Gold Monitor. Murenbeeld & Co

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1 Monitor February 24, 2017 Martin Murenbeeld Brian Bosse Chantelle Schieven GOLD PRICE Source: LBMA, Bloomberg Euro, Yen, Pound US$ - Friday p.m. fix US DOLLAR INDEX Euro, Yen, Pound, Cdn $, Yuan, Swiss, Rupee, Aus$ Euro, Yen, Pound, Cdn $ January 1999 = 100 Source: WSJ, Bloomberg US INTEREST RATES 3-Month T-bill Source: Bloomberg 10-year US Treasury Feb-20 Feb-21 Feb-22 Feb-23 Feb-24-2nd Fix COMEX US Silver - HH H Platinum - NYME O Crude Oil - NYME L CRB Bridge - NYBOT I US $ (Excluding Cdn.) Fed Funds (Overnight) D US Bonds - CBOT A TSX Global Index S&P 500 Y Source: LBMA, CME, WSJ, Bloomberg, The US Trade Deficit and National Savings: Implications for Many economists have argued that the US trade deficit is a direct function of the US budget deficit and the US domestic savings/investment imbalance. They argue that the trade deficit will not disappear until/unless the US corrects these internal financial imbalances. The argument rests on the following (derived) GDP identity: (T-G) +(S-I) = (X-M), where T equals taxes, G equals government expenditures, S equals private savings, I equals private investment, X equals exports and M equals imports. The identity indicates that government budget deficits (where T<G) and deficient domestic savings (where S<I) add up to a trade deficit (X<M). To put it differently, when T<G (when tax revenues are insufficient to fund government spending) and S<I (when domestic savings are insufficient to fund domestic investment) the money to fund these imbalances will come from abroad! Net, net, those foreign capital inflows equal the trade deficit! This is all correct as it stands; at the end of the day foreign capital inflows (i.e. foreign purchases of US government debt, corporate financial assets and direct investments) will always equal the trade deficit; the GDP identity will, ex-post, never be violated. But does this mean that the US trade deficit is solely

2 Monitor 02/24/2017 a function of US domestic policies that discourage private domestic savings and boost government expenditures without commensurate tax policies to help pay for these expenditures? The answer is no, and the simple reason is that it takes two countries to trade, and the policies of US trade partners, i.e. the policies of China, Japan, and Europe, will directly affect the size of the US trade balance with these countries. (The US has long-standing large trade deficits with each!) Overseas policies will also have a direct bearing on US domestic savings and tax revenues necessary to fund domestic investment and government expenditures. Consider the following hypothetical example: country CJE maintains an extremely competitive exchange rate relative to the US and discourages US imports in many domestic economic sectors for national security (and domestic competitive) reasons. This country will accordingly run a trade surplus with the US, if only because the US has few barriers to the imports form CJE - on account of a strong domestic consumer/import constituency and a general free trade policy mentality. So how will this trade deficit affect US financial imbalances? First, CJE s trade surplus will lead to US payments for CJE s exports to the US. Those payments should pressure CJE s currency to rise. But CJE s central bank (and/or government) doesn t want its currency to rise (nor do CJE s exporters), and accordingly decides to buy these US payments in the foreign exchange market (and even force domestic exporters to pass their dollar receipts up to the central bank in exchange for local currency). CJE s central bank then turns around and invests these dollars back into the US financial market (buying US government debt, corporate financial assets, and direct investment by way of government-sponsored sovereign wealth entities). This closes the circle: The US trade deficit with CJE is balanced off with foreign capital inflows from CJE. If anyone doubts the truth inherent in this hypothetical example, note that there are some $10 trillion foreign exchange reserves in the world. Such reserve hoard can only be built on the back of trade surpluses and massive currency intervention. The counter party here is the US, which has massive trade deficits for many years. The Trump Administration wants to put a stop to this! One could write long essays on all the many options the Trump Administration might consider. Yet, many economists would continue to argue that nothing will reduce/eliminate the US trade deficit as long as the US needs foreign capital inflows to balance off its domestic saving and tax deficiencies. I totally disagree; my simple example of country CJE suggests that foreign policies go a long way to explaining the US trade deficit (and hence also the US domestic financial imbalance). Furthermore, if CJE refuses to adopt policies that will reduce its trade surplus, there isn t a damn thing the US can do short of introducing protectionist policies (or adopt domestic deflationary policies, which no US Administration in my living memory has ever considered). Peter Navarro, Trump s Director of the National Trade Council, has indicated that the euro is too low (that Germany benefits hugely from the ultra-competitive euro), and that China (and others) have undervalued currencies and largely eschew free trade. This, he suggests, needs to change. So we need to wait and see what sorts of policies the Trump Administration will employ to nudge (force/command/direct/ threaten) its trade partners in the desired direction. 2

