Coronavirus To Boost Gold Price
Summary
- My concern is that the virus has set in motion a domino effect in a brittle world economy.
- The coronavirus will cause the economy in Europe to suffer a significant setback (as in China).
- When economies contract, stock markets plummet, and banks fail, gold offers the best protection.
As the coronavirus is spreading around the world, its ramifications on the economy will boost the price of gold.
The coronavirus is swallowing the world. What started in January as a local issue in Wuhan, China, is now a global problem. Although there remains uncertainty around the health hazards of the virus, its impact on the world economy is clear. Early on, we witnessed large segments of the Chinese economy grinding to a halt and supply chains collapsing. As the virus is spreading, major economies will likely suffer the same fate as the Chinese. Across the globe, schools and companies are closed. Events are canceled, and traveling is brought to a minimum. People that can work from home are asked to do so.
Government officials are taking precautions as well and for a good reason. In Iran, 23 Members of Parliament have been infected, and one of Ayatollah Khamenei's top advisers died of the virus. On Wednesday, the first case of corona in an EU institution was confirmed.
The European Central Bank called off a meeting on Tuesday out of fear for contamination, and the International Monetary Fund decided to change the spring meetings to a virtual format (video conference). In France, President Macron ordered to confiscate all stockpiles of face masks and to nationalize production, just before the news came out by the World Health Organization, that "the mortality rate for COVID-19 [coronavirus] is 3.4% ..., higher than previous estimates of about 2%."
My concern is that the virus has set in motion a domino effect in a brittle world economy. After the Great Financial Crisis, central banks have over-stimulated the economy through quantitative easing ("printing money") and extremely low interest rates. Unconventional monetary policy has spawned asset bubbles, zombie companies and banks, decreased productivity growth, and global debt to GDP is at a historical high of 322%. Although unconventional monetary policy has worked counterproductive, any subsequent economic downturns will make central banks double down on their previous policy: more stimulus.
The first macroeconomic indicators coming in from China are disastrous. The headline Caixin Business Activity Index fell over 25 index points from 51.8 in January to 26.5 in February.
Courtesy Caixin.
The economic shock made Chinese banks - which were already suffering from non-performing loans (NPLs) on their balance sheet before the virus erupted - to take extraordinary measures in not recognizing bad loans, with the explicit approval of regulators in Beijing. More from Bloomberg:
Some of the measures, … include rolling over loans to companies at risk of missing payment deadlines and relaxing guidelines on how to categorize overdue debt
lenders are also … allowing borrowers to skip interest payments for as long as six months
The four biggest state-owned banks are trading at an average 0.5 times their estimated book value for this year, near a record low.
Courtesy Bloomberg.
These are signs of a double-edged problem: companies aren't making ends meet and banks face insolvency.
The value at which banking stocks are traded relative to their book value is called the "price to book ratio." As stated by Bloomberg, this ratio is near a record low for Chinese banks (at an average of 0.5). If we simplify the price to book ratio, then it can be said to reveal how the market values a bank's balance sheet, versus how the bank itself values its balance sheet. When the price to book ratio is below 1 (alternatively below 100%) the market thinks the bank is in bad shape. If the ratio is 0.5, the market thinks the bank is in very bad shape.
European banks are in no better condition. A few months ago, Dutch independent journalist Arno Wellens computed the price to book ratio for Europe's largest banks. Some banks appeared to be healthy - mainly the ones in countries that are not in the eurozone. But many other Systemically Important Banks, such as Deutsche Bank (DB), Commerzbank (OTCPK:CRZBF), BNP Paribas (OTCQX:BNPQF), Crédit Agricole (OTCPK:CRARF), Societe Generale (OTCPK:SCGLF), UniCredit (OTCPK:UNCFF), Banco Popolare (OTCPK:BPSYF), Banca Monte dei Paschi (OTCPK:BMDPY), and Banco Santander (SAN) have price to book ratios far below 100%. Insiders know these banks are not healthy (no matter what stress test they pass).
Courtesy Arno Wellens.
The coronavirus will cause the economy in Europe to suffer a significant setback (as in China). It will hurt businesses and, in my view, will push the economy into a recession. On Wednesday, European Union officials publicly stated they are "starting the internal reflection" on their methodology for dealing with failing banks. Banks, once again, will face bankruptcy.
Why Gold Will Rise
Gold has been a safe haven for thousands of years. And still, when economies contract, stock markets plummet, and banks fail, gold offers the best protection, as it's the only financial asset that is no one's liability. Gold has no counterparty risk and can't be printed.
Other traditional safe havens are sovereign bonds. In the past years, the gold price in U.S. dollars has been correlated with long-term real interest rates. Whenever real interest rates decline, the gold price rises. Real interest rates are calculated by subtracting inflation from, in this case, the nominal interest rate on a 10-year U.S. sovereign bond (UST). On Tuesday, the nominal interest rate on a 10-year UST fell below 1% for the first time ever. I expect nominal rates in the U.S. to further decline (possibly to enter negative territory, as in Europe and Japan). This would be bullish for the price of gold.
The decline in UST yields came after the Federal Reserve cut its baseline interest rate on Tuesday by 0.5% in an attempt to calm markets. Last week the U.S. stock market experienced its fastest correction in history.
Investors are in the process of running down Exter's inverse pyramid: selling stocks, buying government bonds, and to a certain extent, gold.
I say to a certain extent, as currently gold makes up a small fraction of all financial assets. When I asked Jeffrey Christian from CPM Group how much he estimates gold now represents, he replied over email:
Gold accounted for 0.52% of global financial assets in 2019, up from 0.51% in 2018.
In my view, this means there is still much more upside for gold.
