The Emerging Story on Gold

Wall Street down…and going lower.

Bitcoin headed for the cellar.

Property off the boil.

But what about gold?

Gold’s most recent golden years were the ones immediately following Global Financial Crisis.

Fears over Central Bank money printing bringing in a new Weimer Republic (hyperinflation) helped create demand for the precious metal. Throw in a potential sovereign debt crisis — Greece — and gold spiked above US$1,900 in late August 2011.

Four years later, in late 2015, gold was under US$1,100.

Since the heady days of 2011, it’s been a tough time for gold buffs.

Even all the geopolitical sabre rattling and asset price volatility has failed to stir the gold price of late.

Australian gold investors have been spared some of the price pain thanks to the weakness of our dollar against the US dollar.


Graph of components of Australia's population growth

Source: goldprice.org

[Click to open in a new window]

Still, it’s been a frustrating seven years.

When is gold finally going to deliver on its ‘ultimate’ promises…‘the ultimate store of wealth’ and ‘the ultimate portfolio insurance’?

Based on nothing more than the theory of ‘the great unloved once again becoming the loved’, my guess is we’ll see gold benefit from surge pricing.

Gold will stand alone

As trade tension escalates, bond markets start raising rates on lower rated debt, defaults begin to happen, volatility increases on Wall Street, cryptos get flushed down the drain and property markets continue to fall…the last man standing will be gold.

Gold Buyers Guide: How your gold investment could become the most lucrative mark on your portfolio. Get your free blueprint here.

Ironically, the renewed interest in gold means gold is likely to become a victim of its own success.

How so?

Everything in the world of money is connected.

There are circles within circles within circles.

Nothing happens in isolation.

Something obscure can happen a half a world away and before you know it, the web of global interconnectivity delivers a problem (you didn’t know you had) to your doorstep.

Among the many problems the past decade of debt-fuelled excess has created, is Emerging Market debt.

In the years immediately after the GFC, the US dollar was weak (this was the time when one Australian dollar gave us US$1.10).

As measured against a basket of global currencies, you’ll see the US dollar fell to its lowest (weakest point) in early 2011…to $66.


Graph of components of Australia's population growth

Source: Trading View

[Click to open in a new window]

The basket of currency charts shows us the US dollar was in the weaker zone from 2010 to mid-2014…then there was a sudden spike in the strength of the US dollar.

When did Emerging Markets load up on most of its debt?

You guessed it…from 2010 to 2014


Graph of components of Australia's population growth

Source: Bloomberg

[Click to open in a new window]

As the US dollar gets stronger, the Emerging Market borrowers need to convert more of their local currency to meet their USD debt obligations.

The pressure is already building

Fitch Ratings has recorded a ‘Negative Outlook’ on 12 Emerging Market sovereign credit ratings.

As reported in EFT Trends on 21 November 2018…

‘Rising external financing costs and current account deficits are among the factors plaguing emerging markets debt this year, pressuring exchange traded funds such as the iShares J.P. Morgan USD Emerging Markets Bond ETF (NASDAQ: EMB) and the PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) along the way.

‘The impact of tighter US monetary policy, a strengthening dollar, and risks to global trade and growth will continue to be felt in 2019,” said Fitch Ratings in a note out Monday. “EM vulnerabilities are reflected in Fitch’s sovereign rating Outlooks and recent rating actions. Of the 15 sovereign ratings on Negative Outlook, only three are in developed markets.’

And this negative outlook is before the fireworks on global markets start. 

What’s going to happen when Wall Street really starts to tremble and the debt edifice supporting artificial asset prices begins to crumble?

Firstly, gold is likely to be seen as a shelter from the fallout. That’s the price surge I mentioned.

Secondly, the US dollar should strengthen (significantly) as investors seek that other safe haven…US Treasuries. This is what happened after the dotcom and US housing bubbles burst.

In March 2001, the Aussie dollar touched US 47 cents. And, took another deep dive in early 2009.


Graph of components of Australia's population growth

Source: Trading View

[Click to open in a new window]

To understand the significance of the strong US dollar to foreign borrowers, here’s an example of how a US$ 1 billion debt works in Australian dollar terms.

USD/AUD exchange rate USD value of debt AUD value of debt USD value of interest payment @ 5% AUD value of interest payment @ 5%
$1.00 $1 billion $1 billion $50 million $50 million
$0.50 $1 billion $2 billion $50 million $100 million

The US lender wants to be paid in US dollars. When it’s dollar for dollar…no worries.

However, if our exchange rate was to fall in half, the cost of the principle and interest doubles in Australian dollar terms. That’s serious hurt.

That’s the theory. What about in practice?

With more than US$8 trillion lent to Emerging Market countries and companies, a world of pain awaits.

Getting your hands on US dollars becomes priority number one, two and three.

What’s the one universally held asset class that’s priced in US dollars?

Good guess…gold.

The initial price surge is likely to be met by a wave of (heavily indebted) sellers clamouring to exchange their precious metal holdings for…US cash.

All it takes is 5–10% of that Emerging Market debt to panic and we have a US$400 to $800 billion problem on our hands.

Should the above scenario play out, the ‘good news’ for Australian gold investors is, that the AUD gold price is likely to mimic what’s happened since gold peaked in 2011.

The falling USD gold price will be offset by the weaker Aussie dollar.

It would not surprise me to see the gold price back under the US$800 mark in the coming years.

Won’t happen. Can’t happen.

Well it has happened before.

In 2008, it took only US$300 billion of subprime debt to take us to the brink.

And what did gold do in 2008 as the grip of fear tightened?

Against all commonly held preconceptions…the gold price fell from nearly US$1,000 to around US$700.

It was only after the Fed turned on the printing presses and stoked concerns about hyperinflation, that the gold price turned around.

When the next debt crisis hits, the size of the debt problem is going to dwarf that of subprime.

It will be so large, central banks are going to be powerless to stop it.

Why?

It’s taken a decade and US$14 trillion to solve a US$300 billion problem.

Free Guide: Australia’s ‘Unstoppable’ Economy. Download now.

What’s it going to take to stem the haemorrhaging from debt defaults adding up to trillions of dollars?

There’s not going to be any fear of hyper-inflation, the greater concern will be deflation.

What’s the best asset to hold in a deflationary cycle?

Cash.

With every price reduction your dollar buys more.

Regards

Vern Gowdie,
Editor, The Gowdie Letter


Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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