The November U.S. presidential election is upon us. As always in these elections, many markets will be affected by the outcome. But this time around, there are two underlying markets that should receive serious attention. They are gold and the Swiss franc (USD/CHF). They are correlated inversely, as they both are impacted by the same sentiment concerns (see Gold watch). Fear of growing U.S. debt and the potential increase in inflation have been key drivers for bullish gold moves. Concomitantly, when hope for further quantitative easing or stimulus declines, gold has sold off. The USD/CHF valuation has waxed and waned in response to the bullish or bearish gold waves.
The case for paying close attention and trading gold and the USD/CHF for their response to the 2012 U.S. election outcome goes deeper than a cursory look at their charts. Embedded in the price action of gold has been its long-term correlation with U.S. debt levels. Gold prices and U.S. debt limits have had a high degree of correlation between the years 1996-2011, a correlation coefficient of 0.97, to be exact. In layman’s terms, as the U.S. debt limits have increased, the price of gold has increased proportionally. Relatively, over 15 years we have seen the debt limit increase 176.25% and the value of gold increase 263.18% (see “Debt is golden for gold”).
Notice the predicted slope of the relationship between U.S. debt limits and gold (see “Pay me in gold”). Understanding this is the key to shaping the U.S. election week trading strategies. The relationship between USD/CHF and U.S. debt limits is similar. As U.S. debt limits increase or expect to increase, the dollar should weaken. That is exactly what has happened. The strength of the relationship between the USD/CHF and the U.S. debt limits is not as great as with gold, but the direction is inverse as predicted (see “Follow the money”).
This leads us to two scenarios for the impact of the U.S. election. First, if Romney wins, it will have a bearish impact on gold as expectations will shift toward a decline in the rate of growth of U.S. debt. A Republican win will be negative for further stimulus because Republican public policy will shift toward reduced spending and replacement of Fed Chairman Ben Bernanke. If Obama wins, the expectations for growth in U.S. debt as well as further stimulus activity will increase. The result will be bullish for gold.
Traders therefore can play these scenarios by going long gold instruments or going long USD/CHF spot, futures, plain vanilla or binary options
However, take a close look at the positions of both candidates and you are hard pressed to see deficit reductions. If we have a change at the top, the GOP’s position on stimulus likely will change. So, once markets react to the election, it will be best to follow the size of actual debt rather than political promises.