Gold Rush: Trump, China Puts The Bull Into Bullion
New York (Jan 14) Gold bugs of the world have a simple message for Donald Trump: thank you for making gold great again. Thank you for the spectacle that was your press conference, with the display of braggadocio (“I was offered $2 billion to do a deal in Dubai”) and belligerence (“Mexico will pay for the wall”), rather than a considered outline of your economic agenda, doing little to allay concerns you’re all slogan and no policy.
And thank you for selecting Rex Tillerson as your Secretary of State. He’s not even in the hot seat yet, but he’s already placed the U.S. on a collision course with China – they of nuclear-armed status – with talk of denying them access to the islands they’ve built in the South China Sea. War, what is it good for? Gold prices, that’s what.
This week was a gold bull’s dream, with the yellow metal boosted by a drooping U.S. dollar as Trump’s failure to provide details on his much hyped plans to make America great again got a thumbs down from traders. Gold soared to over $1,200 an ounce, bringing its advance from its December lows around $1,128 an ounce to roughly 6%. RBC Capital Markets’ head of commodity strategy Helima Croft summed it up nicely this week, saying “Trump’s election has introduced a proliferation of unknowns, which the market will have to work through as they surface”. Proliferation is an interesting choice of words, underlining the growing number of unknown unknowns as traders and investors are none the wiser about the new administration’s grand strategy one week out from taking charge of the White House. Gold is a no-brainer hedge against the risks of the unknown.
January has historically been a good month for gold, with the yellow metal ending January with a gain 65% of the time since 2000 according to ABN Amro. This month looks set to continue the trend as gold is up 4%. The question on traders’ minds is whether gold can maintain its upward momentum. History suggests there is a good reason to be bullish as Trump takes control of the Oval Office. An interesting analysis from Merk Investments shows presidential transition years have on average been great for gold. Since President Nixon took the U.S. dollar off the gold standard in 1971, the seven presidential transition years have delivered an average gold price rise of 14.8% compared to a 0.9% fall in the S&P500 in those years. While I’d caution investors against treating history as a predictive science and putting on a long gold- short S&P500 trade, it’s hard to fault Axel Merk’s conclusion: the data shows how stock investors can be disappointed by a new president’s inability to translate rhetoric into reality, and in an environment where the rules of the game are changing that makes gold a safe haven play.
But there’s more to gold’s renewed vigor than the changing of the guard in Washington. The yellow metal is also benefiting from resurgent inflation. Reports of the death of inflation look to have been exaggerated, with China’s December producer price index showing factory prices rising at the fastest pace in five years thanks to rising prices for oil, iron ore and coal. Trump should be pleased: there’s one thing that China isn’t exporting to the rest of the world any more – deflation. But it’s not just China where prices are on the rise - inflationary pressures are also growing in the U.S. and Europe. Janus Capital ’s chief investment strategist Myron Scholes, who also has a Nobel Prize to his name, argued this week that the rise in inflation isn’t just a temporary jolt from higher commodity prices as many asset classes are signaling inflation “is here and on the rise”.
China’s attempts to reflate its economy and snap a five year run of factory price deflation has been helped by the generous use of credit to juice growth. The lending spigot was opened wide in December, with Chinese banks inking new loans worth 1.04 trillion Chinese yuan against expectations of 667 billion yuan. The surge in lending was seen as a preemptive move ahead of a possible tightening of credit later this year. ANZ’s calculation that 67% of all new yuan loans went to non-financial corporates – the first time long term corporate loans have surpassed mortgages – will no doubt embolden the bears concerned about an eventual popping of China’s credit bubble. Crescat Capital is one money manager concerned about the risk of a twin banking and currency crisis, warning its investors this week that attempts to tighten lending may trigger a credit crisis, which would then force Beijing to change course and inject liquidity, which could lead to a currency crisis. The hedge fund manager is short iShares MSCI China (MCHI), iShares China Large Cap (FXI), and the Deutsche X-Trackers Harvest CSI 300 China (ASHR).
While the risks of a banking crisis rise with every poorly thought out loan to a zombie company, most brokers are focusing on short term ways to squeeze the most profit from the rise in inflation. Long term risks be damned! Deutsche Bank strategists Yuliang Chang and Joseph Huo say reflation is their favored investment theme, and reiterated financials and energy stocks as overweight recommendations. The duo are expecting strength in the PPI to extend into the first half of the year, while they see a pick-up in consumer prices in the second half.
Given the tick up in inflationary pressures it’s not surprising that Chinese gold prices are on the rise. The benchmark price on the Shanghai Gold Exchange has climbed 4% from its December lows, and there could be further gains ahead of Chinese New Year celebrations later this month. With Beijing cracking down harder on Bitcoin exchanges, the precious metal may be the last asset class of choice for jittery Chinese investors unnerved by the prospects of a weaker yuan, stricter capital controls, the impact on growth from a tightening of credit, and a lack of alternative options given policies to rein in runaway apartment prices. The deflationary threat may be waning, but China’s track record of allowing inflation to build up a head of steam means Beijing needs to tread carefully with the flow of credit and its plans to shut down capacity at a time when higher prices are beginning to pulse through the economy.
Source: Barron's
