2023-10-11 19:06:48 ET
Summary
- US debt crisis threatens government shutdown or default.
- Bond selloff and rising interest rates indicate a likely recession.
- Gold prices expected to soar due to coming monetary easing and inflation, making it a good investment option.
Ray Dalio predicts doom and gloom for the US economy thanks to the mounting debt load. The country's debt levels surpassed $33 trillion for the first time last month. My fellow Seeking Alpha contributor wrote a very well-thought-out article on portfolio protection if the debt crisis really comes. But the main focus of my fellow analyst's article is on high-yield investments. However, gold is traditionally considered to be one of the best assets to buy during hard times. I have also been highly bullish on the yellow metal for a while. Let me explain the economic situation, the reasons to be a gold bug, and here's why I think GLD is a good way to play this.
My previous coverage
As I have mentioned in another article on gold that was published this summer, gold should cost $4000 per ounce. I have not changed my mind. I came up with this price estimate for the following reasons:
- The Dow-to-gold ratio shows the Dow Jones index is too expensive compared to the gold price.
- The liquidity levels are record-breaking in spite of the multi-decade high interest rates.
- The Fed's balance sheet. The fact that it is so high means it holds a large amount of securities, thus allowing record liquidity levels.
Dow Jones index is still too high compared to gold, while liquidity levels have not decreased by much. So, my thesis remains intact. As I have mentioned in my other articles on gold, America is clearly in a debt crisis. The cost of servicing US debt has surged substantially, which is yet another strain on the country's budget. I mentioned before that America has a big advantage over other countries because the USD has the status of the world's reserve currency. That is why it can print more money without creating hyperinflation straight away. But still, the situation with the rising interest rates and the ever-growing budget deficit cannot last forever. That is why America has been facing the threat of a government shutdown or even default for a couple of years. The Congress has therefore been forced to extend the debt threshold for a while. However, political discussions on the subject have been quite intense. Obviously, a failure to reach an agreement may lead to a shutdown or a default. My thesis is still unchanged. The problem I explained earlier on, is really pressing now as I am writing this.
Current US debt crisis
According to the US Treasury, the US government is spending more to pay interest on its $33 trillion debt than it does on national defense. In the current fiscal year through August, $807.84 billion in interest was spent on paying interest vs. $695.44 billion in military expenses for the same time period.
The problem is not new, by all means. The US gross federal debt exceeded the country's GDP more than ten years ago, soon after the global financial crisis. The debt-to-GDP ratio stabilized somewhat but the global pandemic and the resulting economic crisis changed the whole thing. In April this year, the debt totaled 120% of the GDP. The government's failure to change the situation may make matters even worse.
The need to service a higher debt at higher interest rates will paradoxically force the Fed to resume the quantitative easing (QE) program to print more money. The US budget is struggling to meet the interest payments. In order to be able to do so, more money supply is needed. This will obviously contribute to the rising liquidity in the US economy, lower rates, and higher inflation readings. All this is highly bullish for gold.
Bond selloff and a likely recession
There was a dramatic bond selloff in the last several days. The yields have risen to multi-year highs and so have the interest rates. Many experts believe the selloff is threatening hopes for a soft landing for the US economy. That is because investors expect the borrowing costs to remain high for a longer time period. At the same time, as I have mentioned above, the federal deficit is widening. The fall in the value of the 10-year bonds has totaled 46% compared to the March 2020 levels. This can only be compared to the 49% decrease in the value of US stocks during the Dot.com crisis.
Investing Group Leader Lawrence Fuller says that bond panic-selling does not have anything to do with macroeconomic fundamentals. According to the expert, "It has everything to do with misguided rhetoric from Fed officials who assert short-term rates may need to stay higher for longer to squash inflation. Therefore, any incoming economic data that is stronger than expected fuels fears of higher for longer."
Basically, the borrowing costs are extremely high right now. This does not only apply to 10-year and 30-year Treasurys but also to the mortgage rates. The mortgage rates now stand at about 7.5% per annum, the highest since 2001-2003.
Obviously, this is not good for the economy. Many assets are likely to depreciate in the near future, including most obviously the property market. But the overall consumer sentiment will also get much worse should the situation last. The unemployment data will eventually be affected.
All this may force the Fed to ease the monetary policies to avoid the economic collapse. But if the Fed does not react appropriately sooner rather than later, then there might well be a long-lasting recession. Monetary easing will be necessary in this situation. Obviously, this is bullish for gold.
Gold prices will soar
We all know that there is a strong negative correlation between the gold prices and the interest rates. Lastly, the gold prices have fallen somewhat. But still, in my opinion, they are quite strong, given the record-breaking interest rates.
This can be clearly seen from the diagram below. Between 2019 and 2020 the real interest rates kept falling, whilst the gold prices were rising. Then, since 2022 the rates have been increasing at a very steady pace, whereas the prices of the precious metal have been relatively stable and only fluctuating within the $1,600 - $2,050 per ounce range.
Also worth noting is that the last cycle of rate hikes was the most substantial one in the last two decades.
But the rate hikes will eventually end. So, in my view, the gold prices should start surging. GLD investors will obviously benefit too. The only question is when this will happen.
Inflation readings are still not at the Fed's 2% target, so Powell is open to one more potential rate hike this year. The FOMC will hold another meeting in November. According to Powell , "the process of getting inflation sustainably down to 2% has a long way to go" . The last reported CPI number was 3.7% . This is not an all-time low, and it is surely above the much-desired 2% target. But it is still substantially lower than the numbers reported in 2022. At the time CPI even exceeded 8%. So, it looks like the US inflation numbers are going in the right direction. However, everything can change all of a sudden. For example, the oil prices can surge, thus making the CPI readings rise as well.
