Trump wins — markets in shock!

Trump’s win turned out to be a surprise for all markets and an opportunity for bullion banks to book substantial trading profits on the bear tack. But first reactions to shocks are often wrong.

Gold and silver were hit hard when on the night of 5 November Donald Trump captured not just the US presidency, but his Republicans both legislative houses as well. In early morning European trade today, gold was $2688, down $54 from last Friday’s close, and silver was $31.55, down $1.90.

US equity markets initially rated Trump’s presidency as very bullish, propelling the S&P 500 index to new highs. He is expected to pursue a protectionist, business friendly agenda which also led to a sharp rally in the dollar. The trade-weighted index is next:

Perhaps it will run into resistance at these levels. 

The inconsistency in the markets’ reaction is plain to see. Bond yields soared, with the 10-year US Treasury yield touching 4.44%. This is up next:

Bear in mind that it was high bond yields that led to regional bank failures last year. If bond yields rise from here the damage hits US zombies and foreign governments alike (particularly the UK!).

For conventional macroeconomists rising bond yields are seen to be a headwind for gold. And to a degree, this delusion becomes self-fulfilling, particularly when it is in the establishment’s interests to see gold down. The origin of this fallacy was the carry trade in the 1980s and 1990s, when financial institutions bought gold on lease at under 2%, sold the gold and bought T-bills yielding 8% or more. Conditions today are different with gold in a bull market, just as it was in the 1970s when prime rates rose from 6% to 20% and gold rose over 20-fold from just $35.

An understanding of why times akin to the 1970s have returned and that the experiences of 1981—2000 do not apply today is to be found in the prospective purchasing power of the dollar and the compensation foreign holders will require to continue holding the currency. And it is here that Trump’s agenda is most damaging. 

In the hustings, the President Elect made it clear that he would increase tariffs, particularly against China. But because it will be US consumers who pay for these tariffs, consumer price inflation is bound to rise. Furthermore, the policy of reducing income and corporation taxes is an overall combination bound to increase the budget deficit in the short term, whatever the longer-term consequences. This is pure monetary inflation, being the expansion and deployment of debt unproductively. Add this to the price consequences of tariffs and the dollar’s declining purchasing power is bound to fall further measured against real money, which is gold.

Cutting government spending is the obvious solution, but as successive politicians in the US and elsewhere have found this is easier said that done. It’s not impossible, just unlikely. And there’s the tricky subject of the debt ceiling, due to be reset on 3 January.

Apart from the policy difficulties of renewed inflation for the Fed, the consequences for Treasury notes and bonds will be catastrophic. Why? because foreign holders will require compensation in higher yields not to sell down their $32 trillion dollar mountain, let alone buy more dollars and dollar debt. 

That is the true function of interest rates and bond yields: compensation for the risk that the currency medium will lose value against goods, services, and gold. The days of a gold-based carry trade are over. Furthermore, when a fiat currency is in a debt trap and its purchasing power is declining at an accelerating rate, interest rates and bond yields will rise faster and further than might be expected.

Gold is all about the collapsing dollar, a fact which is lost on those whose trading memories only go back to the mid-1980s. This week was little more than turbulence in the fiat dollars path to worthlessness, as the technical chart of gold confirms:

The current turbulence may not be over yet, but it is a doppelganger for when gold and silver were sold down in the wake of the Lehman crisis, only to more than double subsequently.