By Neland Nobel
We are receiving a number of calls and emails that are roughly worded like the title above. We simply can’t find the time to answer everyone on a personal basis. It is an important question and in this short essay we hope will suffice to answer at least some of your questions.
It should be recognized that this government shut down of activity for the Covid 19 virus will cause the world economy, which was slowing anyway, to nose dive into a recession. We view the shutting down of economic activity (warranted or not) as the pin the busts the credit bubble.
We cruised into this situation with record peace time fiscal deficits during prosperity, Social Security and Medicare are just years from insolvency, corporate debt is at all-time high levels compared to GDP, and about half of US corporate debt is BBB- or lower. There’s a huge bubble in emerging market debt, a credit bubble in China, a problem with low grade automobile debt and student loan debt. Virtually no down payment real estate financing is back, and we “had” an extremely overvalued stock market. That is the general outline.
Years of zero interest rates have distorted risk calculations and misallocated capital. A credit crisis will soon follow the stock market panic. The pandemic needle has ruptured a vast credit bubble. That is the bottom line.
The first stage of a credit bubble bursting is the liquidity crisis. People must sell whatever they can to support their debts regarding business and family obligations. They sell what is easy to sell: stocks, bonds, gold, commodities. Real estate is notoriously slow to sell. So, one of the benefits of gold is that it is highly liquid, so it becomes a negative during the liquidity crisis phase.
Likewise, professional investors such as hedge funds, mutual funds, ETFs, and managed futures accounts, have to sell if their public clients are selling. They have to raise cash. If they own gold or gold shares, they get sold with everything else.
Although history never repeats exactly, let’s look at the Crash of 2008 for some guidance. The chart below requires close scrutiny.
After doubling in price from 2006 to 2009 (and that is after it more than doubled from the low of $250 in 2001 to over $700 in 2006), gold peaked at about $1033 and dropped during the liquidity crisis late October 2008 to $681. That was a 35% drop. The drop so far by bullion in this current crisis is much less.
Look what followed immediately after the low in late October of 2008. By the spring of 2009, gold was up by 48% and went on to peak at over $1900 per ounce in 2011. Gold bottomed out four months before stocks did. We wanted you to see the action before, during, and immediately after the worst of the liquidity crisis phase of the 2008 crisis.
So, what do we learn here? Gold dropped during the liquidity pinch phase of the cycle, and then went on to triple in price. Gold should be acquired during the liquidity crisis when it is temporarily depressed by mass, indiscriminate selling. The stage of advancing prices follows soon after the liquidity crisis phase ends.
Why? Because it responded to all the money printing schemes launched by government to deal with the deflationary recession that followed.
This current crisis has already spawned government policy moves bigger than 2008. The FED has already announced a Quantitative Easing of $700 billion. Last time it was about $400 billion in several stages over several years.
Proposed payroll tax cuts alone will almost double the fiscal deficit. And the additional funds to pay for lost work, rescue Boeing, the airlines and the cruise lines, will be huge. During the recession to come, revenue to the government will fall and expenditures will rise. Deficits could approach $3 Trillion, although that is but a guesstimate.
Some of the debt will be purchased but most of it will be monetized. This is massive currency depreciation and gold historically does very well in such an environment.
Central Banks of the world will soon begin wondering whether even the US can borrow such vast quantities of money and remain solvent. Gold is their only reserve that is not a promise from the US. And it is the only form of cash money, that cannot be depreciated or defaulted upon. They will likely become buyers as well as the public, and for many of the same reasons.
The supply of gold will only increase marginally, as gold mines simply have not found significant new ore bodies over the past 20 years. Rising demand, and stagnant supply is a powerful equation for higher prices in the years ahead.
So, now you know what the sequence has been in the past. Gold can weaken during the liquidity panic phase, and then rise dramatically as it responds to all the emergency printing schemes, which will be launched by all major governments and central banks around the world. The weakness during the liquidity panic will run its course and should be viewed by long term gold investors as a huge buying opportunity.
Charts courtesy of StockCharts.com. Information has been derived from sources believed reliable but investment results cannot be guaranteed.
–Neland D. Nobel is a retired money manager and Certified Financial Planner with 45 years’ experience in financial markets. With a Master’s Degree in Economic History he has been a long-time observer of gold and financial markets from both the practical and theoretical perspective.