Sprott Strategy Report
Donald Trump’s victory in the 2016 United States presidential election has sent deep tremors through the political and financial landscape, both in the U.S. and around the world. While we leave debate over future implications for financial markets to the markets themselves, we offer a few observations about relevance of the Trump victory specifically to precious metals.
The overwhelming implication of Trump’s shocking “upset,” is the glaring disconnect between harsh realities of broad American experience, on the one hand, and the increasingly “out of touch” focus of mainstream media, Wall Street analysis and Washington insiders, on the other. As was precisely the case with Brexit, American elites appear to have lost sight of fears and concerns motivating Main Street. In an electoral college in which 270 votes take the day, election-eve forecasts for Secretary Clinton’s likely electoral votes (330-350) were off by a range of 100 to 120 votes, a staggering misread of national sentiment.
In Figure 1, below, we offer two visual depictions of the 2016 U.S election map, each organized by county. On the left, a simple county-by-county map demonstrates President-elect Trump’s geographic sweep exceeded 85% of the more than 3,000 U.S. voting counties. On the right, a three-dimensional relief map of population densities reveals how Secretary Clinton’s tiny share of U.S. geographies actually commanded a majority in the aggregate popular vote (by more than 1.5 million votes at last count). The several decade trend for big city elites (and their constituencies) to dictate political and economic policies for the nation as a whole may have reached an inflection point! We would argue that Fed policies favoring banks and holders of financial assets are a significant component of the status quo rejected by the 2016 American populist voice. Simply put, Fed-induced financial-asset inflation has not trickled-down to the masses, as in prior iterations, and the collective has now registered their objection in no uncertain terms.
Figure 1: 2016 U.S Election Maps by County (Republican/Democrat) [Metrocosm/Blueshift]
[View & Manipulate 3D Version @ http://metrocosm.com/election-2016-map-3d/]
Perhaps more concerning for investors has been ubiquitous Wall Street prognostication for a sharp market correction in the wake of a Trump victory. Skipping specifics out of professional courtesy, our sampling of prominent Wall Street analysis foreshadowed a correction in U.S. equities between 5% and 15%, should Trump win the White House. Of course, U.S. equity indices have rallied some 2% to 3% since election night. If no one on Wall Street saw the Trump victory coming, and market participants were doubly misguided about financial-market implications of such an outlying outcome, should not reigning Wall Street complacence over U.S. financial-asset valuations be taken with a grain of salt? In our experience, as cognitive dissonance rises in financial markets, gold has generally proved to be a worthwhile portfolio component.
Buoyant post-election response from U.S equity markets (apparently telegraphing economic growth unimpeded by concerns for inflation or the Fed resting behind the curve), has been in direct contrast to a coincident bond-market rout. U.S. Treasury yields have exploded by 37% (through 11/18) and global bond losses have exceeded $1 trillion (apparently foreshadowing surging inflation expectations and emerging concern over the Fed’s policy stance). Amid such monumental and divergent moves in major asset classes, gold has endured a burst of volatility—first rising some $60 in overnight trading as Trump’s victory crystalized, and then falling $130 to an 11/18 close of $1,208 per ounce. At the risk of appearing flippant, we would suggest Mr. Trump’s unexpected triumph holds limited lasting relevance to the gold thesis. Given the gaping mismatch between total U.S credit market debt ($65 trillion) and GDP ($18.4 trillion), we are not sure a 2016 election-night victory by Jupiter, Apollo or Zeus could have significantly altered the economic landscape.
Outstanding financial claims are wildly inflated versus underlying productive output, and no U.S. administration can rebalance the financial system without copious amounts of default or debasement (or both). Gold is a unique portfolio asset in so far as it can neither default nor be debased. Gold is no one else’s liability. In physical form, or in a vehicle such as the Sprott Physical Gold Trust (PHYS), gold offers a unique and unlevered resting place for unlimited amounts of investment capital while the financial system seeks both direction and eventual equilibrium. To us, until aggregate imbalances (on the order of tens-of-trillions-of-dollars) in outstanding credit and household-net-worth are rationalized, gold remains a mandatory portfolio asset. Along the way, corrections offer attractive buying opportunities.
We recently attended the Investment Institute Fall Roundtable in Middleburg, Virginia. The overarching conversation in endowment and pension circles is how to reconcile the compression of reigning rates of return with unrealistic portfolio return assumptions. Roughly speaking, historical expectations for real returns of 5% in equity and 2 ½% in fixed income markets have devolved to the current environment of (optimistically) real returns of 2 ½% in equity and 1 ¼% in fixed income instruments. A great deal of analysis is directed at identifying root causes for return compression and assessing the trajectory of future return vectors. While we may sound a bit folksy in the context of the modern world of quant investing, we see return compression as inextricably linked to one basic issue: global central banks have chosen to address a structural debt problem by collapsing nominal rates to zero (and real rates into negative territory). Rudimentary economics establishes that marginal returns eventually approach marginal costs. Aggregate returns will remain challenged until central banks permit bad debt to default and interest rates to normalize.
Amid frenzied trading in asset markets, as investors place their bets on the economic implications of a President-elect best described as mercurial, we offer a sobering update on the absurdities of U.S. credit creation. In its Q3 2016 Used Vehicle Market Report (http://static.ed.edmunds-media.com/unversioned/img/car-news/data-center/2016/nov/used-car-report/used-car-report-q3.pdf), Edmunds reports that 25% of Q3 used-car purchases involved a trade-in vehicle with negative equity at the moment of the transaction (highest percentage in U.S. history). Additionally, the average amount of negative equity on these trade-in vehicles hit a new all-time high of $3,635. Given the average used car price of $19,200 in Q3, this means that 15%-to-20% of outstanding balances on a quarter of all Q3 used-car-loans originated in the U.S. were actually negative equity from the previous vehicle. Good luck President Trump!