Gold is at the mercy of Trump, China and King Dollar

Not only was gold looking overstretched after surging to a record this year, its price in dollars for non-US investors has become 5% more expensive on top.

By Marcus Ashworth

Typically, the best cure for high prices is simply higher prices, a lesson gold is learning the hard way. Since the prospect of a second Donald Trump presidency became a reality, the shiny pet rock has been hit by a double whammy. A decline of $220 per troy ounce, or 8 per cent, since the end of October may seem minor in the context of it still being up more than 25 per cent this year. But the loss of momentum is significant — gold no longer just goes higher and higher. Whether the rally can resume remains very much in the balance.

Credit: Bloomberg

"America First" trades have seen a flight away from haven assets into riskier ones, and predominantly those denominated in dollars. Not only was gold looking overstretched after surging to a record this year, its price in dollars for non-US investors has become 5 per cent more expensive on top.

This month, outflows from the main US physical gold exchange traded fund have been in excess of $1.4 billion, or around 20 metric tons. Meantime, China's central bank hasn’t added to its 2,264-ton pile for the past six months, according to Commerzbank AG analysts. It simply seems to have balked at too-high prices. Furthermore, perhaps the best gauge of Chinese retail demand, Swiss Federal Custom Administration data, showed August was the first month for more than three years without exports to China.

Deutsche Bank AG analysts led by George Saravelos have drawn three conclusions from gold's stumble. Firstly, regardless of Trump’s victory, markets are not worried about US credit risk. That has manifested in tighter corporate and high-yield bond spreads. Concerns have strangely diminished about spiraling fiscal deficits or qualms over the independence of the Federal Reserve. That’s quite the change from the pre-election narrative, which had been a key driver of higher gold prices.

Secondly, foreign central bank reserves gold demand is falling as "many now need to spend dollar reserves to defend their FX from capital outflows" as the US currency climbs, according to Deutsche Bank. This probably affects China most — though at least it has a big rainy day gold stash to raid. However, that isn’t the case for all. The wider MSCI Emerging Market currency index has reversed nearly 3 per cent since the end of September, wiping out its gains for the year.

Credit: Bloomberg

Lastly, Deutsche Bank analysts reckon that while there may be foreign public sector entities forced to sell dollars, that’s absolutely not the case in the private sector. Piling on the pain, they stress that the greater the risk a government gets sanctioned by the US, the bigger the net demand for dollars. King Dollar lives on as presently all roads lead to the big party going on in US assets — Bitcoin perhaps being the other notable outperformer, having soared 37 per cent since Trump’s win. Rising demand for risky assets is being heavily skewed toward the, US but the exorbitant advantage of being the global reserve currency means it’s also enjoying increased safe-haven demand too.

It’s important to appreciate the changing investment landscape. Societe Generale SA strategist Andrew Lapthorne calls US equities “undeniably expensive” but notes valuation conversations with investors “are increasingly rare.” The US represents about 74 per cent of the MSCI World index market capitalization, a record high. “This is almost entirely down to the valuation premium, without which the US would be closer to 50 per cent of MSCI World,” Lapthorne calculates.

This is close-your-eyes and buy price action. It's worth repeating that the rest of the world accounts for only only one-quarter of global equity market capitalization. To paraphrase Gore Vidal: “It is not enough to succeed. Others must fail.”

Michael Kelly, global head of multi-asset strategies at Pinebridge Investments, reckons that Trump causes problems far and wide, “Europe has a big bullseye on their head on all these trade issues,” he says. Furthermore, the policies China is putting in place will at best “slow down their slowdown, not reverse it. So the companies or countries that rely on exporting to China are really gonna suffer.” European exporters are the most exposed if tariff wars break out.

The big three historical drivers of gold prices, according to Chris Watling, founder of Longview Economics, are the dollar, inflation expectations and interest-rate forecasts. Tempering inflation expectations are less supportive of gold. Even though US consumer prices ticked up in October, the Treasury market was quite sanguine about it, raising expectations for another 25 basis-point cut from the Fed in December.

Nonetheless, Fed Chair Jerome Powell appeared less enthused about the need for sequential interest-rate cuts in his most recent speech, making a pause early next year looking quite possible. With 10-year US Treasury yields nearing 4.5 per cent, delivering a healthy return of more than 2 per cent in real terms after adjusting for inflation, then gold's glister isn’t quite so alluring when it pays no income and comes with storage costs. The backdrop has suddenly altered from being supportive for gold to working against it.

Strategists at Goldman Sachs Group Inc. remain optimistic, looking for the yellow metal to finally reach $3,000 an ounce by the end of 2025, driven by renewed central bank buying and further Fed rate cuts. They see a Trump administration, pursuing increased tariffs and potentially worsening deficits, as benefiting gold in the long run. A Trump presidency will be unpredictable. Gold will always have its uses, but it just might take a more aggressive Fed rate-cutting approach that materially weakens the dollar to reignite its charge higher. Ultimately, though, its fortunes remain dependent on the needs and whims of China.