Tuesday, April 21, 2020

Gold to Surge in Flight to Safety Stampede

Present and near-future expenditures of trillions of US dollars in stimulus packages issued globally already add to the almost unsupportable pre-Covid 19 debt levels. The following provides a basic overview of the factors that make investment in a gold a serious consideration.


IMF Warnings

With respect to a global debt overview provided by the IMF, according to the Financial Times article dated 14 April 2020 Coronavirus Poses ‘Serious Threat’ To Financial System, IMF Warns, the pandemic is a serious threat to the global financial system. It added that firms are more vulnerable today than pre-Great Recession 2008 particularly in piling on riskier debt such as junk bonds, leverage loans and private credit totaling $9 trillion. Furthermore the weakest link is emerging world debt.

Sovereign Defaults - Emerging Markets

Emerging market countries are highly vulnerable to defaults with the spread of pandemic on already weak public health systems. According to the Wall Street Journal article 29 March 2020, Coronavirus Heightens Risk of Emerging-Market Defaults, there are 18 countries who have US dollar denominated bonds trading at distressed levels with yield 10 points above US Treasuries.

Furthermore many emerging market countries are in deep debt to China. As articulated by the Wall Street Journal’s article 30 March 2020, Hidden Chinese Lending Puts Emerging Market Economies at Risk, factors complicating efforts to accurately quantify this debt outstanding is China’s opaque lending practices, lending in US dollars at commercial rates vs institutions like the World Bank which lend money at below market rates and lack of a repayment schedule.

Corporate Sector

The Economist provided an excellent comprehensive overview of the challenges the corporate sector faces in the 12 March 2020 article In a Sea of Debt. They focused on four elements described briefly as follows:

1.    Borrowing: Corporate debt has risen from 84% of GDP in 2009 to 92% in 2019 as a result of lower underwriting standards with total outstanding debt of $20.9 trillion. Almost 67% of non-financial corporate bonds are rated junk or BBB.
2.    Pandemic and oil slump: They ran a “cash crunch stress test” of 3000 non-financial, non-Chinese firms a 67% sales slump 13% of these firms would exhaust their cash on hand; 6 months 25% would run out of cash.
3.    Credit derivatives: These are the cost of insuring against default on investment-grade debt, have slumped badly. The possibility of issuing new debt is almost impossible.
4.    Institutional Resiliency: Most American bonds are owned by pension funds, insurers and mutual funds which can sustain losses but will be reluctant to buy more.

Governmental Debt

Domestically the authors of the Council of Foreign Relations 26 March 2020 article Why the Fed’s Bazooka Will Not Stop A Wave of Defaults, 26 March 2020 persuasively explain why the stimulus packages are not the solution as follows:

“For many cash-strapped companies, however, the Fed’s interventions will be of little or no help. The central bank’s corporate-debt buying will focus on companies with high credit ratings. But it is riskier-company borrowing that has skyrocketed of late. As the right-hand chart above shows, large shares of nonfinancial commercial paper issued since 2017 have come from lower-rated companies—much like in the run-up to 2008. This mirrors the pattern in corporate-bond markets, where junk-bond issuance has soared. All this suggests that Fed buying will not stem the rising tide in corporate defaults.”

As governments worldwide issue billions upon billions of stimulus aid, they are adding onto the pre-Covid 19 debt levels at an unprecedented rate. The information provided by the IMF in the following chart presented by Statista, an online German information service 17 April 2020, Next Stop: Debt Crisis? Shows a snapshot of government debt as a percentage of GDP in 2018:

Historically gold perform well in a world of debt and today’s debt at the governmental and corporate levels are unprecedented.

Oil Crash

Despite the OPEC+ agreement was nothing more than a political paper exercise meant to appease but not to resolve the production issue. Their efforts to create a soft floor backfired with the recent implosion of prices. With zero demand, the heavily-indebted oil are unable to sell to customers who themselves are heavily indebted and are hobbled by a strong US dollar making any oil purchases challenging.

The Fed’s Nuclear Option

Because of the unprecedented level of stress on the global banking system, there exists the unpalatable possibility of the declaration of a bank holiday by those at the highest levels of government.

The newly elected President FDR declared a bank holiday – suspension of all bank transaction - at 1 am on Monday, March 6 which would last 4 days, for the purposes of avoiding a financial panic and restore confidence. Below is the description of the Bank Holiday of 1933 on the Federal Reserve website:

“At 1:00 a.m. on Monday, March 6, President Roosevelt issued Proclamation 2039 ordering the suspension of all banking transactions, effective immediately. He had taken the oath of office only thirty-six hours earlier.

The terms of the presidential proclamation specified that “no such banking institution or branch shall pay out, export, earmark, or permit the withdrawal or transfer in any manner or by any device whatsoever, of any gold or silver coin or bullion or currency or take any other action which might facilitate the hoarding thereof; nor shall any such banking institution or branch pay out deposits, make loans or discounts, deal in foreign exchange, transfer credits from the United States to any place abroad, or transact any other banking business whatsoever.”

For an entire week, Americans would have no access to banks or banking services. They could not withdraw or transfer their money, nor could they make deposits.”

Admittedly although today’s dynamics and circumstances vary from those from the start of the Great Depression in 1929 to 1933, the commonality is that the banking system was under extreme strain. Although I doubt that the current administration would resort to such a maneuver, particularly so close to the presidential elections in November, a successor might, just as FDR did.

Golden Investment Possibilities

For the aforementioned reasons cash-rich investors who kept their “powder dry” gold may be offer the exceptional opportunity for both a safe and lucrative “flight to safety” investment.

Copyright 2020 Indo-Brazilian Associates LLC

Indo-Brazilian Associates LLC is a NYC-based think-tank and advisory service that provides prescient beyond-the-horizon contrarian perspectives and risk assessments on energy investments, geopolitical dynamics and global urban security.

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