The first round of the French Presidential election is this weekend and markets are eerily quiet given how fluid the support is for all the major candidates in the polls. The high degree of uncertainty has not improved as we approach election day as undecided voters dominate the response to pollsters.
We’ve seen this before, markets refusing to price in the tail risks associated with both Brexit and Donald Trump’s victory in November last year. The same thing happened in the 2015 British Parliamentary elections which were handicapping a ‘hung parliament’ before the votes were cast only to see the Tories win an outright majority.
In all those scenarios, the poll numbers were way off from the result. Your interpretations may vary, but my opinion is the polls are as biased as the media reporting on the election. And yet, the markets continue to believe them. And for that reason alone, investors should be prepared for seismic changes come next week.
Any upside surprise in the results for either Front Nationale’s Marine LePen or Communist candidate Jean-Luc Melenchon will result in a major sell-off of the euro (NYSEARCA:FXE), which clings to tenuous support above $1.06 versus the U.S. dollar.
Both candidates are fiercely anti-EU and, in LePen’s case, anti-euro as well. LePen finished her campaigning speaking to a raucous crowd reported to be 10,000 people strong.
Those are Donald Trump-like numbers for a political rally and it speaks to just how solid her base is. Melenchon has been rising quickly in the polls since the debates at the expense of Socialist Benoit Hamon on his positioning himself farther than Le Pen on the ‘Frexit’ spectrum.
There is a real need for complacency in markets given the fragility of the European banking system. No one wants to be the first to spark a panic, and with central banks standing ready with trillions in slush funds to throw at markets, even if they are, we can’t see it. Risk premiums between German Bunds and Italian and French bonds have been widening all year (see Chart) as the European Central Bank tries to maintain the veneer of stability through its various quantitative easing programs.
These spreads have tightened this week likely anticipating a centrist election result. But, with the latest attacks in Paris targeting police officers, this only feeds into Marine Le Pen’s strengths as she is the fiercest opponent of German Chancellor Angela Merkel’s EU immigration policy.
If Le Pen’s vote totals are far higher than the polls suggest, markets are going to be shocked on Monday. If neither Emmanuel Macron nor Francois Fillon are her opposition in the run off, that shock could turn into complete meltdown as the reality of a Frexit mandate from French voters further undermines EU authority.
The European Union is already in denial about Brexit and the secessionist movement in Spanish Catalonia. Thinking they will strong-arm British Prime Minister Theresa May into signing an exit deal that is worse than the U.K.’s current position with the EU is madness.
May’s call for snap elections in early June is another sharp retort against Brussels’ poor negotiating tactics. I covered the immediate reaction to this in my last article. The effects on gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) have continued to play out, with gold looking well bid on mild safe haven flows to end the week.
Silver, on the other hand, continues to trade with the strategic commodity complex – oil (NYSEARCA:USO), natural gas (NYSEARCA:UNG) and copper (NYSEARCA:CPER). Friday, it broke down below $18 along with oil’s retreat on rumors OPEC had not agreed to continue production cuts for another six months and increasing U.S. rig counts.
Gold closing this options-expiration week with strength is a strong follow-through to last week’s breakout above the February high of $1,264. Silver’s non-confirmation continues to leave me worried about the big picture for the metals.
But, that said, it is obvious we are now seeing a bifurcation between them based on macroeconomic weakness, keeping silver trapped and regime uncertainty in the U.S. and E.U. fueling moves into safe-haven assets.
To support the macro weakness view, this week we had two more data points which point to a slowdown in the U.S. First, Nestle (OTCPK:NSRGY) reported tepid earnings due to continued contraction of its North American sales, especially in its confectionery and dairy segments. Real Internal Growth numbers were down 1.5% in Q1 in the Americas.
Second, Subway announced it was closing stores (359) for the first time in the company’s 52-year history. Restaurant sales are faltering badly and Bloomin’ Brands (NASDAQ:BLMN) announced 43 store closings out of 1,500 for this year.
Conversely, the safe haven trade saw the British pound (NYSEARCA:FXB) hold onto most of its gains through the week and that bodes well for some follow-up short-covering next week. The long-term picture for the pound, however, is bleak and I would be ready to fade any further rally if the euro tanks next week thanks to French election results.
And lastly, for the euro, I am fundamentally bearish. The political dissolution of the Euro-zone is rising in probability every day. 2017 looked to have two major elections that would determine its future, the French ones starting this weekend and the German ones in the Fall.
Now, we add British snap elections to ensure an ugly Brexit process and things get even worse. EU leadership thinks it dodged a bullet with the Dutch re-election of Mark Rutte as Prime Minister, but it didn’t. It only sets up an even more dangerous situation now with the French elections because more people believe Le Pen can’t win now than if Geert Wilders had won in the Netherlands.
I have a directional position on the euro via the ProShares Ultra Short Euro ETF (NYSEARCA:EUO) placed during the last rally towards $1.09. And I plan to keep that position on for the rest of 2017 regardless of what happens this weekend.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EUO over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own some gold and silver, a few guitars and a lot of goats.