Over the last few months, gold’s performance has been remarkable. Many market observers and mainstream analysts have pointed to various geopolitical developments in their efforts to explain away the bullishness as a reaction to whatever happens to be in the headlines at the time. The Trump impeachment, the US-China trade war, more recently the tensions with Iran, are all among the reasons that have been put forward so far to justify the current gold rush. And yet, while all these events might have played some part in fueling short-term price spikes, I personally think that the explanation for the overall rise in gold demand runs much deeper than that. The real motivations behind it have a lot more to do with fundamental issues and chronic ones at that, which means that this uptrend is only getting started and likely to accelerate as we enter the new year.
Economic and monetary shifts
2019 has been an important year in central banking history. As fears of a recession gathered and the US stock market rally showed its first cracks, all major economies were swiftly returned to the easing path. The ECB went back to its massive money printing scheme, the Fed started injecting billions into the repo market, while interest rates either remained or were pushed further into ultra-low and negative levels. There is no sign and no reason to believe that this policy trend will be reversed any time soon. If anything, central banks appear more likely to double down on it, as they continue to fail to deliver on their own goals. After a decade of trying to “cure” the economy with the same methods, they seem convinced that it’s not the medicine that’s wrong, but the dose. Thus, as the patient continues to be unresponsive, they can be relied upon to increase it, once again.
That is especially true in the Eurozone, where economic data and key developments have been increasingly worrying, making an ECB tightening scenario seem extremely unrealistic. Germany, the union’s workhorse, has been steadily and consistently showing signs of a slowdown and raising well-founded fears of an imminent recession. Italy has been struggling to avoid re-entering one and barely succeeding, an outcome that could easily be reversed in 2020, as political frictions once again threaten stability in the country. Spain has been facing unemployment levels unseen since the 2008 crisis, while France has been plagued by protests, strikes and disruptions, essentially non-stop since the fall of 2018. Meanwhile, Brexit, now finally taking a practical shape, presents its own set of unique challenges for the bloc moving forward. This all paints a rather dismal picture for the new year, ensuring that ECB will have to continue to support the ailing Eurozone economy. It wouldn’t be surprising to see these efforts intensified, with new President Lagarde at the helm of the central bank, as she has already shown her willingness to continue down the same interventionist and expansionary path that her predecessor has set.
The bull market illusion
Over in the US, the historic bull market does seem to hold for the time being, with stocks breaking new records, despite the recent geopolitical tensions between the US and Iran and the impeachment proceedings against President Trump. At first glance, one might think this strength, defying clearly elevated risks, might actually be here to stay. Nearly daily S&P 500 record-breaking might be the new normal. And yet, when one takes a closer look at what lies underneath this superficial bullishness, it becomes clear that it is far from sustainable. In fact, it is doomed to collapse.
The reckless monetary experiment of the last decade has resulted in serious market distortions, with stock buybacks and dangerously inflated asset prices, that by no means reflect actual value. What they do reflect instead, is pure greed, reckless risk-taking, short-term thinking, and an obsession with instant gratification. We’ve seen investors line up to buy shares of consistently loss-making companies, make irrational bets on a never-ending uptrend and celebrate bad economic data, as that increases the chances of another rate cut. Obviously, none of this is sustainable.
To make matters worse, the mountain of bad debt and even worse investments that the artificially low rates have facilitated and encouraged have reached a point of no return. Even researchers from the New York Federal Reserve directly had to acknowledge and warn against the gigantic risks this poses to the markets and to the entire economy. According to a report published in early January, the record spike in demand for riskier corporate debt poses a “financial stability concern”, especially since an economic downturn could force investors to dump these assets en masse. And they’re not wrong to fear this.
There are currently only two companies in the US that still have a triple-A rating. A wave of downgrades over the past months has made it clear that the overall debt quality has severely declined and in some corners of the market, already beginning to turn sour to a very dangerous degree. In fact, it is in these very corners that sales have reached record levels: “triple-B” bonds, the lowest level of investment-grade bonds, as well as high-yield or junk bonds, have seen a dramatic spike in demand. The increasingly probable scenario of a default wave would have serious contagion implications, trigger panic selling and threaten to destabilize financial markets at large.
