What lies ahead for gold in 2020
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 work horse, 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 a 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 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.
In the upcoming second part, we explore why a growing number of investors are now prioritizing risk management over profits, and we take a closer look at the rising demand for gold, where it comes from and why it’s bound to accelerate.
Claudio Grass, Hünenberg See, Switzerland
www.claudiograss.ch
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