A New Wrinkle in the U.S.-China Trade Dispute

by Frank Holmes of U.S. Global Investors, 12/7/18

This week I had the opportunity to attend the Young Presidents Organization (YPO) parliamentary intelligence forum in Washington, D.C. More than 200 members of parliaments from as many as 60 European countries joined us to hear from such dignitaries as Congressmen Robert Pittenger (R-NC) and Mike McCaul (R-TX), chairman of the Homeland Security Committee.

While in D.C., I was very honored to be invited into the epicenter of power and decision-making. That includes the Senate Press Office, pictured above, and the west front of the U.S. Capital facing the National Mall, where every president since Ronald Reagan in 1981 has been inaugurated.

It was there that George H.W. Bush took the oath of office, exactly 200 years after George Washington did. Newly arrived to Texas from Canada, I remember watching Bush’s inauguration on TV and being moved by his testament to freedom: “We know how to secure a more just and prosperous life for man on Earth,” he said, “through free markets, free speech, free elections and the exercise of free will unhampered by the state.”

The memory was made all the most poignant by the flags flying at half-staff, and the fact that I was standing in the same building where, just 24 hours earlier, the former president’s remains lied in state.

Remembering the 41st President

The life of George Bush, son of a U.S. senator and father of two governors and a president, stands as a case study in sacrifice and service. On the same day that he graduated from high school in 1942, he enlisted in the United States Navy. The country’s youngest Navy pilot at the time, Bush went on to receive the Distinguished Flying Cross after completing a bombing mission despite his plane being engulfed in flames from Japanese fire.

And from there it only gets more interesting.

Founder of a successful oil and gas company, congressman in the House of Representatives, ambassador to the United Nations, special envoy to the People’s Republic of China (before the U.S. had diplomatic relations with the Asian country), director of the Central Intelligence Agency (CIA), two-term vice president—Bush was and remains to this day perhaps the most qualified and well-equipped chief executive ever to set foot in the Oval Office.

As the 41st president, he oversaw the collapse of the Soviet Union and reunification of Germany, putting him at odds with U.K. Prime Minister Margaret Thatcher and French President Francois Mitterrand, who favored a divided Germany. His decision to push back Iraqi forces from Kuwait, arguably the greatest defining moment of his one-term presidency, was both a military and political success.

American voters ultimately denied him a second term, however, once they felt his pledge to create “no new taxes” went unfulfilled. As part of a compromise with the Democratic-controlled Congress, Bush agreed to raise taxes to help reduce the national deficit. The episode is a reminder of a time when politicians’ duty to country trumped duty to party, even if it jeopardized reelection.

That deep sense of duty sustained him for the rest of his 94 years. Bush was involved in a number of charities and humanitarian efforts, most notably the Bush Clinton Coastal Recovery Fund. The fund— spearheaded in cooperation with his former political rival and, some might say, unlikely friend Bill Clinton—raised tens of millions of dollars for families impacted by 2005’s Hurricane Katrina.

On behalf of everyone at U.S. Global Investors, I extend my gratitude and sympathy to the Bush family. May George Herbert Walker rest in peace and remain firmly in our memory.

Stocks Hit on Renewed U.S.-China Trade Concerns

On a very different note, global stocks this week plunged on concerns that trade negotiations between the U.S. and China are not running as smoothly as initially thought. The S&P 500 Index is not only having one of its worst quarters in years, but it could also end up in the red for the year for the first time since 2008.

Adding to the uncertainty was news of the arrest in Canada of the chief financial officer (CFO) of Chinese tech giant Huawei. Although no charges have been filed yet, the company has long been investigated by U.S. authorities, and more recently it’s been suspected of violating economic sanctions against Iran. The CFO, Meng Wanzhou, faces extradition to the U.S.

The name might not be known to most Americans, but Huawei is the world’s second-largest manufacturer of smartphones following Samsung, and the largest supplier of telecommunications equipment. Meng is not only a top executive but also the daughter of the company’s founder, Ren Zhengfei, a former officer in the People’s Liberation Army who has close ties to the Communist Party of China.

