and actions from presidents and senior politicians can have market consequences. It is well known that President Trump has been at odds with Janet Yellen, the chair of the Federal Reserve Board. Mr. Trump has even threatened to replace her.

While her term is not up until February 2018, Mr. Trump could move to replace her sooner. That could bring a clash and set off alarm bells in the markets, mainly because the president does not have the power to remove the chair of the Fed until the end of the term.

Mr. Trump and Congress are also facing the need to raise the debt limit in March 2017. In the past, this has prompted clashes between Congress and the White House.

The current debt limit is at $18.1 trillion while the U.S. debt is poised to pass $20 trillion, most likely before March 2017.

Potentially the most disruptive economic policy (especially up here) is Mr. Trump’s desire to shake down Canada, Mexico and China on trade. The president has threatened a 35 per cent border tax, a move that if instituted could cause considerable disruptions to the Canadian economy.

The Mexican peso has suffered considerably already, falling roughly 16 per cent since the U.S. election. In turn, social unrest is growing in Mexico due to inflationary pressures from a weakening peso coupled with a sharp 20 per cent hike in the price of petrol.

Farther away, Mr. Trump has been challenging the Chinese government’s “One China” policy and his nominee for secretary of state, Rex Tillerson, has suggested that China should be ousted from the Spratly Islands and others that China currently occupies in the South China Sea. These comments have brought sharp retorts from China including the threat of war, as trade protectionism ultimately leads to impoverishment and war.

Gold and silver under a Trump presidency

All of this could be beneficial for gold. Gold has been the best performing asset since 2000 with silver in second place.

Following a four-year bear market, both gold and silver prices recovered significantly in 2016.

Gold and silver are the second- and third-best performing assets since the end of 2015, outpaced only by oil prices. Historical data shows that the first year of a presidential term is difficult for stock markets.

Unlike stock markets, gold has enjoyed strong gains averaging 15 per cent in the first year of the presidential term. Since gold started free trading back in the 1970s there was only one year, 1981, that did not see gold rise.

The first year of the presidential cycle is sometimes a year of change and uncertainty.

All of these have the potential to push gold prices higher in the following years and in particular it could push gold mining stock prices sharply higher, especially for junior exploration gold mining companies. Political comments may cause gyrations in markets, but investors might be wise to counter that by holding a bit of gold.

The first year of the presidential cycle is sometimes a year of change and uncertainty. Given President Trump’s volatility and unpredictability, there is even more tension than usual.

There is political uncertainty on the geopolitical front and on the domestic front because of conflicts with the U.S. security and intelligence apparatus. As well, Mr. Trump is inheriting the huge debt built up in the Bush and Obama years.

While gold demand has softened in China, India and even among central banks in the past year, the reality is that gold is once again being viewed as a safe haven.

Mining output is estimated to top out possibly by 2020. This means that more gold needs to be found. However, the amount of gold being found by gold mining exploration companies has plunged an estimated 85 per cent over the past decade, according to a study by Bloomberg.

It is no surprise then that gold stocks topped mining deals by value in 2016, with an estimated $16.1 billion in deals. Finally, gold miner’s reserves may have peaked and have begun to decline.

All of these have the potential to push gold prices higher in the following years and in particular, it could push gold mining companies’ share prices sharply higher, especially for junior exploration gold firms. Political comments may cause gyrations in markets, but investors might be wise to counter that by holding a bit of gold.

David Chapman is an independent economic, market and technical analyst. Mr. Chapman has worked in the financial industry for over 40 years, having spent his career on the trading desks of some large Canadian financial institutions and as an investment advisor. Mr. Chapman can be reached at david@davidchapman.com.

 

This is an edited version of an article that was originally published for subscribers in the February 10, 2017, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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