Investors have decided gold is not the place they want to be during the Trump administration. In the volatility following the election gold jumped about 2%, but it soon gave up that rally. Now it is actually down 4% from before the election results came out. There is a confluence of reasons why gold is moving lower. I view gold as something you should buy to avoid the long-term currency risk the dollar faces given the current $600 billion deficit and $20 trillion debt.
Predicting the short term moves in gold are difficult because the movement has to do with market sentiment. It depends which market narrative the market decides to believe. While this is the case with stocks as well, eventually stocks move to their true value which is the worth of their future cash flows. Gold trades on supply and demand, but a lot of the demand affecting the price has to do with investors’ appetite for it. When I buy gold for the long term, I ignore trends in demand, such as for jewelry, and use it as a substitute for the dollar.
One of the reasons gold has declined is the opposite reason it was soaring immediately after the election. Because of the conciliatory nature of both Trump and Clinton’s speeches and the positive meeting Trump had with President Obama, the uncertainty over whether Trump will lose touch with reality and do something irrational has been quelled. During the election Trump called the market a bubble and couldn’t describe President Obama any worse. This is what gave rise to the initial fears over what Trump would do. Even as this election was vicious, the transition of power appears to be as peaceful as it usually is. Gold, being bought during fear and sold during confidence, has responded as you’d expect given the events which have taken place over the past week.
Prior to the election, gold was in the sweet spot. The cycle was peaking which would lead to uncertainty, inflation was picking up and the Fed wasn’t trying to stop it by raising rates, and finally stocks were expensive and bond yields were low which meant the opportunity cost for buying gold was low. If you can’t get a return on bonds or stocks, then buying gold which yields nothing isn’t a bad idea. In fact, compared to some of the negative yielding government bonds, gold had a decent yield of zero.
Now that we have the new Trumpflation, the market is responding with rising long term bond yields. This raises the opportunity cost for buying gold as it appears investors actually want a return on their investment with the money they lend to the government. Junk bonds have sold off in response to the risky fiscal decisions Trump plans on making and the increased inflation it will bring. As someone who is a huge bear on junk bonds because I believe the default stress cycle is here based on the low recovery rates, this is one of the few market reactions which makes sense to me. I also agree with government bond yields going up. Considering most governments are bankrupt, the concept of lending money to them at near zero rates didn’t appeal to me.
While the near term movement in gold moving lower makes sense, as I said there’s another narrative which is being ignored now. The Trump spending plan increases the likelihood of a dollar collapse. Trumps tax cuts and deficit spending is being compared to Reaganomics. During Reagan’s presidency the inflation of the 1970s was quelled through rate hikes by Fed chair Paul Volker.
There are two sides to the coin of Yellen possibly raising rates at a faster clip than she has been going at. On the one hand, the Fed has been avoiding raising because global central banks have been easing. If the Fed raises in this environment, it could cause the dollar too increase too much versus international currencies and hurt multinational corporate profits and America’s exports. On the other side, if inflation continues to rise, Yellen will be forced to act.
Getting back to Reaganomics, the point I am making is I don’t think the current debt level would allow Trump to increase deficits the way Reagan has. As you can see in the CBO chart below, Reagan spending did increase the debt as a percentage of GDP, but it was beginning at a much lower level than we are at today. The current debt as a percent of GDP has only been higher during World War 2. Reagan didn’t cut entitlement spending which is also what Trump plans to do.
As you can see, the projected debt without entitlement cuts would be the highest in national history. Trump’s solutions are the exact opposite of what we need. We need to cut more than just waste. We need to make drastic cuts to the growth in government spending on health care. President Trump wants to repeal Obamacare, but he wants to keep the policy of forcing insurance firms to cover those with pre-existing conditions. This is exactly why Obamacare doesn’t work. Because Trump doesn’t understand this point, I foresee the projections coming true.
Conclusion
Gold is down because we had a peaceful transition of power. Gold also looks like a worse investment now that bond yields are rising. While Reagan was able to get away with budget deficits and still have inflation decrease, Trump can’t do the same because he is starting from a worse position. If Trump doesn’t cut entitlement spending and decides to follow through on a massive infrastructure spending plan, it means rising inflation and increasing gold prices. Trump does not represent the economic policy change that we need. He still thinks infrastructure spending creates jobs and is great for the economy. At beast infrastructure spending is a necessary evil; it should not be used to prop up the economy. Only private investment can create sustainable job growth and economic growth.
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