Did UBS and JPM Just Imply a Bottom for Gold?

Background- Why UBS and JPMorgan's Reports are Important for Gold

The Yen and Gold have enjoyed a high correlation in recent years. Below is a chart of Gold in Dollars plotted with the USD/JPY pairing.

As one can see, gold prices denominated in the greenback and the yen often move together. There were only two significant divergences in the relative performance of gold priced in the U.S. dollar versus gold prices in the yen. The first case occurred in the 1980s, when the yen strengthened against the greenback, leading to strong declines in yen-denominated gold prices. The second case started in mid-2014. In the second half of that year, gold priced in yen has outperformed its dollar cousin due to the strength of the greenback against the yen and the decline in Japanese real interest rates. full article here

Today, while Gold hovers between $1150 and $1200, the Yen is trading around 114 to the USD. That to our eyes puts Gold a little oversold relative to the Yen. This should be watched closely by Gold investors for re-convergence or continued divergence.

In trading terms: If things have not changed; Gold will rally and/or the Yen will appreciate (go down) vs. the USD. That is the arbitrage if things are as they were.

 

Are UBS and JPM Implying a Gold Bottom is Near?

In light of this major decoupling we make it our business to look for  reasons for the divergence. Among them are: Trump's election, CB Policy divergence between BOJ and the Fed, and a combination or possible causation between the 2 major factors.  Today we found commentary by UBS and stating they expected a stronger yen. If they are right, a bottom in the yen implies support for Gold.

UBS Bearish on Dollar vs Yen

Bloomberg : UBS Group AG’s $2 trillion wealth-management arm predict the yen will strengthen to 98 to the dollar as expectations of a Trump-led fiscal expansion have become overblown. The yen dropped as low as 114 to the dollar on Friday last, capping a sell off that began with the results of the U.S. election.

UBS' Tokyo-based head of Japanese equity research Toru Ibayashi says expectations for fiscal expansion have become overblown: “The market has latched on to only the juicy bits of Trump’s policies, and wrapped them up with unreasonable euphoria, which we think is pretty much a misinterpretation. A market that’s been overbought on hope will quickly fall apart."

In simpler terms, UBS feels that Trump's fiscal expansion will not come to pass in the way markets are projecting. Their read is Trump's proposed tax cuts, protectionist policies, and fiscal spending expectations are over-baked in the markets, that is if they happen at all. Therefore they believe the Yen will strengthen against the dollar.

The firm’s Tokyo-based head of Japanese equity research  says expectations for fiscal expansion have become overblown, and protectionist policies will come first in the new U.S. administration. Trump campaigned on pledges of “massive” tax cuts and spending of as much as $1 trillion over a decade to rebuild infrastructure, while also promising to tear up existing trade deals and punish companies that send jobs overseas. Speculation the president-elect will unleash reflationary stimulus drove the yen to an eight-month low near 114 on Friday, capping the biggest three-week decline since 1995.

 

Taking a Knife to UBS' Rationale

No Protectionism is Bearish for the USD

This logic may not seem clear at first. What they likely mean is that, the Yen has weakened vs. the dollar on fears that "America First" policies like protectionism will weaken existing trade with Japan, and thus lessen  the need for Yen being held for international trade. A simple example is, the US would cease importing Japanese produced goods thus removing the need for not only the US, but other nations hold Yen for trade with Japan. That much makes sense to us. But if you were to take a knife to the pieces of the reasons UBS sites and peel off protectionism from fiscal spending the 2 policies are inversely correlated to the USD.

But NO Deficit Spending is Bullish for the Dollar-Yen, Right?

What we note and do not understand is the weight the banks are giving to protectionist policies in this scenario vs deficit spending.  Protectionism is bullish for the USD vs the Yen as noted above. But deficit spending is bearish for the USD. Taken together, it would seem obvious to us that the $1Trillion proposed fiscal stimulus should have far more bearing on the Dollar than the potential for protectionist policies. UBS seems to put more emphasis on potential protectionism as drivers of USD/JPY than the  fiscal spending proposed by Trump. By inference, if Trump's policies were not implemented, then that would seem more likely to cause a stronger dollar vs the JPY.

Therefore for UBS' position to have credence it would mean they are more focused on protectionism than fiscal spending as drivers of the FX pair. Fiscal spending would surely weaken the dollar, while protectionism would on balance strengthen it. We think for what it is worth, there are practical and political factors that are not expressed here.