Imagine a foreign power arresting the daughter of Steve Jobs, and you might get some idea of how big a deal this is.

President Donald Trump has levied much of his criticism on China for “unfair” trade practices and stealing intellectual property from the U.S. As I told you back in March, China’s J-31 stealth fighter jet is believed to be a knockoff of Lockheed Martin’s F-35. (A 2014 whitepaper on Huawei, in fact, states that the tech firm got its start in 1987 by “reverse-engineering foreign products and using that as the foundation to develop more complex technologies.”) But America’s beef with Huawei, and its Hong Kong-listed rival ZTE, go back further than the start of this administration and rest on suspicions their phones and other telecomm products might be used for espionage.

In 2012, after investigating Huawei and ZTE, the House Permanent Select Committee on Intelligence concluded that the two firms could be seeking to “undermine core U.S. national-security interest.” Committee members recommended that the U.S. block any mergers and acquisitions involving the companies and that all U.S. governmental agencies not use their equipment. Earlier this year, officials with the CIA, National Security Agency (NSA), Federal Bureau of Investigation (FBI) and Defense Intelligence Agency (DIA) testified before the Senate Intelligence Committee that Huawei and ZTE’s phones posed a security risk to American consumers.

In any case, Meng’s arrest this week rattled investors, convincing many of them that U.S.-China trade talks are deteriorating rather than improving. We saw a knock-on effect among a number of Huawei’s suppliers, including lens-maker Sunny Optical (down almost 5.5 percent on Thursday), data networking firm Inphi (off 9.25 percent) and California-based NeoPhotonics (down more than 16 percent).

U.S. Trade Deficit Just Widened Even More

Speaking of trade, the U.S. deficit with the rest of the world tumbled to a 10-year low in October. According to Zero Hedge, the “trade deficit was $55.5 billion in October (worse than the $55.0 billion expected and well down from the $54.6 billion revised print for September)… underscoring continued fallout from the trade dispute with China.”

As for the U.S.-China trade deficit—the difference between exports and imports—that measure widened to a new all-time low of $43.1 billion in October, down from $40.2 billion a month earlier. The fall in net exports is expected to weigh heavily on fourth-quarter gross domestic product (GDP) growth.

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The trade report comes at a time when additional tariffs on goods coming into the U.S. are increasingly to blame for stock volatility this year. A new analysis by Bank of America Merrill Lynch suggests that worries about tariffs have trimmed some 6 percent off domestic stocks in 2018 alone.

What’s more, tariffs could be costing American households more than most realize. Last month a study conducted by consulting firm ImpactECON and commissioned by Koch Industries—an opponent of Trump’s trade policies despite its billionaire chief executive brothers, Charles and David, being top Republican donors—estimated that tariffs would cost each U.S. household nearly $2,400 in 2019, or $915 per person. GDP growth could be reduced 1.78 percent next year, with losses close to $2.8 trillion between now and 2030, if current trade actions were allowed to stay in place, the study says. As many as 2.75 million American workers “are likely to become unemployed” in 2019 “if all trade actions are implemented concurrently.”

Gold Price Rises on Weaker-Than-Expected Jobs Report

Speaking of employment, the U.S. added 155,000 jobs in November, falling far short of expectations. The U.S. dollar pulled back slightly as a result, prompting gold to trade at a five-month high of more than $1,255 per ounce. Earlier in the week, the price of palladium briefly overtook gold’s on tightening supply and increased automobile demand. (The silvery white metal is used to manufacture catalytic converters). But if economic uncertainty continues to weigh on the dollar, we could see gold lift even higher and safely retain its spot as the most valuable precious metal.

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As I reminder, I recommend that investors maintain a 10 percent exposure to gold in their portfolio—half of that in gold coins, bars and jewelry; the other half in high-quality gold mining stocks, mutual funds and ETFs. Remember to rebalance at least once a year. Have a wonderful weekend!

