Trade War May Pressure New Bottom in Gold

President Trump's escalating trade war appears to be affecting gold prices, which respond to a stronger dollar.  The tariffs will make Chinese goods more expensive, but the Chinese can make their goods cheaper by making their currency cheaper to offset the effects of the tariffs.  There are many ways the Chinese can do this:  The yuan is pegged to the dollar, so they can lower the peg.  This is easy to do because the Chinese owe at least a trillion dollars in loans to the US, and they hold trillions in dollars and dollar-denominated loans that they’ve made to the US government. If they purchase dollars, the dollar will strengthen, and Chinese goods will become cheaper, offsetting the tariffs.  

In turn, the price of gold is affected by the dollar. A stronger dollar means cheaper gold. That correlation has held this week. 

In light of today’s White House threats of an additional $200 billion in tariffs,  the S&P 500 fell almost one percent and gold fell back to $1244, a fall of about $10.  The yuan renminbi-to-dollar exchange rate has fallen over the past couple of days to $0.1497, the lowest level this year.   

 It will be seen whether gold can hold a technical $1240 inflection point.  If not, there may be a good way down as the Sino-American trade-and-currency war escalates. That might provide a good entry point for gold, perhaps below the $1,000 mark.

Hope is not prediction, though.

How Long Will the Dollar Runup Last?

Below is a picture of the log of the dollar valued in milligrams of gold. The sharp decline in the dollar began around 1971, following the Great Society and around the time of the abolition of the gold standard in 1971. The Great Society and mega-government of the LBJ and Nixon eras and the post-Reagan stock market bubble have been funded with paper money. Before then the dollar was relatively stable. The source of the chart is PricedinGold.com . (See the chart here.)  The inflection point that worries people holding gold now is the local bottom. My late friend Howard S. Katz wrote about the commodity pendulum  whereby Fed monetary expansion reduces the cost of capital, expands the number of miners, pushes down the cost of gold and other commodities, causes bankruptcy among the miners, which in the end results in a whipsaw and additional sharp leg down in the dollar and up in gold. You can see that in the post-1983 Reagan reflation pattern, which ended with the stock market correction of 2000 and an additional sharp decline in the value of the dollar. The question is whether the massive monetary expansion of 2008-2014 will result in an even greater upturn in the value of the dollar than the 1983-2000 upturn. That is, will the current upturn in the dollar's value continue for 17 years or more, as did the 1983-2000 upturn in the value of the dollar. I don't claim to know the answer, but gold miners have sold at depressed levels for some time.

Bearish on Gold, Stocks

I have sold more than half of my gold and silver holdings. I am bearish on gold right now, and I think the recent declines can go to $1200.  I am keeping my long-term holdings in gold but selling my short-term holdings.  I will get back in if the current declines stabilize.

The reason for the current declines seems to parallel the declines in the 1980s and 1990s.  When the Fed expands the money supply, part of the credit expansion is borrowed by commodity producers, who expand production.  Because commodities are fungible, expanded production goes directly to increasing supply, hence reducing price. When price declines cause shakeouts in the market, the price stabilizes, but the producers no longer have access to easy credit. Then the cycle renews.  I learned this concept from the late Howard S. Katz.

Unlike earlier cycles, the Fed has imposed a massive monetary expansion, a fresh cycle, on top of the intermediate stages of a bull market.  It is impossible to know how far the gold price will fall, but I  doubt that the current weakness in the gold price will continue for 20 years, as it did from circa 1982 to circa 2002.

I am also gradually selling stocks.  If you have been following the stock market, we are more or less at the peak that provided resistance in 2000 and 2007.  The massive Fed stimulus might change the real values of the peaks so that the current upswing can go further.  The recent news that the Japanese are going to buy assets around the world with counterfeit yen also may help perpetuate the current rally to new highs.

Are American grandmothers going to cash in their CDs and buy stocks?  Are the Japanese going to pump up the US stock market for more than a year?  I am dubious.  I am holding my high-yield securities but gradually selling my index funds and going into cash.  If there is a market correction, I aim to get into natural gas tankers and energy MLPs. I have a number of MLPs now (about six percent of my portfolio is currently in MLPs, including Kayne Anderson, Clearbridge, and Neuberger Berman), and I want more MLPS and natural gas tankers.

Where Do Markets Bottom?

Five Year Gold Price courtesy Kitco.com

The above is a chart of the gold price over the last five years. The steep falls of the past week are tiny blips. But while one experiences them they are significant. The question is: where does gold bottom? The current decline like the one in fall 2008 is due to concern about financial problems, this time one in Greece and Spain that threatens the Euro; and the possibility of future Fed tightening. It is paradoxical that despite long term ill prospects for the dollar, in the short term it is viewed as a safe haven from risk assets, including gold. In fact, gold is much safer, but the short term psychology of Wall Street Keynesians leads to that thinking.

Gold has further to fall, according to my coin flip test, but not so far as in 2008. Maybe to $950, which came up heads.