Protectionism is Harder to Implement than Deficit Spending

Practically speaking, it is easier to spend money domestically than it is to implement protectionist policies unilaterally without some international blowback. Protectionist policies are not unilateral things. For, every time a country does something to protect its own trade, another country will seek to counter-balance it with actions of their own. We do not control Japan, Russia or China's policies and ability to react to our own protectionism.

Fiscal spending on the other hand is politically and thus practically easier for Trump to accomplish. The GOP controls the Senate, House and Presidency.  So if, (and it is a big if), Trump wished to spend more money, he would have an easier time of it than levying trade tariffs w/o global consequences.

Thus we see the USD weakening on balance due to our prioritizing the likelihood of increased fiscal spending over Trump successfully implementing protectionist policies. Protectionism actually would peel back some of the policies of past administrations, making a kind of America First Isolationism counter the increasingly complex global network we have.

Our Dilemma and Gold

Perhaps it is not the UBS report we have issue with. Perhaps it is the fact that the USD has strengthened to begin with in light of Trump's inflationary policies proposed. That is the real rub here. Upon closer inspection we note that Trump has stated on balance that he intends to increase deficit spending. He has made it his point to advocate "Infrastructure tax-credits". So he intends to finance infrastructure spending with tax breaks. We are not shocked that he would subsidize developers.

But that incentive is not a given to succeed by itself. And if they do succeed, tax revenues will drop. Where will the government get the money it is missing out on?  We feel that gov't tax breaks are not enough and are the starting point in any negotiation with private business. Developers will want subsidies up front. Cash flow is crucial in these type of businesses. They will want cash up front. And that will cause deficit spending ultimately.

So the Dollar's strength has been as befuddling to us as Gold's weakness in this context. And so we face a  problem

  • The markets are never wrong. Gold is down, the USD is up.
  • We continue to believe the price for Gold will be much higher in the next 5 years as the USD weakens.

How do we reconcile the above 2 statements then? Because we know with almost certainty that the endgame for all countries is inflation. We are never married as to how we get there. Our analysis is strategic, not path dependent. That macro approach will miss trades along the way, but other models are used for that. We are concerned with our macro opinion.

Opinion Restated: Competitive devaluations are not going away. The Dollar will just be last to circle the drain. Gold is not a predictive market historically, but a reactive one. The last 5 years have been the speculative bull market for Gold in part as a function of the remonetization of the yellow brick. Hopefully the hot money will leave Gold alone now, and a more sustainable rally can occur.

JPM Confirms Our View?

Then we read something JPM stated, and it made sense. Or conversely, we saw what we wanted to see.  Whether our continued macro opinion is rational or delusional remains to be seen. Dear Santa: For Christmas we want to be Fed Governors, and never have to pay for being wrong again. (Also see last year's request to not have skin in the game)

Anyway, JPM focuses on the protectionist part of the Trump Platform

JPMorgan Is More Specific than UBS

JPMorgan Chase & Co. is also forecasting the yen will gradually strengthen to beyond (under) 100 per dollar next year because of Trump’s “America first” trade stance. So in this way, they agree with us that the protectionist ideas are unlikely to happen as proposed. And with that we can breathe easier in our own understanding of the situation.

UBS statements as quoted by Bloomberg are a bit broad in their rationale. It is not the unlikelihood of Trump's Fiscal spending that is causing the Yen to weaken. It is the piece on protectionism that is drivingthe USD/JPY from what we see here. Lumping them together without UBS differentiating (Protectionism and Fiscal Spending) was confusing to us. full article here

 

This is What we Believe Gold's Path Will Be

Keynesian Dogma is Too Big Too Fail

Trump or no Trump, too much is at stake now in global markets for deflation to be permitted to return. Pot-odds dictate things now. The Global Central Bankers are "all in" now. If that fails, fiscal policies will be used. And if those fail, government controls will kick in. And finally , if deflation still comes back, the war machine will step in and clear all the markets as only it can.

This is complexity in its glory. Adding to both sides of a see-saw in an attempt to keep the dynamic equilibrium. In the end, esoteric risks cause imbalances, or the board  breaks at the fulcrum under the weight. Noone in politics (Fed) reduces things to help markets self-clear. No matter, war will step in if need be. 

On the Additive Nature of Complexity- FWIW

It is far easier in this complex global system to ADD to things than to subtract. Too much is at stake globally, and the political solution is always to add complexity in pursuit of globalized trade. The only way out of such a situation is war (a consequence of trade wars frequently), or complete societal collapse under the weight of the complexity.

Vince Lanci

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