3 Monitor 02/24/2017 But what of the GDP identity? Well, if CJE adopts policies that quickly reduce its trade surplus with the US: i.e. as a start forcing its currency higher against the dollar and opening its market to more US exports (and back these policies up with policies boosting domestic consumption instead of policies boosting yet more domestic production and exports) the specifics of the US GDP identity will change quite dramatically. For example, when US exports (X) rise and US imports (M) decline (1) monies spent on imports will be spent domestically meaning among other things that the domestic savings pool will rise; (2) revenues of exporters will rise, which will draw investment to export sectors (funded more by the higher domestic savings pool and less by foreign capital inflows); (3) employment will rise in import-competing and export sectors of the economy, (4) government expenditures on social assistance will likely decline, and (5) tax revenues will rise on the back of rising GDP. In other words, the variables on the left-hand side of the identity (T-G) +(S-I) = (X-M) will all change when (X-M) rises sharply in response to more balanced foreign policies. Taxes will rise, government social expenditures will decline as employment rises, savings will rise, and investment will rise. Any imbalance resulting from a pickup in domestic investment can usefully be plugged with tax policies that encourage US corporate savings held overseas to return to the US. Ex post the identity holds, but ex ante we cannot specify all the dynamics of the eventual balance in the identity. The key point here is that it is not set in stone the US must first solve its domestic financial imbalance before the trade deficit can decline! Future Trump/Navarro policies will, I suspect, go at this much along the lines I have suggested here these will force trade partners to reduce their deficits with the US by adopting more import-friendly policies and more appropriate currency values. If US trade partners do not yield on this, a trade war is likely because the US will almost certainly commence blocking foreign goods (with taxes, tariffs, and non-tariff barriers). investors need take note; a trade war will benefit the price of gold! investors need also take note of the fact that a weaker dollar, which is somewhat central to foreign trade surpluses coming down, is also very positive for the dollar price of gold. S&P/TSX COMPOSITE INDEX S&P 500 INDEX DOW JONES INDUSTRIALS Source: Bloomberg, 3

4 Monitor 02/24/2017 GOLD VS S&P S&P Index: = 10.0 : US$/oz. Depression : revalued to $35 in 1934 revalued 5 years after peak RATIO: S&P 500 VS. GOLD Recession : price cut loose: in 1971 cut 5 years after peak Current = 1.00 Annual Data Source: Global financial Data, Bloomberg, This chart tells a vital story across 150 years. More importantly, please note how since the 1920s, this ratio traces out the secular bull and secular bear cycles of the S&P 500. Three clearly visible spikes depict the three secular bull markets in living memory. Each spike is greater than the previous spike. An unanswered question remains: is the current secular bear in equities finally exhausted, or will this ratio eventually move back down below 5? Certainly this is a topic we intend to discuss in depth later on in Stay tuned. Daily GOLD AND S&P 500 DAILY DATA Corr: -.52 Corr:.12 Corr:.41 Corr:.74 Corr: -.71 Corr:.56 Corr: -.88 S&P 500 (axis inverted), Source: Bloomberg, S&P 500 (axis inverted) The S&P 500 and the gold price generally trend opposite to each other, but both have been rising as of late. Note that the S&P 500 axis is inverted. 4

5 Monitor 02/24/2017 Daily p.m. fix THE SHORT-TERM TECHNICAL PICTURE 50-day moving average 200-day moving average, Source: Source: LBMA, LBMA, Bloomberg, Dundee Economics 5-day sum of daily change tonnes 2015 CHANGE IN GOLD ETFs had a good week last week and the 4-year technical picture is beginning to suggest a breakout of the downtrend channel. However, a developing pattern of higher lows and higher highs since December 2015 must come to fruition before it can consign our red lines to the dustbin of history. 2013: -869 T 2014 : -164 T 2015 : -137 T 2016 : 315 T 2017 : 52 T To Date Demand for gold ETFs remains quite strong Source: Bloomberg 2015 Last date: February 23, Specs net long (tonnes) Price 7 tonnes COMMITMENTS OF TRADERS DATA GOLD AND SILVER ETFs Source: US Commodity Futures Trading Commission, Bloomberg *Futures Contracts: in tonnes-equivalent ETF-Silver Total price (%Q/Q) tonnes Last date: February 21, 2017 ETF- Total Last date: November 23, similar improvements can be seen in the Commitments of Traders data chart. The year end low of is hundreds of tonnes higher than its equivalent. Source: ExchangeTraded.com, Bloomberg Price

6 Monitor 02/24/2017 GOLD AND THE DOLLAR DAILY DATA, 2017 Corr: -.75 to date US Dollar Index (EFXR0C) (axis inverted) Corr: -.71 Corr: -.54 Corr: -.59 Corr: -.85 Corr: -.63 Corr: Last (EFXR0C date: February - US$ 24 index includes: Euro, Yen, Pound) NY Crude 2017 EFXR0C (axis inverted) Daily GOLD AND 10-YEAR TIPS DAILY DATA Corr: -.16 Corr: -.78 Corr: -.91 Corr: -.46 to date Corr: -.92 Corr: -.27 Corr: year US TIPS (Axis inverted) , year USTIPS (Axis inverted) GOLD AND OIL DAILY DATA New York Crude NY Crude Corr:.56 Corr:.39 Corr:.13 to date Corr: -.32 Corr:.18 Corr: -.41 Corr:.76 Daily, Currencies 9 Source: Bloomberg, GOLD AND OIL DA New York Crude 6