Gold Market

This week spot gold closed at $1,248.14 up $25.64 per ounce, or 2.10 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, ended the week higher by 5.33 percent. The S&P/TSX Venture Index was off 2.91 percent. The U.S. Trade-Weighted Dollar fell 0.66 percent.

Date	Event	Survey	Actual	Prior
Dec-2	Caixin China PMI Mfg	50.1	50.2	50.1
Dec-3	ISM Manufacturing	57.5	59.3	57.7
Dec-5	ADP Employment Change	195k	179k	225k
Dec-6	Initial Jobless Claims	225k	231k	235k
Dec-6	Durable Goods Orders	-2.4%	-4.3%	-4.4%
Dec-7	Change in Nonfarm Payrolls	198k	155k	237k
Dec-11	Germany ZEW Survey Current Situation	55.3	--	58.2
Dec-11	Germany ZEW Survey Expectations	-25.0	--	-24.1
Dec-11	PPI Final Demand YoY	2.5%	--	2.9%
Dec-12	CPI YoY	2.2%	--	2.5%
Dec-13	Germany CPI YoY	2.3%	--	2.3%
Dec-13	ECB Main Refinancing Rate	0.000%	--	0.000%
Dec-13	Initial Jobless Claims	228k	--	231k
Dec-13	China Retail Sales YoY	8.8%	--	8.6%

Strengths

The best performing metal this week was palladium, up 3.88 percent on very tight physical markets. Dutch bank ABN Amro noted that palladium has overshot and may slide back 20 percent to $1,000. Gold traders and analysts are the most bullish they’ve been in at least three years on the yellow metal this week, according to Bloomberg’s weekly survey. Walter Pehowich, executive vice president of metal investments at Dillon Gage Precious Metals, says he expects “the price of gold to rally off a slowing economy and with the Fed being handcuffed from raising rates.” After selling its gold for much of the year, Turkey’s central bank gold holdings actually increased this week by $284 million from the previous week, according to the bank’s official figures. The Perth Mint released November sales data that showed 64,308 ounces of gold coin and bar sales, compared with 36,840 ounces in October.
Gold is heading for its best close since July as investors are betting on whether the Federal Reserve will continue its rate hike cycle, and as the Treasury market flashed a warning sign early this week, writes Bloomberg. Kunal Shah, head of commodities research at Nirmal Bang Securities, says that “as global GDP growth slows down, and the U.S. Fed slows down the pace of rate hikes, the dollar index will weaken,” and investors will diversify into gold.
Bloomberg reports that U.S. jobs and wages rose by less than forecast in November, while the unemployment rate stayed at the lowest level in almost 50 years. The price of palladium has exploded in the second half of this year, rising nearly 50 percent in less than four months. The metal briefly exceeded the price of gold this week for the first time in 16 years, but then tumbled as much as 3.1 percent on Thursday.

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Weaknesses

The worst performing metal this week was platinum, down 0.68 percent. It appears to be in surplus as some hedge funds have shorted it and used the proceeds to go long palladium. Although the Perth Mint saw strong sales in November, the U.S. Mint saw declines. It reported sales of 8,000 ounces of American Eagle gold coins, down 67.3 percent from the previous month. London-based BullionVault reported that its gold index measuring the balance of buyers against sellers fell to 53.4 last month as prices rose, down slightly from the previous month’s reading of 53.8. However, a reading of 50 or above indicates more buyers than sellers among BullionVault’s clients. Adrian Ash, director of research at the company, said that “2019’s worsening political outlook is likely to support gold prices by deterring sales from existing bullion investors.”
Venezuelan President Nicolas Maduro and Turkish President Recep Tayyip Erdogan met this week in Caracas where Maduro welcomed Turkey to mine gold in Venezuela and partner in mining development. The troubled South American country has been a big seller of gold in recent years and sent representatives to meet with the Bank of England staff to try and repatriate 16.5 tons of gold reserves currently held in London.
Meng Wanzhou, chief financial officer of Huawei Technologies – one of China’s “foremost corporate champions” – was arrested in Canada over potential violations of U.S. sanctions against Iran, reports Bloomberg. Her arrest sparked outrage from China and comes at a critical week in trade negations between the U.S. and China.

