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A Tale of Two ‘exits’: Brexit vs Trexit (or Brexit 2.0)

Citation:The Northern Miner Date:2016-11-15 11:27:24

Donald Trump’s electoral victory last Tuesday surprised both America and the world – as much or more than the Brexit vote in June. In addition to the unconventionality of the president-elect, Trump’s proposed policies seemed to presage serious negative effects on global markets – so much so that the world expected gold prices to surge by hundreds of dollars and global equity values to drop significantly.

Though the events have many parallels – people are even starting to call the Trump Presidency ‘Trexit’ – when it comes to gold, the differences begin. Despite the shock of the election, gold’s performance just two days after Trump’s victory was surprisingly moderate.  

On the day after Brexit, June 23rd, gold jumped from US$1,262.15/oz. to US$1,315.50 and then to US$1,324.55.  In less than two weeks, it shot up by more than US$100, to peak at US$1,366.25 by July 6th.  Thereafter, it stayed well above US$1,300 until October.

 Although gold surged overnight before the US markets opened the morning after Trump’s Tuesday win, it flattened out on Wednesday and fell on Thursday and Friday, ending the week at US$1,236.45, according to the London Bullion Market Association – the exact opposite of what analysts had predicted in the case of a Trump win.  The equity markets responded similarly; the Dow ended the week with a 5% gain.

Perhaps due to the president-elect’s more conciliatory post-election tone – such as backtracking on his promise to trash Obamacare completely – the markets were surprisingly calm. Nevertheless, some pretty consistent trading right after the election last week revealed a relatively clear market direction.  

Of course, it is still early in the game, and more iterations are bound to come. However, it is becoming clear that what Trump said on the stump is one thing, and what he will do when he takes office is entirely another. And he should be intelligent enough to steer the American economy away from harm.

Now that volatility seems to be reined in for the short term – and hopefully sustainably – after all the noise is gone, the medium - and long-term market for gold, will be shaped by fundamentals.

One of the most important fundamentals lies in the aftermath of massive quantitative easing in almost all major advanced economies (which is still going on in Europe and Japan). This will continue to debase the major currencies of these economies, thus making gold a safe hedge as an asset class to protect value and wealth over the medium and long term.  

Interest rates could also be a major factor in the price of the yellow metal going forward.  

In the past few quarters, we have seen that whenever there is a hint of an interest rate hike, gold prices drop. There seems to be a clear and direct correlation between gold prices and interest rates recently.  But the ultimate determinant of how gold prices respond to moving interest rates is the underlying expectation for inflation. To express it in a slightly different way, it is the real interest rate (nominal, such as the Fed rate, less expected interest rate) that is driving the value of gold vs. the dollar. If there is a rate hike, but the real rate is still negative, gold will increase.  And vice versa.

All in all, after the drama/comedy of the US presidential race, the double surprise of the last two days – both the outcome and the effect of the outcome – constitute a good beginning. Hopefully responsibility will rule and the global economy can be put back on the right track.