Will Trump’s Programs Bring Helicopter Money?
With the surprise Trump election victory, the markets have undergone a massive rotation. Literally overnight virtually every major position trade has been turned on its head. Because gold is relatively minor in the grand scheme of markets, it has become caught in the wake of this massive rotation. The bond market has undergone a monumental sell off. To get a sense of the scale of these moves the sell-off in bonds as measured by the TLT was almost a 5 sigma move on Wednesday November 9th using daily price data. Financial services, healthcare and almost anything cyclical (and especially infrastructure related) were aggressively bid. Anything approximating a bond proxy (utilities, staples, telcos, REITs, and gold) were sold off equally aggressively. The issue for gold is that the sell-off in bonds and the rise in nominal yields are outstripping the rise in inflation expectations causing real rates to rise. We think the bond sell-off was predominantly flow driven. The rise in the USD is also likely driven by the expectations of better relative growth in the US due to tax cuts and expected infrastructure spending plans. The market is pricing in the known outlines of Trump’s policies as highly inflationary.
Beyond this initial across the board asset class repositioning, the biggest question is how will the revenue shortfall from the tax cuts be plugged and how will the infrastructure spending be paid for. The obvious answer will be bond issuances but the numbers are numbing. The Tax policy Center estimates that Trump’s tax plan alone would increase the federal debt by $6.2 trillion over the next 10 years, but it is doubtful that Congress will approve anything close to that (source: BCA Research). Add the proposed $1 trillion infrastructure spend to the above and you have a material increase (+$7.2 trillion) on the already bulging $20 trillion public debt. That’s about a 36% increase in public debt to +$27 trillion. The above will undoubtedly add to the fiscal strain of growing entitlement spending, such as Social Security, Medicare and Medicaid. Total entitlement spending accounts for close to 2/3 of the debt. In addition, higher interest rates will increase the cost of servicing the growing debt burden.
On the positive side, the growth from the tax cuts and infrastructure spending will offset some of this revenue shortfall. During the QE years of 2008 to 2014, US public debt expanded by $8.9 trillion but we had QE1, 2, & 3 to mop that up. In the absence of any QE program the question becomes how high can yields rise before it dampens economic growth? Will the Fed stand by and watch the benefits from several years and trillions of dollars over multiple QE programs become eroded? To issue the amount of debt necessary to make up for the tax cuts and infrastructure spending but also not let bond yields rise uncontrollably, the idea of helicopter money or debt monetization (same thing) is starting to make a lot more sense. We could see similar scenarios unfold in both Europe and Japan with debt monetization as the next leg of unorthodox monetary / fiscal policy becoming increasingly likely or at the very least a lot more tempting. The mechanism that seems most plausible would be to place some (or a lot) of this new debt onto the balance sheet of the central banks, cap yields (like the BoJ just did) to keep funding costs under control so growth stays intact, and then monetize the debt. The only other realistic choice would be to let real rates fall into deep negative levels but you would really destroy the bond market.
On the charts, gold bullion has important support at the $1200 level. Total known ETF holdings of gold have held essentially flat since June. The CFTC gold bullion data post the election will not be released until Friday November 18th. We would guess there was significant selling by investment funds but have we reached statistically significant oversold levels? GDX has fallen below our $22/23 support level and we are looking at the $19.50/20.00 level, the 38.2% Fibonacci level and the last LT bull support level. Volumes were very high and selling breadth significant. By any measure the GDX is significantly oversold and is now down – 37% from the peak matching the -38% drop in the 2002 bull market correction. The selling pattern has also completed five waves. Speaking of selling patterns, the GDX is trading in line with bond proxies (just overlay a chart of XLU with GDX). Until the US 10 year yield stabilizes, we will have downside risk or at the very least a lot of chopping volatility. DXY (US dollar proxy) is trading at 100, the high was 100.5 which given the strength of this trade we should surpass. USDJPY has put in a base and is trading at 108.4 with an upside target of 112/113 (gold bearish).
As we mentioned earlier many asset classes are at extreme positioning and a mean reversion trade is likely even if it is just in the short term. We will likely use the rallies to reposition the fund to more liquid positions and lower volatility holdings. The surprising Trump election victory appears to be a game changer and the market moves have the look and feel of a massive squeeze. In the short term, the sharp moves in yields (nominal and real) and the overwhelming USD strength is very negative for gold. Right now we are oversold enough to wait for a rally to reposition the funds. Medium term there will be a lot of volatility and repositioning across most asset classes. We still do not know what the actual polices will be going forward nor how it will ultimately impact growth. Longer term the amount of debt that needs to be funded will be staggering. So far the market is running on the optimism of tax cuts and stimulus spending. But at some point the market will need to factor in the realities of how this debt will be financed, higher yields slowing growth, the stronger USD pressuring vulnerable emerging markets and US exports, and rising trade protectionism pushing inflation higher and growth lower. In this context, we view last week’s market action as an overreaction. We do not believe that Trump’s plan can be self-financed through tax credits to businesses and the debt levels that will accompany the plan cannot be ignored for long.
The Gold Team
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