[This post is an excerpt from a recent TSI commentary]

There are three reasons that the Trump Presidency will very likely go down in history as a disaster for the US, only the last of which has anything to do with Trump. The first two reasons are inter-related in that they are primarily the consequences of distortions/imbalances created by the Federal Reserve.

Due largely to the aggressive interventions of the Fed, including the creation of trillions of dollars via QE programs and keeping interest rates pegged near zero for eight years, the mal-investment problem in the US economy today is more serious than the mal-investment problem that led to the “great recession” of 2007-2009. This means that the next recession will probably be even more severe than the previous episode. It is possible that the extension of ultra-easy monetary conditions combined with fiscal ‘stimulus’ in the form of tax cuts will delay the start of the next recession by another 6-12 months, but for no fault of Trump it will almost certainly happen on his watch.

Also due to the aggressive interventions of the Fed, the US stock, bond and real-estate markets are now valued at levels that all but guarantee terrible performance over the coming few years. As is the case with an economic recession, it is possible that the extension of ultra-easy monetary conditions combined with fiscal ‘stimulus’ in the form of tax cuts will delay the start of the coming period of terrible performance; however, for no fault of Trump there will very likely be bear markets in the major US asset classes during his first — and almost certainly only — Presidential term.

While the coming severe recession and the bearish trends in asset prices were bound to occur and clearly have nothing to do with Trump, it looks like Trump is unwittingly setting himself up to take the blame.

His one chance of avoiding blame and paving the way for a genuine recovery to be in progress by the time of the next Presidential election would have been to stay out of the way and allow a major liquidation of the mal-investments to happen during the first half of 2017. This would have enabled the blame for the debacle to be appropriately placed at the feet of the Fed and the preceding Administration. However, having previously (and correctly) chided the Fed for having created a “big, fat, ugly bubble”, it seems that the deadly combination of hubris and ignorance has convinced Trump that he can set in motion a long period of strong growth with no intervening painful purgation.

In summary, certain bad economic and financial-market outcomes are currently set in stone. What’s not set in stone is who gets the blame. Unfortunately, Trump appears to be positioning himself to take the blame for the economic damage caused by others.

Here is an excerpt from a TSI commentary that was published about a week ago.

A cottage industry has developed around manipulation-focused gold commentary. In this industry, gold’s price changes are portrayed as the outcome of a never-ending battle between the forces of good and evil, with the evil side constantly trying to beat the price down and the good side constantly buying or holding. Also, in the world imagined by this industry the fundamental backdrop is always gold-bullish. The implication is that all price rises are in accordance with the fundamentals and all price declines are contrary to the fundamentals and likely the result of manipulation by the forces of evil.

In the real world, however, the fundamentals are always in a state of flux — sometimes bullish, sometimes bearish, and sometimes mixed/neutral. Furthermore, our experience has been that gold tracks fundamental developments more closely/accurately than any other market.

When the gold price was topping in July-August of this year, the fundamental backdrop wasn’t gold-bearish; it was neutral. The ‘fundamentals’ therefore didn’t signal a top, but they did indicate that additional gains in the gold price would not have been fundamentally-supported and would therefore have required a further ramp-up in speculative buying.

From early-July through to early-November the ‘true fundamentals’ shifted between being neutral to being slightly-bearish for gold and then back again (we thought they were slightly bearish from mid-September through to mid-October and otherwise neutral). They turned bearish, however, a couple of days after the US Presidential Election and since around mid-November have been their most bearish in at least three years.

The fundamental backdrop is now definitively gold-bearish because we have a) real interest rates in an upward trend and at a 6-month high in the US, b) US credit spreads immersed in a major contraction (indicating rising economic confidence), c) dramatic relative strength in bank stocks (indicating sharply-rising confidence in the banking/financial system), and d) the Dollar Index in a strong upward trend and near a multi-year high. Given these conditions, any analyst/commentator who is now claiming that the ‘fundamentals’ are bullish for gold is either clueless about gold’s true fundamentals or is trying to promote an agenda.

That’s the situation today, but the situation will change. In broad-brushed terms, here are the two most likely ways that the situation could change to become supportive of an intermediate-term gold rally:

1) Rising inflation expectations

US inflation expectations have been rising since 11th February and have been rising at a quickened pace since late-September, but since Trump’s election victory the rate of increase in nominal interest rates has exceeded the rate of increase in inflation expectations. This has brought about a rise in REAL interest rates.

In effect, over the past month economic growth expectations have risen faster than inflation expectations. This doesn’t make a lot of sense considering the plans of the Trump Administration, but when speculating in the financial markets we must deal with ‘what is’ rather than ‘what should be’.

It’s certainly possible that at some point over the next few months the markets will figure out that the combined plans of the US government and the Fed will lead to more “price inflation” than economic growth, resulting in a relatively fast increase in inflation expectations. As well as causing real interest rates to fall, this would result in a weaker US$ and a further steepening of the yield curve. All told, it would result in the fundamental backdrop becoming gold-bullish.

2) A banking crisis in Europe

The major banks around the world are intimately and intricately connected via their massive derivative books, so a banking crisis that began in Europe would not remain confined to Europe. It would lead to concerns about the profitability of US banks, which, in turn, would lead to relative weakness in bank stocks and a general shift towards safety. Interest rates on Treasury debt would fall faster than inflation expectations, resulting in a lower real interest rate in the US. Also, short-term interest rates would fall relative to long-term interest rates due to a flight to liquidity and the market beginning to anticipate a shift in the Fed’s stance, resulting in a steepening of the yield curve. The overall effect would be a fundamental backdrop that was gold-bullish.

Either of the above could happen within the next few months, but neither is happening now.

By one measure, the Dow Industrials Index is now at its second-most ‘overbought’ level since 1980. The measure I’m referring to is the 14-day RSI (Relative Strength Index), a short-term momentum oscillator shown in the bottom section of the following Dow chart.

Being the most something-or-other (the most overbought/oversold, optimistic/pessimistic, etc.) since a distant past time often isn’t as important as it sounds. For instance, the only time since 1980 that the Dow’s daily RSI(14) was as high as it is today was in November of 1996 (interestingly, almost exactly 20 years ago), but nothing dramatic happened during the days, weeks or months that followed the November-1996 momentum extreme.

As illustrated below, a pullback to the 50-day moving average (MA) got underway within a few days of the momentum extreme, after which the Dow resumed its long-term advance. There was a more significant short-term pullback (to the 200-day MA) a few months later and an intermediate-term correction a few months after that (more than 8 months after the momentum extreme), but the bull market continued for another 3 years.

A short-term momentum extreme occurred at the price peak that was followed by the October-1987 stock market crash, but it is a lot more common for such extremes to be followed by nothing more serious than a routine multi-week correction. With measures of market breadth pointing to a 6-12 month extension of the bull market we probably won’t get anything more bearish than a routine multi-week correction within the next couple of months, although I admit that the near-vertical rally since the Presidential Election has me ‘on edge’.

Blackham Resources (BLK.AX), a junior gold producer that has just begun to ramp-up production at a newly-commissioned mine in Western Australia, reported something interesting earlier this week. Having forward-sold about half of next year’s expected gold production a few months ago when the gold price was near its highs for the year, the company recently took advantage of gold’s price decline by closing-out the bulk of its forward sales. It did so by purchasing gold and delivering it into the forward sales contracts, thus realising a cash profit of A$6.3M.

In other words, having sold high during May-September, BLK’s management turned around and bought low over the past couple of weeks. Sell high, buy low. Sounds like a good strategy to me. More gold producers should try it.