Opportunities

Goldman Sachs predicts that 2019 will be another poor year for risk-adjusted investment returns due to slowing economic growth, shrinking central bank balance sheets and continued bouts of volatility. UBS Group wealth managers wrote in a report that gold may rise to $1,300 an ounce in 2019 as volatility grows. They write that “inflation will likely rise, EM investors will face currency volatility and real interest rates will peak,” which has historically lifted the value of gold. Credit Agricole recommends buying gold at $1,240 with a target of hitting $1,420 an ounce, due to currency fluctuations increasingly driving the yellow metal in the short term, reports Bloomberg.
Thursday was a record-breaking day in terms of trading volume for fed futures contracts, including a record volume in December 2019 Eurodollars contracts, amid falling confidence in the Fed’s ability to achieve its projection of three rate hikes next year. Traders of interest-rate futures are also uncertain that the Fed will raise rates next year, reports Bloomberg. The Fed has raised rates eight times since December 2015 and is expected to continue raising in 2019. However, many investors are unwary of this projection due to this week’s slide in global equities and the U.S.-China trade war tension.
President Donald Trump’s top economic advisor Larry Kudlow said in an interview this week that he expects the Fed to pause its interest rate increases for “quite some time” after the hike this month. As the Fed reconsiders its hiking cycle, gold could be set to rise next year on a falling dollar. Trey Reik, senior money manager at Sprott, sad that “once you get to the consensus view that the Fed may be done, the dollar may come under severe pressure. Gold will erupt.”

Threats

According to Bank of America, a “major blowout” in securitized product spreads is likely next year. The bank’s economists expect five rate hikes between now and the end of 2019, which would bring the Fed funds rate to 3.5 percent. The bank writes that the Fed looks to tighten up financial conditions, which could lead to a liquidity shock, as liquidity risk is at levels seen in late 2007 when the Fed was cutting rates, reports Bloomberg.
During an event on Thursday for new lawmakers from both parties, Gary Cohn, former top economic adviser and an ex-Goldman Sachs executive, got into a testy exchange with newly elected House freshman Rashida Tlaib of Michigan. The congresswoman tweeted that Cohn, in the meeting, told lawmakers that “You guys are way over your head, you don’t know how the game is played,” to which Tlaib responded “No Gary, YOU don’t know what’s coming – a revolutionary Congress that puts people over profits.”
The relationship between U.S. President Trump and Russian President Vladimir Putin may be souring after another round of cancelled talks between the two leaders. President Trump cited the cancelled talks at the G20 Summit in Argentina to be due to the naval clash between Russia and Ukraine near Crimea. However, Russian lawmakers are not as understanding. Bloomberg reports that senior members of the ruling United Russia party have regretted Trump’s victory in U.S. elections over Hillary Clinton. Frants Klintsevich, a Russian senator, said the current relations are “far worse than it would have been under Clinton” and that “she’s an experienced politician and any of her actions would have been based on logic and some kind of discussion. Here we’re seeing huge swings in one direction and another.”

December 6, 2018

U.S. Global Investors Continues GROW Dividends and Share Repurchase Program

December 6, 2018

Frank Holmes' 2019 Market Outlook

December 5, 2018

Estimated Year-End Distributions Now Available

Index Summary

The major market indices finished down this week. The Dow Jones Industrial Average lost 4.50 percent. The S&P 500 Stock Index fell 4.60 percent, while the Nasdaq Composite fell 4.93 percent. The Russell 2000 small capitalization index lost 5.56 percent this week.
The Hang Seng Composite lost 1.74 percent this week; while Taiwan was down 1.29 percent and the KOSPI fell 1.01 percent.
The 10-year Treasury bond yield fell 13 basis points to 2.85 percent.