Tiny Hungary Becomes Huge Gold Bug, Possibly As Preemptive Measure In Face Of Global Turbulence

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Includes: AAAU, BAR, GLD, GLDM, GTU, IAU, OUNZ, PHYS, QGLDX, SGOL
by: Zoltan Ban

Summary

Central bank net gold buying has been the global trend for a decade now, in a reverse from earlier decades.

Hungary's ten-fold increase in gold reserves is different in that it is the first such move made by an EU member in many years.

Given Hungary's recent track record of intuitive preemptive moves made to coming crisis, it is worth contemplating whether it is reacting to prospects of a coming global crisis.

Implications for gold may be that the trend of central banks continuing to accumulate the precious metal may signal an increased role as a currency, or as backing for fiat.

The news that the Hungarian central bank increased its gold holdings tenfold recently may seem sensational.

Hungary gold reserves Source: Forbes

The ten-fold aspect of it sure is impressive, as is the fact that it is the first such move made by any central bank in the EU in a very long time. The actual volume involved is about 28 tons, since Hungary only had about 3 tons before, which is less than impressive or even worth mentioning in terms of what direct effect this may have on the overall gold market. I nevertheless believe that this is an event worth keeping an eye on because, among other things, Hungary has a decent track record on taking correct preemptive decisions, whether it was on the economy or on other matters. Within the context of a number of other countries also opting to increase their gold reserves lately, it may be an unspoken worry about the future that a number of central banks around the world may be harboring. Evidently, they seem to think that whatever may be coming our way, there is some safety from any resulting consequences in having some gold reserves on hand.

Hungarian central bank's move echoes other moves around the world

Fellow Central European country Poland was also reported to have increased its central bank gold holdings by 4.4 tons in the past few months. Turkey is said to have increased its gold imports by three-fold recently. Then there are of course more significant players on the scene, like Russia, which nearly quadrupled its gold reserves in the past decade.

Russia gold reserves Source: Trading economics.

In the case of Russia as well as China, we seem to be witnessing a preparation for longer-term goals, which they started to prepare for a long time ago and they are continuing down their path. Perhaps they want to offer gold backing to certain financial instruments, or as is the case with China, in order to back the development of its own oil trading hub denominated in its own currency. In the case of Hungary, it seems to be a drastic reaction to a perceived change in the regional or global situation.

The many possible reasons why Hungary is frantically increasing its gold holdings

The obvious question that begs an answer is why is it that Hungary suddenly seems to be once more scrambling to introduce what can only be seen as a preemptive measure to some sort of risk? There seem to be some thoughts that it may have something to do with Hungary preparing for further disagreements with the EU. I personally don't believe that to be the case. The EU situation overall is a mess these days, with Brexit, Italy rebelling against EU-imposed austerity, as well as the vicious ideological divisions occurring since the start of the migrant crisis in 2015. I personally believe that the Euro currency is a permanently flawed project, where some countries stand to permanently benefit, while others are permanently being strangulated by it, with no prospect of escape. It is therefore most likely only a matter of time before it will fall apart, at which point a country like Hungary, or any other country on the continent for that matter, would want to have an ample supply of gold. The Euro is currently the dominant currency on the continent for Euro zone members and for non-members alike. The prospect of an eventual collapse of this project would have cataclysmic effects worldwide, while the old continent itself would most likely suffer a spectacular collapse.

While the problems facing the EU are real and potentially catastrophic in a worst-case scenario, these problems have been evident and around for a while now, it is therefore unlikely that Hungary is now reacting to the accumulating problems that the EU is facing. I think it is more than likely that Hungary is looking at the global factors, which might of course aggravate the already dire situation in the EU. It is a little bit like being in a flimsy, rickety boat on the sea and looking out in the distance as an ugly storm is moving in. The boat is of course the EU, the storm clouds may be a global trend, while the gold may represent a life raft for Hungary, which might just be enough to survive the storm as the boat breaks apart.

