Election Scenario Analysis of the Markets

We avoid making simplistic if-then scenario analysis on the US elections for US equities, solely based on the notion that a Democrat president is negative for stocks and a Republican victory is a positive due the presence of three major elements:

1) Potentially positive market implications of Obama keeping pro-QE Bernanke, likely offsetting classical partisan implications for equities.

2) Implications of Romney threatening trade war retaliation with China as a consequence of labelling Beijing as a currency manipulator (which is a USD negative).

3) Interaction between the new White House and Congressional balance of power and its impact on averting the Fiscal Cliff.

The least ambiguous scenario analysis from the US presidential elections is that a Romney victory would be deemed a negative for gold and metals due to the Governor’s plan not to re-appoint Fed Chairman Bernanke when his term expires in January 2014. Considering Fed Chairman Bernanke’s explicit support for ongoing quantitative easing, which could extend into mid 2014 (until unemployment drops below 7.0%), removing Bernanke and his dovish supporters would likely sustain serious damage to gold and possibly boost the US dollar (in the event that Romney does not push China into a trade retaliation to his labelling them as currency manipulators).

If Romney threatens a trade action with China, as did Bush in February 2002 with his trade war on foreign steel, it would be a de-facto negative for the US currency. Recall that February 2002 marked the top of the US dollar despite prevailing so-called ‘strong dollar policy’ by Treasury Secretary O’Neill.

The implications for metals are especially magnified by the threat of the potential fiscal cliff; the combined expiration of the Bush era tax cuts; and across-the-board spending cuts in the event that Congress takes no action to avert it by end of year. Both of the spending cuts and the removal of the Bush tax cuts are expected to remove $607 billion from the US economy, or 4-5% of total GDP. Such a bite from the world’s biggest economy is estimated to drag down growth to 1.0% in the first half, before possibly printing a 2.0% contraction in the first quarter.

The above is magnified by the possibility that Romney could well ask Bernanke to resign instead of waiting until January 2014.

Aside from the Presidential race, the balance of power in Congress could also be crucial. A Congressional status quo (Democrat-led Senate and Republican-led House of Representatives), combined with a Romney victory may reduce the odds of the fiscal cliff but is likely to ease the way for a Bernanke ouster.

The worst case scenario for gold and metals would then be a Romney victory with no change in the House and the loss of further Republican seats in the Senate but without the Republicans gaining more seats in the Chamber.

The combination of a Romney victory and persistent budgetary stalemate in Congress would have a negative knee-jerk reaction throughout the metals complex. Gold has already lost half of the gains accumulated this summer. It could lose a lot more this quarter, and risk testing the $1600 territory.