The “Risk Asset” Dip Not Worth Buying is on its Way
The prices of the metals rose, gold by +$11 and silver by +$0.25. The question on everyone’s mind (including ours) is: what will cause a change in the gold price trend, or what will make gold go up in a large and durable way? And that leads to another way of looking at this question.
Here is a very good technical reason to adopt a constructive attitude toward gold despite the fact that its nominal price in USD terms is seemingly not going anywhere of late. By remaining fairly stable in recent weeks, gold is rising relative to the S&P 500 index (SPX). In other words, the purchasing power of gold is increasing – and not only relative to the stock market. Similar trend changes can be observed elsewhere (e.g. in gold vs. industrial commodities). We will soon discuss this in greater detail. [PT]
Price is set at the margin. We have covered several times Warren Buffet’s pointed (and disingenuous) comment that gold has no utility. It just sits, and there is a cost for it to sit. And an opportunity cost.
So why do people buy something which has no utility and no return?
One, which we discuss a lot, is speculation. They buy whatever is going up, in an attempt to cash in on the rise. So let’s not dwell on this.
A second reason is fear of counterparty default.
Third, is gold is a non-expiring hedge for monetary collapse and/or a currency regime change. This is a broader version of simple counterparty default.
Right now, General Electric is in the news. Its investment grade rated bonds are trading like junk bonds. This is like an echo from the past. Bear Sterns retained its investment-grade rating until just before its demise.
GE has about $115 billion in debt. If it defaults, that could put fear into a lot of investors. They will certainly buy Treasury bonds (which are defined as risk free). Will they buy gold, which is the only financial asset which is truly free of default risk? Maybe.
Cost of insuring against a default of GE bonds (5-year CDS spread) compared to an investment grade 5-year CDS index. This strongly indicates that the markets no longer regard GE worthy of an investment-grade rating. Naturally, the markets may err; in fact, based on the sum of its parts, an outright default of GE appears quite unlikely at the moment. GE has assets whose value and profitability compares favorably to its admittedly large debt hoard (which it is busy reducing via non-core asset sales). Of course the markets are actually not saying “GE will default” – what they are saying is that the risk of a default down the road has increased. Hence the qualifier “at the moment” above: we have to at least assume ceteris paribus conditions – but conditions are certain to change in the future and may well become challenging (e.g. a recession could strike). [PT]
However, in addition to GE we know that a significant fraction of bonds out there are issued by so-called zombie corporations, whose profits are less than their interest expenses. Rising interest rates can only have increased the percentage, though the increased cost kicks in with a lag (as each bond matures and must roll).
In addition to the problem of rising default risk from these companies, there is the risk that if a large enough number of them is hit at once, the credit market they depend on goes “no bid” again, as it did in 2008. Of course, if their bonds are impaired then their equities will become worthless. Stocks will be crashing in this scenario.
We raise the issue of price being set at the margin to make a point. In this scenario, the marginal buyer of gold will not be the speculator. It will be the mainstream investor who is desperate to protect himself from a financial system going mad again. When will this happen? Watch for news of GE and other major debtors sinking deeper into trouble.
As to systemic default risk, i.e. monetary collapse, it is early yet. There are some peripheral currencies like the bolivar and lira that could go away soon. But their troubles are widely known, and visible far in advance. We would not expect their demise to have much impact on the world’s monetary order (though of course it is horrific for the people who live in Venezuela and Turkey).
A currency on its way to oblivion – the exchange rate of Venezuela’s bolivar vs. the USD in the black market near the border with Colombia. Note, this is a log chart, otherwise one would see a longish almost flat line near the bottom of the chart, followed by a near vertical upside move beginning in 2016 (the chart shows the number of bolivares needed to purchase 1 USD). The move since 2010 was from around 8 to 1 to the current level of ~28,000,000 to 1. To call this currency toilet paper would by now be an insult to the latter. The bolivar has definitely ceased to be a viable medium of exchange and its collapse continues unabated – economic calculation has become impossible. [PT]
Other currencies are also in trouble — we have written a lot about the franc. It is impossible to predict the timing of such a thing, though our gut feeling is that it is still a ways out.
As to the de-dollarization, loss-of-reserve-status, end-of-petrodollar, gold-backed-yuan, SDR-to-replace-USD ideas, we say: rubbish. The dollar will get stronger from here, if not in terms of gold then as measured by other currencies.
Panicky people in Istanbul do not think “let me buy Brazilian reals, Russian rubles, Indian rupees, and Chinese yuan” because someone coined the glib term “BRICs”. They do not think “I will buy me some Saudi riyal because, petro.” They buy USD.
Postcard from Istanbul: a nice place offering plenty of opportunities to panic throughout its storied history… [PT]
So we end on a conclusion we have reiterated many times. When gold goes to $10,000 it is not gold going up. It is the dollar going down. It is inevitable that the dollar will go down. I just gave a talk at an Austrian economics conference in Madrid “There Is No Extinguisher of Debt” (paper to be published soon). The collapse of the dollar is baked into the mathematics.
People could buy gold today at an 88% discount from that price. But do yourself a favor. Watch any politician on TV. Watch a Republican promise to “grow our way out of the debt”. Or watch a Democrat promise a free university education to everyone. Watch even many libertarians promote Universal Basic Income(!).
If you think they don’t understand, you are right. But the vast majority of voters support these politicians. The voters, too, don’t understand. And the same holds for investors.
Buying gold is a non-expiring hedge. But only people who perceive a need to hedge, will buy the hedge. The rest may think that stocks are a bargain here, being down almost 7% from the high last month. So far in this incredible boom following the crisis, every time people who bought the dip were rewarded.
Are we getting close to the point where it won’t be? If GE is any indication, if GE will have a contagion effect (remember that word?) then the answer is likely yes.