Mid-Summer Musing

July 26, 2016

A week from Thursday will mark the midpoint between the summer solstice and autumnal equinox.  In theory, August is a sleepy month when investors and traders take their holidays.  Historically, however, August has been hardly insulated from market volatility or the event risks.  For example, both world wars began in late summer, and Iraq’s 1990 invasion of Kuwait occurred in early August.  Former President Nixon severed the link between gold and the dollar in mid-August 1971.

The summer of 2016 has already produced a monumental shock, the British referendum decision on June 23 to leave the European Union.  In foreign exchange, the biggest casualty of that watershed has been sterling, and the main beneficiaries are the yen and dollar.  Sterling weakened from $1.5019 to as low as $1.2798, and the dollar is currently trading 5.3% above its June 1 – July 25 average level against the pound.  In other comparisons of the U.S. currency’s current value compared to its means since the start of June, the dollar has advanced between 1.4% and 2.0% against the yuan, euro, loonie, Swiss franc and Australian dollar, but it is up just 0.7% against the kiwi and down 0.2% relative to the yen.

The uncertain fallout of the British vote to leave the EU has led a slew of central banks and governments to revised growth prospects lower and for officials to move to a higher level of alert in their readiness to provide more macro-economic support lest growth sag excessively and the prolonged experience with insufficient inflation get extended. The United States stands apart from this crowd.  If anything, Fed officials seem more inclined now than a month ago to raising the federal funds target later this year.  That said, tomorrow’s FOMC statement will most likely read ambivalently because of the fluidity of the U.S. and global economic situation, the extent to which such may hinge on the uncertain outcome of this year’s U.S. election, and the desire of Fed officials not to pre-commit and to instead leave all their policy options open as long as possible.

The Bank of Japan but not the Federal Reserve appears likely to change policy this week.  In that light, the yen’s well-bid status is impressive.  Such may reflect a lack of investor respect for the effectiveness of Japanese monetary stimulus, which has been aggressive on paper for over three years already.  Japan’s growth prospects in 2016 and 2017 are generally worse than those of the United States and Euroland.  If currency markets behaved altruistically, which they do not, the yen would be losing value, since yen appreciation will reinforce the weak growth profile and fan disinflationary forces.

A separate anomaly since the start of June has been the resurgence of gold.  The dollar is presently 8% weaker than its mean level against gold since the first of June.  More often than not, gold is well-bid when the dollar loses favor and vice versa.  So gold appreciation at a time when the dollar has done better than hold its own against other paper currencies qualifies as a counter-intuitive development when viewed through a foreign exchange lens alone.  This juxtaposition makes sense from two other standpoints.

The first stands from my expectation that Donald Trump wins November’s election.  He’s proven to be a better political campaigner than Clinton.  Republicans are more likely to put aside their misgivings over his atypical stands on trade and big government for the greater perceived good of securing a more conservative Supreme Court. Supporters of Sanders, on the other hand, care little about the consequences of putting principal above pragmatism. When the objective is political revolution, chaos is acceptable collateral damage.  The dollar is threatened in several ways by a Trump presidency.  First, America’s relationships with its allies will become more confrontational.  Second, the Federal Reserve’s real and perceived independence will diminish in the face of Republican control of the executive, legislative and judicial branches of the federal government.  Segments of the Party want to abolish the central bank altogether and to put the United States back on the gold standard.  Third, trade wars will become more prevalent, which favors currencies already underpinned by a strong current account surplus.  The U.S. has a deficit. Fourth, Trump favors an unpredictable style, but markets favor consistency and and a manageable degree of uncertainty. Finally, U.S. vital economic signs since 1960 — growth in real GDP, growth in jobs, inflation, stock market performance, and the strength of the dollar — has been consistently better during democratic presidential rule than at times when the president was a republican. Inauguration Day on January 20, 2017 is now less than a half year away.  It’s not too early for gold to make a move higher to hedge against the strong possibility of Trump winning.

A second broad reason for being bullish on gold in a Trump-led world has to do with the implication for the environment. Long before his presidential candidacy, Trump was vocal in his belief that the assertion of man-made climate change is a hoax, so the United States government under his leadership will do absolutely nothing to address that threat.  Since the planet can not afford a four- or eight-year delay, it will be the end of the world as we know it, and survivalist demand for precious metals over paper money will accordingly climb sharply.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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