Hungary's jitters may have same roots as recent market jitters

The recent market selloff is clearly signalling some deep anxiety among at least some investors in regards to the short- to medium-term outlook for the US and global economies. The list or reasons to be nervous at this point includes the rising interest rate environment within the context of global debt, which has grown significantly since the last recession.

global debt Source: Bloomberg

It goes without saying that the roughly $60 trillion increase in the global debt load since the last crisis presents the global economy with a heavy burden in the absence of the low interest rate environment we have been enjoying since the 2008 crash.

We should also note that since 1999, the global debt burden has tripled from about $80 trillion, to almost $240 trillion, while global GDP did not increase by nearly as much. The world's GDP measured in current US dollars did increase from $33 trillion in 1999 to $76 trillion by the end of 2016, which is a 230% increase, meaning that we would find ourselves in deep crisis if we were to ever move back to the average global interest rates we experienced back then.

The current trade war situation is of course not helpful either. It represents a potential slowdown in economic growth, which is the last thing we want to see, given that growth in global debt has been outpacing nominal economic growth for some time now. In the absence of nominal economic growth once more reaching a point where it can match the longer-term trends in debt growth rates, it goes without saying that this is a road to eventual disaster, which will shake the world to the core.

Hungary is of course a crew member on a particularly rickety boat in the form of the EU, which will likely be one of the most affected entities in the event that a severe global economic crisis may be upon us. This might explain why Hungary decided to take the drastic step of increasing its gold holdings by ten-fold. Given its track record of preemptive policies from the past few years, I think we should take notice of the news in this regard. I wrote an article a while ago about Hungary's seemingly genius, or at least fortunately well-timed, move to convert the large pile of FX consumer debt back into the local Forint, just before the Swiss decoupled their currency from the Euro, back in 2015. Many countries in the region were negatively affected by that event, while Hungary managed to largely escape the negative consequences of Swiss Franc denominated debt becoming harder to service due to a jump in its value. That same year, they decided to start building a fence on their border with Serbia, before it became entirely clear to everyone else that there was a massive migrant influx on the way and that the EU and its member states needed to respond by securing their borders. It is possible that this country is making the right call once more, and we might be headed for some interesting times, where gold might once more become a core medium of trade.

Implications for gold

Hungary's central bank is by no means unique in its quest to increase its gold holdings. We know of course about Russia and China being major gold buyers in the past decade or so.

central banks gold holdings Source: Bloomberg

As we can see, a period of central banks ridding themselves of their gold reserves has ended with the beginning of the last economic crisis and they did not stop being net buyers since then. The likelihood that we will see more and more use of gold in international transactions will, in my view, increase as long as central banks continue increasing their holdings. The extra-territorial sanctions being imposed against those looking to do business with Iran, for instance, may serve as a catalyst for such transactions to take place.

Going back to the global debt issue, it is a factor that may lead to increasing anxiety about paper assets backed by nothing but fiat currency supply policies. As I pointed out in a recent article, the current global reserve currency, the US dollar, may be faced with an unprecedented challenge to its current status as the main facilitator of global trade, reserve currency as well as safe haven asset, if the current trade war intensifies and leads to an all-out economic war. Needless to say that the second most popular reserve currency, the Euro, is no instrument of stability either, especially given the acrimonious situation within and between EU nations at the moment. Within such an environment, it is entirely possible that all nations might have to resort to at least partially backing their fiat currencies with hard assets in order to maintain enough trust to continue facilitating global trade relationships.

It may seem almost unreal for us to be discussing fiat currencies having to be backed by gold, while we are in parallel discussions on how an even more sophisticated, perhaps non-government backed cryptocurrency system may eventually replace fiat currencies. I think this is a real possibility given the overall big picture outlook for the global economy, as well as global relations trends currently unfolding. The Hungarian move to drastically increase its gold holdings may be just another indication that we may be getting closer to reaching a crisis point. I think it is worth keeping an eye on how central banks around the world will behave in this regard in coming months and years.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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 physical gold.