A rude awakening
While most mainstream observers and speculators have been willfully blind to the deteriorating fundamentals, clinging to unrealistic hopes of an eternal expansion, to the discerning investor, most of the aforementioned risks have been apparent for quite some time now. Indeed, the past couple of years were particularly vexing for many responsible savers and conservative investors. They had to watch their savings and pensions wilt through negative interest rates and their rational, prudent investment choices get punished, while the reckless borrowing and spending of others was rewarded. It was easy to think that this complacency and mass denial could keep propping up markets for much longer. However, quite a few things have changed by now, making this scenario seem very unlikely.
As more and more central bank officials had to publicly recognize the toxic side effects of their loose money “cures” and to openly admit the risks they introduced into the financial system and the economy, this attitude of denial is becoming increasingly hard to maintain. It is true that the latest uptick in US equities has lulled a lot of investors and analysts into a false sense of security, while overall recession fears have been somewhat quieted. And yet, the release of official statements, central bank meeting minutes, and the latest Financial Stability Report, have attracted considerable attention.
The warnings are now getting louder from seasoned investors and economists that urge great caution going forward and highlight the need for risk management over greed and mindless profit chasing. Given the performance of gold over this period, it is clear that these words of caution certainly did not go unheeded. This growing risk-aversion and safe-haven demand is also vividly illustrated by the spike in gold-backed ETF inflows. With investor demand for gold surging, especially in the second half of 2019, the amount of gold held by gold-backed ETFs hit an all-time high and grew by 14% over the last year.
In addition to all the official warnings and raised concerns that have begun to refocus investors’ minds on the risks that lie ahead, we must also take note of the historic wave of central bank gold buying that truly spiked in 2019. It appears that central bankers have long been taking their own advice, in building up their gold reserves and preparing for adverse scenarios. While most reports on this topic have been focused on Russia and China, the top hoarders over the last years, other central banks have quietly been stocking up as well. Poland, Serbia, Hungary have also been adding large amounts by historic standards.
In fact, this points to a wider and much more important shift that investors should really pay attention to. As Jeff Currie, the head of global commodities research at Goldman, put it: “De-dollarization in central banks – demand from central banks for gold is biggest since the Nixon era, eating up 20% of global supply”.
Preparing for the next recession
The precise timing of the next downturn is, of course, impossible to predict. The same goes for the specific trigger that will set it in motion. It can be a swift chain reaction that begins in toxic corporate debt, or a severe downturn in the intensely vulnerable Eurozone economy, it might be a military escalation, or even a political shock in the US, emerging from the impeachment proceedings or during the 2020 election campaign. There are too many risk factors and weak spots in most major economies and any one of them can act as a catalyst for a wider meltdown. What we can tell for sure, however, is that we’re sitting on an economic and financial powder keg.
For the prudent investor looking to survive the next recession and to protect their wealth from the risks that await, there are very few options left and, in my view, only one of those is truly and demonstrably reliable. At the end of the day, only physical precious metals are money, everything else is just credit. For over 5000 years, fiat money used to be a mere property title on physical gold or silver, a fact that very few people realize today. We’ve only had unbacked paper money since 1971, with the end of the gold standard, which only kickstarted a long-term debt cycle. Thus, monetary history is clearly on the side of precious metals. Physical gold and silver are two time-tested stores of value and therefore offer a solid hedge in times of crisis.
While the price gains that can be expected for investors in the next years are indeed enticing, it is essential to remember that short term alone shouldn’t be the driving force behind bullion purchases. Physical precious metals should instead be primarily seen an insurance and a protection against economic turmoil and crises of all kinds, from stock market corrections to full-blown recessions and geopolitical shocks. As such, their storage must also be carefully considered. A stable, predictable and historically resilient jurisdiction, like Switzerland, with a strong track record of respect for private property, is, therefore, an ideal location.
Claudio Grass, Hünenberg See, Switzerland
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