At 12:11 AM Eastern Standard Time the website of US based financial periodical Fortune Magazine announced to stunned investors around the world that the price of gold had risen 4% to $US1,316 per ounce, as “investors are frantically looking for safe havens as the prospects of a Donald Trump presidency looks more likely.” Fortune referred to gold as “one of the world’s safest assets” and highlighted the fact the 4% uptick was the largest upward move in the price of gold since the Brexit vote.
The immediate response to the possibility of a Trump victory appeared to be right on the mark put forth by many investing experts. Uncertainty over Trump’s policies would be bad for stocks and good for gold. As the late evening turned into early morning the ASX began to drop and the futures markets in the US plummeted, with the Dow Jones Industrial Average (DJIA) dropping 800 at one point and both the S&P 500 and the NASDAQ closing trading after a 5% drop due to automatic circuit breakers.
As the unthinkable moved toward reality it appears investors were spooked by some of the many pre-election speculations regarding winning moves in the at that time unlikely event of a Trump win. Here are two.
• From Julian Jessop, of London based Capital Economics: ‘The only clear winner would be the safe haven of gold, whose prices has already topped $1,300 per ounce on Trump worries.’
• From Georgette Boele, of Netherlands based ABN Amro: ‘If Trump were to become president, gold prices will likely perform well, because we expect that his policies will be inward looking and will weaken the fundamentals of the U.S. economy. Weaker U.S. growth would help push gold toward $1,850 an ounce over the coming years…’
US stock markets had begun declining in the late October as Trump’s chances of winning improved. Within days of the election markets reversed course as expert upon expert predicted a Clinton win. Pre-election speculation for stocks was almost uniformly bleak. Here is a sample.
• From Bridgewater Associates, the world’s largest hedge fund in a note to clients: …the Dow Jones Industrial Average could plunge nearly 2,000 points in one day if Trump is elected president. That would be the biggest one-day slump in stock market history, by more than double, besting the 777 point plunge that happened on October 29, 2008, at the high of the panic surrounding the financial crisis. The drop would translate into a 10.4% dive, and immediately send the stock market into correction territory.
Predictions passed the common sense test based on market behavior into the election. The following graphic comes from the Wall Street Journal and suggests a correlation between the price of gold and the prospect of a Clinton victory.
As is now obvious, markets reversed course on both gold and stocks in dramatic fashion. The reversal began in the early morning hours of 9 November as President-Elect Donald Trump stepped to the podium in New York and made a conciliatory victory speech, promising to be the president of all the people and pledging to “seek common ground, not hostility, partnership, not conflict” with foreign countries. US stock market futures immediately began to improve and the following day a historic market rally began, with markets there hitting new all-time highs. And as stocks went up, the price of gold went down, falling below US$1,200 per ounce on 23 November, a drop of 11% from the $1,337 per ounce price before the post-election reversal.
Despite the current downturn the price of gold is still up close to 10% year over year and the big name ASX gold miners have fared well. The following table lists the 24 November closing price performance of four ASX gold stocks with robust earnings growth forecasts.
Conventional wisdom that feared the uncertainties associated with Trump seems to have “discovered” that Trump is very pro-business. The betting now appears to be that much of what he proposes to do will boost the US economy, at least in the medium term, causing the US Federal Reserve to quicken the pace of raising interest rates in the coming year. As you know investors turn to gold as a hedge against troubling times, and rising interest rates and a potentially booming economy hardly qualify as troubling.
After being proved wrong on both predicting the outcome of the election and its aftermath, by what rationale are the experts now telling us the current trends are real? Is gold doomed while stocks in select sectors like banking, construction, and pharmaceuticals assume the mantle of market darlings?
Trump’s ideas for boosting the US economy laid out during the election were more broadly stated aims rather than specific proposals. Right now the rally rationale appears to be coming from enthusiasm for three of those aims:
1. Corporate and Individual Tax Cuts2. Regulatory Reform3. Fiscal Stimulus via Infrastructure Rebuilding
The most obvious question when considering these three key aims is can Trump’s team craft specific legislation and get it passed in the US Congress. There are regulatory reforms Trump can enact on his own but tax cuts and spending initiatives have to go through the Congress.
A less obvious question is will Trump alter promises made during the campaign. To address that question consider the following list of changes in his posture already appearing in the days following his election:
• In the closing weeks of the campaign Trump promised supporters that if he won he would ask the US Department of Justice to appoint a Special Prosecutor to investigate alleged Clinton scandals. Now he says he won’t.
