For most of 2016, the price of gold and the Dow Jones Industrial Average (DJI) moved in tandem; but since the November 8th Trump victory, the gold price has dropped five weeks in a row, while the DJI has been gaining and breaking records. Last Friday, the London Bullion Market Association (LBMA) afternoon benchmark gold price reached US$1,163.60/oz., a drop of about 17% from its July peak and a 10-month low, with strong headwinds ahead.

The underlying reasons for the opposing trends are the same: the optimism of the honeymoon period after the Trump victory, suggesting massive fiscal stimulus programs and tax giveaways in an attempt to re-grow the US economy; and the expectation that the Federal Reserve will tighten monetary policy with positive economic indicators such as near-full employment in the country. The emergence of these conditions typically entices institutional investors to reallocate sizeable capital from holding gold to the equity markets. ICBC Standard Bank argues that the risk of a bearish gold market ahead in the near term is high, given the recent sustained fall in gold holdings (in fact, in any asset class in similar situations) and recent subdued gold demand from the world’s two largest markets, China and India. As the COMEX speculative positions are not at extremes, they expect that a move in the US 10-year treasury to 2.6% could easily see gold drop below US$1,100/oz. This is possible because the current optimism about Trump’s new fiscal policies continues to buoy US Treasury yields to rise faster than expected inflation, pushing up real interest rates. As can be seen in the figure below, historically, the correlation between real interest rates and gold has been very strong in recent years.

ICBC Standard Bank believes that optimistic investors have not priced in the pain of the inevitable cost of the scale of fiscal stimulus outlined by Trump (whether it be repatriation of foreign earnings, infrastructure building or anything else) in the face of a deteriorating US budget deficit and ballooning national debt, which will come back to haunt the administration and the US. Further, Trump’s promise of massive tax breaks to induce demand, again, has to be financed by budget deficits and national debt. The last big tax breaks were executed by the George W. Bush administration at the beginning of the century. During his administration, independent researchers at “Tax Notes” estimated the tax giveaway at some US$3.3 billion. Along with the credit bubble, the US set itself up for the international financial crisis that called for trillions of US dollars of quantitative easing programs across major developed economies. One difference since Bush’s time is that when he took office, the US was operating at a surplus and the debt to nominal GDP ratio was only 60%. But as Trump takes office, the government is already operating under deficits and the debt-to-GDP ratio has grown to 105%. The weight of both US government budget deficits going forward and all-time-high US national debt will be the defining reality that may well spell the beginning of the end of the honeymoon after the inauguration on January 20, 2017. At that time, in the aftermath of the massive quantitative easing, it is likely that gold will start to regain its strength again, with a return to its fundamentals as a safe hedge to protect value and wealth over the medium and long term. （Written by Chief Executive Officer, Chairman of Century Global Commodities, Sandy Chim）