Looking ahead to the first full month of Donald Trump's presidency, many investors may have gotten a bit "over their skis" on resource stocks.
Most metal prices are going to face a strong headwind in dollar strength from Trump's protectionist pro-growth agenda. The Federal Reserve will make moves on any fiscal stimulus to raise U.S. rates at a pace much faster than the European Central Bank, because Germany and Southern Europe are on different growth paths, and Mario Draghi, president of the European Central Bank, has no answers.
Gold in particular will be negatively affected by dollar strength. This is why I have been calling for gold in euros to set all-time highs in 2017. I do not think there will be a large pullback in gold over the next month (and especially not in euro terms) as positioning is presently very light and SPDR Gold Trust (GLD) - Get Report and other gold ETFs have seen massive outflows since Trump's election.
Still, there has been upward momentum in gold since the start of the year fueled by commodity trading advisor (CTA) short covering. This momentum is starting to look as if it has peaked in the short term, so February could be a tough month and you may get a better entry point as gold may retreat back below the 50-day moving average.
Macro investors moved out of gold and on to equities for two main reasons, the expectation for dollar strength and Trump's tax and regulation overhaul. The risk on trade proved that there was no need to own gold for portfolio protection. This was reversed since the start of the year and gold has rallied back by nearly $100 as the timing and priority of tax and regulatory overhaul may take a backseat to trade and border adjustment taxes.
None of these issues are going to be sorted out quickly as politicians have a way to slow down any president no matter how bold or brash. I believe there will be enough volatility and uncertainty in the market and enough money on sidelines for gold to remain a part of prudent portfolios. By the end of February, it will be time to add gold and other "safe haven" assets to portfolios.
I also believe that the copper/gold ratio, which is a traditional risk barometer and sits at all- time highs will peak by mid-February. An investor needs to look no further than Trump's nominee for the Office of Budget and Management. The pick, Rep. Mick Mulvaney, R-S.C., who has been focusing his testimony on reducing the $20 trillion debt as a reason why you need some gold in your portfolio. Although Mulvaney's testimony has been centered on the two "saved cows" of Social Security and Medicare, it will be the March debate on raising the debt ceiling that could get contentious in the first quarter. I would want to be long some gold ahead of this.
Although I am fairly blase about gold in the short term from present levels of $1204/ounce, I do think gold will outperform both the Market Vectors Gold Miners ETF (GDX) - Get Report and the Market Vectors Junior Gold Miners ETF (GDXJ) - Get Report , which represent both major gold producers and junior gold producers. GDX is up 84% and GDXJ is higher by 124% in the past 12 months.
Obviously, these stocks rallied from oversold conditions, but the gains were not commensurate with the underlying commodity. Like industrial metal producers, gold producers did a lot to spruce up their balance sheets, selling off assets and raising equity. But mines are getting older, input costs (energy and steel) are starting to move up and the ability to get cheap financing will dissipate as interest rates move higher.
As far as the other precious metals, I have been a supporter of palladium over the past year on fundamentals, but it looks as if it may have peaked on calls that U.S. auto production has hit a ceiling. We may see palladium fall back to the $650 level in February (presently $750). But it remains the one metal in deficit as the Russian stockpile dwindles, so if Chinese auto sales come in strong, then palladium should rebound.
The only view on platinum is that its discount to gold, which has been over $300 (presently $220) should narrow in February and throughout the year. Silver, which is the higher beta gold will drift lower with gold over the next few weeks. But like gold, i would buy silver at the end of February and with its industrial attributes, silver should prove to be a better reflation purchase than gold through 2017.
Base metals have had a drastic move higher since the Trump election and the base metal equities since last January have been the best performing sector. All of these metals have benefited from the Trump infrastructure rhetoric combined with the Chinese government stimulus in 2016.
It was just reported that China's fourth-quarter GDP grew by a higher-than-expected 6.8%, and copper imports increased by 5% in December. This is normal restocking ahead of Chinese New Year, which started the end of January. China's copper inventories are at six-month highs, and I think the loose money policy is going to change in 2017. If you add in the possibility of a trade war or tariff fight with the Trump administration, it's likely copper and other base metals will be under pressure starting Wednesday.
It should be noted that copper consumption in the U.S. has to rise by 10% (which it won't) to offset a 1% drop in Chinese consumption. In my opinion,it is much more likely that we get closer to the 1% drop than the 10% rise. When you see base metal equities like Glencor, and Freeport higher by close to 400% in 12 months, when in January 2016, we were worried about bankruptcy, it seems that we have reached irrational exuberance in the sector.
I would expect that all these companies will have a difficult time continuing their upside momentum in February as their production numbers miss targets. Aluminum has been helped over the past six weeks by hopes that the Chinese will curb production by as much as 3 million tons. This has helped aluminum rally from $1600 to $1875 a ton and, in turn, has doubled Alcoa's share post-spinoff share price from $20 to close to $40 in the same period.
I still see aluminum in a huge surplus with a plethora of metal sitting in stockpiles around the globe. I believe that unlike steel, the Chinese are still sensitive to jobs and will not cut smelter capacity and, therefore, see aluminum and copper both topping out in the first week of February before retreating.
More information on TheStreet's guide to trading in the month of February can be found here:
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.