[Ed. Note: In Part I of this column, published yesterday – see here – Jeff looked at how gold fared against other assets in 2018 and gave us his long-term view of the market. Today, in Part II, he tallies up the ever-growing pile of global debt and breaks down gold’s fundamental supply and demand picture. Please enjoy his analysis, below…]
Debt: Not Slowing Down
While debt is always with us, the concern at this juncture is that debt creation is no longer fostering a significant amount of economic growth. Virtually every category of society is weighted down with unsustainable debt loads:
US Federal debt: In just 10 years, it has grown from about 60% of GDP to 104%.
Consumer debt: Credit cards, auto loans and student loans (excluding mortgages) just hit $4 trillion. This is an all-time high, and was $3 trillion just five years ago.
Student loans: Total student loan debt is now $1.6 trillion, an all-time high. Of particular concern is that this amount is now larger than the amount of junk mortgages in late 2007 (about $1 trillion). Further, default rates on student loans are already higher than mortgage default rates were in 2007.
Corporate bonds: Over the last decade, the amount of corporate bonds outstanding has almost doubled, hitting $9 trillion. And nearly $2.5 trillion of that figure is rated BBB, nearly triple the amount of 2008. This includes stalwarts such as G.E., AT&T, Campbell Soup, Bayer, CVS Health, Sherwin-Williams, IBM, and Keurig Dr. Pepper. The particular concern here is that it can be more difficult to manage or bail out corporate debt than sovereign debt.
Leveraged loan market: Collateralized debt obligations, or CDOs, were valued at $61 trillion globally in 2007, according to the Bank for International Settlements. Despite attempts to regulate this sector and avoid or limit the damage caused by these instruments in the financial crisis of 2008, the total leveraged loan market has since doubled, based on the S&P/LSTA Leveraged Loan Index. S&P Global stated that "risks attributable from this debt binge are significant.”
China: China had about $2 trillion total debt in 2000. Today, it’s about $40 trillion, an increase of 2,000% in less than 20 years.
The levels of debt reached in many areas of society are not realistically repayable, except in radically inflated currencies. Either way, any fallout from a debt event or crisis, or a return to QE efforts, would draw investors to gold.
There are also factors within the gold market itself that bear watching.
New Gold Supply: Decline Locked In
Mine depletion, geopolitical risks, start-up delays, and a lack of industry investment over the past several years all point to lower gold production levels going forward.
Pinched supplies of new gold stocks could impact the price.
There’s a related concern for the mining industry: due to falling ore grades, production costs will likely never return to where they were a decade ago. Production costs ultimately serve as a floor for gold prices.
Central Bank Buying: Trend to Remain Up?
Despite some gold sales from Venezuela and Turkey in 2018 to offset currency declines (one reason why gold is so valuable), central banks have been net buyers since 2008.
While central banks in North America and Western Europe are not adding to their gold reserves, strong demand continues to be seen from Asia, Russia, Eastern Europe, the Middle East, South America, and Africa.
Investment Demand: The Ultimate Indicator
While retail demand for bullion hit an 11-year low in 2018, global fund holdings (including e-funds and depositories) remained buoyant.
Investment is the biggest variable among all demand sources. According to a Legg Mason survey of over 16,000 investors globally, a growing percentage cited gold as the best investment opportunity over the next 12 months. Roughly a quarter of those polled in Germany, Italy, Switzerland and the UK identified gold as the best investment opportunity. In the UK gold was seen as better than equities, bonds, cash, and alternatives.
As investment goes, so does the price.
The Hard Asset Hedge
Gold holds a distinct advantage over most paper assets. Gold…
- Is the best-performing asset over the last 20 years
- Can hedge against systemic risk, stock market pullbacks, and inflation
- Is a store of wealth
- Improves the risk-adjusted returns of portfolios, while reducing losses
- Can provide liquidity to meet liabilities in times of market stress
An appropriate balance of gold in a portfolio can serve as a useful hedge, particularly as we face ongoing risks in geopolitics, markets, currencies, debt, and interest rates.
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