Anyway, one more rate hike will likely happen this year. There is much guesswork to say how many rate hikes will happen next year. But all of a sudden, the economic statistics, most importantly the employment numbers can start deteriorating. The Fed cannot hike the rates forever without eventually provoking a recession. There is plenty of guesswork to be done but it might happen as early as next year. I will explain exactly how I will monitor the macroeconomic indicators later on in this article. In my view, everything depends on them.
Ways to invest in gold
This article focuses on GLD ETF as a really good way to benefit from rising gold prices. At the same time, I have always advocated buying a physical gold bullion . Like this investors are not relying on any business the way they would if they invest in shares of a gold-mining company. They do not have to rely on any exchange rates the way they would if they buy ETFs and any other related gold products. For example, if European investors buy and then sell a share in a US ETF, they may have to convert their USDs into Euros. In this case the USD/EUR rate matters. But most importantly if there is a market panic and the demand for real gold surges, physical gold investors can sell their own precious metal. However, a share in a gold ETF cannot be directly exchanged for any physical metal. In other words, when you redeem your gold ETF, you do not get physical gold, but receive the cash equivalent instead.
Gold futures are suitable only if you invest for the short - to medium-term and if you are sure the gold prices will rise in the next several months. Otherwise, they are not appropriate.
Mining stocks need some very careful research. Before investing, you have to carefully check the company you invest in, including its balance sheet, profitability, and dividends.
If you invest in ETFs that own mining stocks, you are spreading the risks but you do not invest directly into gold.
The same is true if you invest in gold ETFs. You are not directly buying physical gold. At the same time, you get some very strong correlation with the gold prices. Plus, you do not have to pay any insurance and storage costs. This is the only disadvantage of owning gold bullion.
I have only included two ETFs. The first one charges the lowest fees. The second one has been existing for the longest time period. It is possible to make a big profit, whilst buying leveraged ETFs. But they carry too much risk. So, I decided not to include them.
Its expense ratio is only 0.09%. One of its main advantages is that it is structured as a true ETF because its only holding is gold bullion. However, it was only established on 15 June 2021, whilst its assets under management are lower than $1 billion. This suggests that the ETF is not very large and cannot boast a long history of operation.
- The most Liquid Gold ETF is SPDR Gold Trust ( GLD ).
Its assets under management total a whopping $58.5 billion. GLD has been existing since 18 November 2004 The expense ratio of GLD is only 0.40%. The three-month average daily volume as of 6 October is 6.774M.
GLD tracks the LBMA Gold Price as a benchmark. The ETF aims to reflect the price of gold bullion. SPDR Gold Trust is the most popular and oldest gold ETF. It is listed on the Hong Kong Stock Exchange and can be easily traded throughout the day. SPDR Gold shares represent fractional interests in the SPDR Gold Trust and can be traded as ordinary stocks. The Trust's primary asset is allocated gold. The price, holdings and net asset value can be easily monitored on the ETF's website . But the most important advantage of GLD is its liquidity, in my opinion. The structure allows for shares to be created and redeemed according to the current market demand.
My thesis on GLD is still unchanged because I have recommended buying GLD as a fair alternative before. I still prefer physical metals but GLD might be a good option for investors who do not want to pay insurance and storage fees. The reason why I prefer GLD over other ETFs, including IAUM, is because of GLD's reasonably long history. Other ETFs have been existing for much less time. It also has the largest amount of assets under management. Therefore, it is the largest and the best-established ETF in the US. As a conservative investor, I prefer size and reliability over low commissions.
Risks
The risks are obvious. The most important one is centered around timing. Some investors might want an immediate price surge of the commodity, which might not happen. The most important reason for this is the Fed's hawkishness. But " this too shall pass ". Eventually, all central banks would have to stop tightening and start easing their monetary policies. Moreover, even now when the interest rates are near their multi-decade highs, the gold prices show relative resilience.
At the same time, a market sell-off will eventually come. This will make the USD surge to new all-time highs, whilst all the other assets, including gold, will depreciate. But after a sell-off, the gold prices may surge to new all-time highs.
I will be carefully monitoring the inflation data, the unemployment statistics as well as any economic and political shocks. The first two macroeconomic indicators are vital for the Fed to decide on its monetary policies. In particular, I would watch for the non-farm payrolls and the unemployment rate. These indicators are most closely monitored by investors because they reflect the general employment situation in the US and also the job growth in this country. As concerns the inflation data, I would look at the CPI index as well as the core CPI (CPI minus food and fuel). These statistics show just how much more expensive life has got for ordinary consumers. Obviously, if the unemployment statistics still suggest the labor market is strong, whilst the inflation numbers do not increase substantially, then there is a risk of the Fed's tightening and an immediate recession.
But any political and economic news can also affect the US economic statistics. Moreover, investors tend to seek a safe haven when there are any unexpected events. So, if something unpredictable happens, some market participants might rush to buy gold, thus pushing the prices upwards.
Conclusion
Gold is not the most popular asset right now. Only smart investors like central banks seem to be buying the precious metal right now. The prices have recently corrected a bit but still show relative resistance, given the sky-high interest rates. This could be a good opportunity to buy gold. My preferred way of investing in it is physical gold bullion but GLD, the largest ETF is a very good way to do so too.
For further details see:
Hard Times Are Coming So Buy GLD