Yes, physical gold is a safe haven, but gold also attracts a lot of speculative capital, particularly the paper markets. Gold futures are among the most traded futures in the world, and there is nothing physical about them. So when there is a panic, gold tends to sell off along with everything else as liquidity dries up and everyone rushes to cash.
The US dollar is actually the safe haven, except that it isn’t, because you are bleeding 7 or 8% of value every year to money supply growth.
I am getting so many messages at the moment asking me what to do “when the collapse comes”, as though the collapse of fiat is a foregone conclusion. I don’t think it is. I think continued depreciation is more likely. Fiat could collapse, of course, but we are in a probabilities game and I’d give it perhaps a 25% probability, while continued depreciation I’d put at well over 50% likelihood.
At present we have three financial storms on the horizon. Whether they actually reach us or not remains to be seen, but we should be aware of them nonetheless, so that we can be prepared if they do eventually close in.
Nasty stock market correction ahead?
They are, first, the fact that US markets are so leveraged to AI. You don’t even need the AI bubble to pop, you just need it to deflate a little bit, and it takes the S&P500 down with it.
It’s not like I, and many others besides, haven’t mentioned this before, but it bears mentioning again: the Magnificent Seven, which are highly AI oriented, currently account for about a third of the combined market capitalisation of the S&P’s 500 companies. Ten years ago the equivalent concentration was around 15%, and that seemed like a lot.
From an asset allocation perspective - particularly with so much passive investing - this is dangerous, to put it mildly. Concentration is fine when markets are going up. If you’re concentrated in the right sector you make a lot of money. But when things unravel you get your backside handed to you on a plate. Diversification spreads risk. The S&P500 “should” be diversified. It isn’t. Passive investing is supposed to be diversified. It isn’t.
But this has been the case for a long time. It hasn’t mattered. It doesn’t matter until it does.
Then there is the fact that every mid-term election year since 1962 has delivered an autumn - should I say fall? - drawdown.
1962: -12.3% (Kennedy)
1966: -18.2% (Johnson)
1970: -7.1% (Nixon)
1974: -28.6% (Ford)
1978: -9.3% (Carter)
1982: -27.1% (Reagan)
1986: -8.4% (Reagan)
1990: -18.2% (Bush)
1994: -9.3% (Clinton)
1998: -18.3% (Clinton)
2002: -21.1% (Bush)
2006: -6.9% (Bush)
2010: -16.0% (Obama)
2014: -11.2% (Obama)
2018: -21.2% (Trump)
2022: -16.9% (Biden)
The average is -16%. And not a single positive return.
If we get a 16% drawdown in the S&P500, the safehaven that is gold will sell off too.
Wobbly bonds
The second financial storm - is it even on the horizon any more? - lies in the government bond market. It’s worth remembering just how large the bond market is. The global value is estimated at around $145 trillion, so larger than the combined stock market which is closer to $130 trillion.
You have probably seen headlines this week saying bond markets are “on fire” and that governments are “in hock to the bond market”. Government debt across the developed world - and deficits with it - have risen dramatically since Covid, and the bond markets are not so willing to finance that borrowing at the ultra-low rates of the previous decade. Investors want more yield for their risk. Can’t say I blame them.
That basically translates as, “if I am to lend you money for ten years, you are going to have to pay me 5% interest, maybe more. 2% is no longer enough.”
As yields rise, the cost of servicing debt rises with them. Just a small increase can add tens of billions to annual interest payments.
The US has the enormous advantage of issuing the world’s reserve currency, but its huge structural deficits mean it is vulnerable. Japan, Britain, France and Italy are particularly at risk because they combine high debt burdens with fiscal or political problems.
Higher yields mean higher interest payments, which make deficits larger, requiring governments to issue still more debt. Vicious circle time. Governments try to avoid this by issuing shorter-term debt, but that merely increases refinancing exposure. The US Treasury’s increasing reliance on shorter maturities is therefore a concern.
Politicians might promise to spend more, but somebody has to buy their debt. If investors want a significantly higher return, governments may find that fiscal policy is increasingly dictated by the bond market rather than by politicians.
You may see that as a good thing and it probably is. Government spending has to be reined in somehow. But higher interest rates will put pressure on real estate and equities, and they increase the likelihood of defaults, which tend to snowball. See 2008 for more details.
Defaults should also increase demand for gold, because there is no liability or counterparty. But that doesn’t happen straight away, necessarily. The liquidity has to come out of the market first, and that means everything goes lower. Just gold doesn’t go down quite as much and it turns back up first.
The reaction of governments to a debt crisis will of course be to print. And that too benefits gold.
Which brings us to financial storm number three on the horizon, although this one is really a subset of two.
The UK. It is a standout amongst all of this. Our interest rates are already high, which means greater pressure on the government (they are the main reason sterling has held up). We have a new Prime Minister, who is currently trying to buy popularity and who seems to think that the solution to many of the UK’s problems is more government spending, not less, and that will require more borrowing and higher taxes. But he has inherited a precarious fiscal position and a bond market that is already demanding a substantial return. Ten-year gilt e yields have risen above 5%, their highest level in 18 years, and longer-term borrowing costs have reached a 28-year high, with 30-year gilt yields closing down on 6%.
The political situation is also awkward. The combined right-wing vote exceeds the Labour vote by some considerable distance, but it is split between the Tories, Reform and Restore. Does Burnham exploit this to call an early election? Will his backbenchers even let him if he wants to do this? Will an early election mean greater or less stability?
On the other hand high rates are at least propping sterling up. I say propping up. On a purchasing power parity basis, the UK is actually cheap and sterling too. Doesn’t mean it can’t get cheaper.
As UK nationals, we have inevitable exposure to sterling, but the prudent thing for a UK citizen to do is reduce sterling exposure. Hold non-government currencies is my advice: gold and bitcoin. I’ll have more on the la tter soon.
BOLD.L might be the way.
Most roads lead to gold at the moment but they are rocky roads.
If you live in a third world country such as the UK, I urge you to own gold or silver. The pound will be further devalued, as will the euro and dollar. The bullion dealer I use and recommend is The Pure Gold Company. They deliver to the UK, the US, Canada and Europe. More here.
Other matters
I have turned my Britain On Sale series of seven undervalued companies that could be taken out during the current takeover frenzy into a downloadable PDF report. Here it is.
There is a real opportunity here right here and now. I cannot stress that enough. The UK is cheap and being bought up.
And last but not least, The Secret History of Gold is now out in paperback in the UK, so get your copy now. It has had excellent reviews and has now reached best seller status, I’m delighted to report, with the audiobook especially popular.
