gold to hedge global risk as the world in a state of disequilibrium

Invest in gold to hedge global risk as the world in a state of disequilibrium...

The optimism on the Trump’s tax proposal and the increasing likelihood of a rate hike by December led to further strengthening of the dollar. This onward pressured gold to consolidate below the USD 1300 an ounce mark.

The US Senate’s passage of budget motion revived tax reform optimism as this help alleviate the obstacles for the Republican majority passing a tax cut package without the support of their Democratic counterparts.

Gold faced sustained headwinds from another round of record highs in US equities, as well as markets now placing a more than 80 percent probability of a December rate hike by the US Fed. Gold prices ended the month with a marginal decline of - 0.7% for the month at $1,271 an ounce.

The economic data is far from showcasing a consistent trend and has been volatile at best. Good numbers keep alternating with not so encouraging ones and vice versa. We did see a string of good numbers last month bolstering Fed’s case for raising borrowing costs.

While a number of workers on U.S. payrolls declined last month, the jobless rate fell to a 16-year-low and wage gains accelerated. The fact that there was no real decline in numbers in light of the two hurricanes that ravaged Florida and Texas recently made these numbers stand out.

However, it will be important to note that hourly earnings rose sharply, probably because the people who temporarily dropped off payrolls are lower paid than average.

In terms of other data, industrial production and capacity utilization numbers came in strong, meeting expectations. Markets took this as a sign that the Fed is still going to remain firm on raising rates by end of the year.

Republicans unveiled long-delayed legislation to deliver deep tax cuts that President Donald Trump has promised. The need of the hour was to come up with tax cuts within the confines of only increasing the deficit by US$1.5tn over the next ten years.

This is the requirement as laid down by the FY2018 Budget resolution. Obvious ways to generate the revenues to pay for the tax cuts, just as ending the deductions for state and local income taxes, are difficult to implement in practice because Republican Congressmen from high tax states like New York will not want to vote for them.

Tax reform is far from being a done deal. The bill contains several specifics that will prove sticking points, which increase the difficulty of finding the votes to support the plan in both the House and the Senate.

Outlook

The much-awaited Trump tax plan in its current form would almost certainly give disproportionate benefits to wealthy Americans, who tend to benefit from corporate tax cuts more than non-wealthy Americans and who could likely exploit the pass-through rate by setting up dummy corporations.

The tax plan being considered in Congress would inflate the nation’s budget deficit and expand the debt. But, the bill will almost certainly not remain in its current form.

As written, it is almost guaranteed to increase the budget deficit by trillions over 10 years, and quite possibly keep increasing the deficit after 10 years. So long as the legislation still increases the long-run deficit, it’s a nonstarter in the Senate.

There still lies a small probability to get a landmark tax reform bill given the obvious need for the Republicans in Congress to demonstrate at next year’s mid-term elections that they have achieved something.

However, the current tax changes being proposed by the President will morph over time and will be significantly watered down if it is ever to become law.

Therefore, since the final plan will be significantly diluted from the proposed form, its effect on the economy and for equity prices will be extremely attenuated. This means the current ebullience on Wall Street is about as far offside as possible.

The most powerful job in the world will now be manned by Jerome Powell, another dove in the long line of Fed bubble builders. Powell, in fact, will be the first investment banker to take the reins at the Fed.

Although it is widely expected that Powell’s leadership will be in line with the current monetary policy and thinking of Janet Yellen’s Federal Reserve, he differs in his view of existing regulations and is much more in line with the president than that of the outgoing Fed chairperson.

Powell is considered to be a dove and so he’s likely to keep interest rates low-for-longer.

The Fed continues to remain data dependent and there is no certainty that U.S. economic growth can sustain that level of tightening. Fed tightening also represents the biggest risk to the current stretched valuations on Wall Street.

As the Fed tightens, the more likely it will trigger a renewed deflationary reality check. This could lead, again, to some form of unconventional monetary policy.

It is the Feds and other central banks inability to exit from unconventional monetary policies that would serve as the real trigger for gold prices to break out of the current consolidation.

The world is in great disequilibrium, both with respect to the global economy and geopolitics as well. The fallout of the geopolitics globally seems to now cap the downside in gold.

Given the macroeconomic picture, gold will be a useful portfolio diversification tool and thereby help you to reduce overall portfolio risk.