Conclusion
Although I think gold has a lot more upside, it can be a bumpy road. When the economy contracts, deflationary forces can hold back gold. Central banks will not tolerate deflation, though, certainly not with sky-high debt to GDP levels. Deflation causes nominal income to decline, which makes debt unserviceable. This would trigger a chain reaction of defaults. Central banks stand ready to avoid this scenario and will continue to pursue inflation to alleviate the debt burden.
When the economy contracts, or deflation looms, I wouldn't be surprised if central banks either hand out cash financed by new money creation (helicopter money) or directly devalue their currencies against gold as they did in the 1930s. Both scenarios could significantly increase the price of gold.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
This article was written by
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Comments (60)
So much information along with official government holding records.
Seems like a treasury of pretty solid data in various sources.
Another fascinating article on your Au expertise! my compliments.
Your documentation of Au movements east to west and back again included Great, believable data sources. how about Au movement from central banks? ~40 years ago around 1978, the imf make a set of large bullion sales as did UK ~20 years ago. now when central banks either buy or sell Au, are the transactions publicly disclosed or confidential? Surely, inlows and sales by central banks are a critical part of how much Au is into or out of the market as well as private sales in Hong Kong, Shanghai and London. Any idea of the governmental inlows and sales in 2020?
That was so very infoormative. This is really interesting. So many of the biggest repatriators are EU AND West/central Europe not the far east.
thanks
HopefulPaul
this is set of puzzles which resolve/make a coherent solution as more layers of info come into view. Vennezuela repatriated bullion with which to pay Russia, so that flow was eventually east but not to China or India but Russia government.
Expect bank, governmental holdings less labile than private holdings. I suspect short-term fluxes are a very tiny part of these holdings which are reflected in daily pricings which move the fluctuating bullion pool but ordinarily never move most bullion which just sits in one place for decades. what a picture!
thanks again, fascinating.
I see four Italian banks at the end of the list in your table. Not good, with the rapid extension of Coronavirus in this country.
Own bullion and miners. It has been painful since the lows in Dec 2015. The trajectory however was never in doubt....
What are they going to do about it? Another round of QE? They are part of the deflationary forces to begin with...
I can't be convinced that they don't know while it's for everyone to see.
fred.stlouisfed.org/...When you lower rates, you deduct the economy of income, which is deflationary.
When you add income to an economy, inflation will pick up.Keep on doing the same thing, hoping for another outcome.
They must be Dems...Rigging Bernie for the second time, hoping for another outcome.
There is no need to 'guide' an election.
The people will have their say anyway.
I thought that mw. Warren was quite feisty, now she still needs to think about who she will support? Orders, mw. Warren, orders mw. Warren, from the top...show us you got some 'cojones'. And don't forget why Rocky was so popular, the more stuff was stacked against him, the more most wanted him to win...
Not pro or con Bernie, but i'd like a showdown between the Donald and Bernie. They both have something 'real' about them.
It seems like it's difficult to contain, no matter where you are.www.nytimes.com/...
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*Found in Chapter 4 titled "The Perfect Portfolio" in William J. Bernstein's book 'The Four Pillars of Investing' (link below) ..."Precious metals stocks—companies that mine gold, silver, and platinum—historically have had extremely low returns, perhaps a few percent above inflation. Not only that, they tend to have very poor returns for very long periods of time and are extremely volatile. Why expose yourself to this asset class? For three reasons...""First, precious metals stock returns are almost perfectly uncorrelated with most of the world’s other financial markets. During a global market meltdown, they are liable to do quite well. For example, from 1973 to 1974, gold stocks gained 28%. We don’t have exact returns for gold stocks from 1929 to 1932, but anecdotally, they seemed to have done quite well at that time as well, when everything else was getting hammered.""Second, precious metals stocks will be profitable if inflation ever again rears its ugly head. During such periods, “hard assets” such as precious metals, real estate, and “collectibles” (e.g., art, rare coins, etc.) tend to do very well.""And third, this asset’s random volatility will work in your favor via the re-balancing mechanism. If you can hold precious metals stocks in a retirement account and trade them without tax consequences, the natural buy-low/sell-high discipline of the re-balancing process should earn 3% to 5% per year in excess of the low baseline return for this asset. Be forewarned that this process takes discipline, because you will be continually moving against the crowd’s sentiment. While you are selling, you will be reading and hearing some very compelling reasons to buy, and when you are buying, you will find that others consider it an act of lunacy."1.droppdf.com/...
Where in the article did you read gold going to $5000? Perhaps you read another article and mistakingly responded in the wrong post?Of course gold is bullish. Those of us who have owned gold since it was $250 while the Bank of England sold 1/2 of their lot, or those of us who bought since Dec 2015 when it was 1050 per ounce always knew what would occur. None of us know how high the gold price will go nor do we know the speed of the trajectory. However, for those of us who have expertise in Macroeconomics, it has always been clear what would occur. One does not need to be a genius to look at 2008 world debt of 170 trillion now 250 trillion with no tools in the shed for CB’s and governments around the world as real interest rates continue to fall well below zero and QE never ending that this would not end well. I really do not care if gold goes just to 2000 (it will) or 5000 (I have no idea). What I do know is that this will be painful for far too many around the world, in which billions are already disenfranchised economically as the divide between rich and poor has widened since the 1970’s. This will not end well.....with the social economic consequences significant. For those of you who believe in Science (Climate Change) as I do with my doctorate degree, the perfect storm is occurring between the perils of climate change and the economic reckoning awaiting the irresponsible policies of governments around the world.Therefore the issue is not whether gold goes to 5000 or whether one defines themselves as a gold bull. These are mere distractions of the real risks that are forthcoming over the next several decades.
Wondering if the top is not in and gold and the next move under a 1000.
interest rates and/or change in real rates.🎆