As Gold Hedge Gets Higher, Consumer Demand Shrinks

 | Jan 10, 2017 | 3:00 PM EST
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Although my weekend column was headlined "Trump Will Be Good for Gold," I didn't address the reasons why substantively enough. I'll do so here. 

The post-election market euphoria of what might be is about to run head on into the pragmatic reality of what is immediately possible as Donald Trump pursues his agenda. 

It appears Trump is going to proactively pursue fundamental changes to both domestic and foreign policies simultaneously that are principally ideological and largely independent of both the current state of the domestic economy and foreign trade relations. 

The fact that they're proactive and simultaneous is enough to give investors pause as to whether he'll succeed, and if so, whether the changes will succeed. That uncertainty alone should provide a substantial shift toward gold simply for hedging purposes. 

But there is a more immediate and tangible issue that should also cause investors to start shifting assets into gold for hedging purposes. That is the lack of demand in the economy right now, which I've written about on numerous occasions. 

These changes being pursued by Trump are broad and sweeping and will take years to produce the kind of economic response that the ideology he's pursuing implies, but the markets have been pricing, since the elections, on expectations for an immediate response. 

An immediate economic response can only come from direct fiscal intervention and stimulus, which requires an increase in federal outlays. The approach Trump is taking is indirect in that it will focus, as near as can be ascertained now, on relying on tax-system changes that will afford the private sector the opportunity to stimulate domestic economic activity rather than the government directly. 

Although it is possible that such changes, should they be successfully passed into law, will eventually be beneficial to the economy, they do not address the immediate issue of lack of demand. 

This is not a minor point. 

A demand catalyst is necessary for the private sector to make the kinds of investments Trump believes will be made if tax and regulatory burdens are lessened. 

Without an increase in demand, reductions in domestic taxes and regulation, even if coupled with increased tariffs on foreign goods and services, will not produce the demand. All they can do is make it easier for companies to respond to an increase in demand when it is evidenced. 

There is nothing in the Trump agenda that addresses the immediate lack of demand, as near as I can tell. It's completely possible that Trump and his team are aware of this but have decided that attempting to provide direct fiscal stimulus will come at the expense of being able to get the structural changes passed. 

That indeed would likely be the case. 

It is also possible that they are not aware that demand has been exhausted, or believe that it hasn't been exhausted, or that they are willing to accept underperformance of the economy due to exhausted demand while they concentrate on getting the structural changes to domestic and foreign policies passed. 

I've not been able to determine which of any of these possibilities is the case. 

The fact remains, however, that the U.S. equity and bond markets have been pricing for an imminent increase in economic activity that must be led by an increase in consumer demand, while seemingly being unaware that there is nothing in the Trump agenda that addresses that need. 

Having said all that, the Trump agenda will be very positive for U.S. equities, and the euphoria investors have expressed with respect to its logical impact on corporate finances is warranted. 

A reduction in corporate taxes causes retained earnings to increase and warrants an upward repricing of equities. It does not, however, mean those retained earnings will be deployed in capital investments or job creation. 

Companies make such investments to meet demand. Demand leads production and investment. 

The bottom line is that pursuing indirect fiscal stimulus, coupled with exhausted monetary policy and exhausted consumer demand, leaves a gap in immediate economic potential that investors do not appear to be cognizant of. 

The increase in long-end Treasury yields and mortgage rates since the elections is already providing a drag on housing activity, and that will probably be transmitted to the broader economy as well during the first half of this year, at least. 

As all of this unfolds, I expect investors will increasingly become aware of the fact that there is no direct fiscal stimulus coming from the Trump administration and will begin to increase gold holdings for hedging the uncertainty. 

As I maintained throughout 2016, my preferred method of participating in that is through the VanEck Vectors Gold Miners ETF (GDX) .

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