• Trump repeatedly promised repealing and replacing the US Affordable Care Act – now known as Obamacare. Now he says he wants to keep two of the key components of the Act.
• Trump promised to bring back waterboarding in interrogations of terrorists. Now he says he won’t
• Trump flatly stated he would not touch Medicare. Now he says he is considering “modernizing” Medicare.
• Trump once stated climate change is a hoax perpetrated by the Chinese. He claimed he was going to pull the US out of the Paris Climate Accord. Now he says he believes there is ‘some connectivity’ between changing climate and the activities of humans and is keeping an “open mind” on the Paris Accord.
Assuming Trump and his team put viable proposals before the US Congress, what are his chances of success, given the fact both houses are now under Republican control?
Odds are he will get his tax cuts through. Democrats have a history of working with Republican presidents, having passed tax cuts proposed by Ronald Reagan following the 1980 election.
Current investors trying to make some sense of this situation would be well advised to look back to the outcomes of those 1980 tax cuts. Reagan also proposed and got spending increases in defense. Within two years the tax cuts were scaled back due to increasing deficits and fears of rising inflation. The country actually went into a brief recession.
The parallels to the current situation should be obvious. Faced with dangerously high debt levels, will the US Congress follow along on a path of tax cuts and massive spending increases? Estimates for the Trump infrastructure initiative range as high as US$ 1 trillion dollars.
Note that the prospect of increased spending exciting investors barely notices defense spending increases promised by Trump with little mention since the election. Add to that the fact immigration reform and trade policies are receiving little more than a passing nod from much of the financial press. Trump proposes a wall along the southern border in the US without much thought given to how it will be paid for. The agricultural sector in the US depends on immigrant labor, much of it illegal. Deportations of illegals with criminal histories – Trump’s current proposal – will cost money and potentially strip the agricultural work force. Trade policies could ignite a trade war, driving prices up for US consumers.
Finally, the optimism largely ignores the potential for market turmoil from upcoming elections in Europe. Put this all together and one could argue there is a strong case for caution and keeping a watchful eye on the gold sector, which is sure to benefit from negative news on the US economy.
The gold miners have been hit particularly hard. However, investing in gold has been challenging at best over the last several years and our top miners have thrived. The following table includes historical performance and some forward looking indicators for what most experts would acknowledge are the “best of breed” among ASX gold miners.
The outstanding three and five year performances were made possible largely by the miners working to reduce All In Sustaining Costs (ASIC), keeping them profitable even at recent lows in the price of gold.
Back in July Morgan Stanley issued a research note highlighting its selection of Evolution Mining (EVN) as its top pick in the gold mining sector. The growth forecasts bear this out. Both value investors and growth at a reasonable price (GARP) investors salivate at the prospect of stocks with Price to Earnings Growth ratios below one. All of the four miners in the table reach that mark, both in current measures and five year projections.
Evolution posted Full Year 2016 Financial Results showing a 100% rise in revenue and a 114% underlying profit increase. However, one-offs due to acquisitions and goodwill impairment dragged profit down to a net loss of about $100 million. Investors were also disappointed in management’s lowering 2017 guidance slightly. Evolution owns and operates six gold mines in Australia.
Oceana Gold (OGC) has an additional issue about which investors should be concerned, beyond the falling gold price. The company has gold mines in New Zealand, the US, and in the Philippines where the government there is making noises about forcing Oceana’s flagship mine to cease operation.
Northern Star (NST) has made solid acquisitions over the past several years and boasts the best combination of historical performance and forward growth. In addition, it is the only miner to pay a fully franked dividend, with a current yield of 1.9%.
In closing, gold has fallen apparently due to a shift in perception about the impact of a Trump election in the US, moving from uncertainty to certainty Trump’s policies will propel economic growth, leading to higher interest rates, a strong dollar, and increasing profits for US corporations.
The counter argument has yet to gain much momentum, but there are those expressing concerns. Bill Gross, a recognized financial expert and founder of Pacific Investment Management (PIMCO), now works at Janus Global Unconstrained Bond Fund. He is of the opinion the Trump presidency will be “damaging” to the US, which of course would be good for gold prices. Here is what he had to say:
• Global populism is the wave of the future, but it has taken a wrong turn in America. Investors must drive with caution, understanding that higher deficits resulting from lower taxes raise interest rates and inflation, which in turn have the potential to produce lower earnings and P/E ratios.
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