Finance: Gold as a refuge from debt risk?

Gold remains one of the assets that has performed the best since the start of the year when compared to other traditional assets. There are several reasons which can explain this increase such as the fact that it is considered a safe haven for example. However, we are facing a regime change where several countries are gradually abandoning bonds and buying gold. This is where we will look together in more detail at the current situation.

Abandoning US bonds to buy gold?

Generally, bonds and gold are both considered safe assets. This is why in periods of geopolitical tensions, default risk or economic risk, there may be a tendency to move towards one of these assets. However, we are facing a special situation at the moment because there is a tendency to get rid of bonds and buy gold. From the table below, it can be seen that the central bank like China has gradually accumulated during 2022-2023:

And at the same time, we can see in the graph below a gradual reduction in China’s US bonds/treasury bills:

A less popular situation: fiscal dominance

We are in a new era, that of fiscal dominance. This means that monetary policy is dependent on fiscal policy. As the debt is high and the interest rates high, this implies a higher cost of servicing the debt. Therefore, even more bills and bonds must be issued to pay the interest. Here is a graph highlighting the acceleration of emissions in 2023-2024:

This situation should persist in the US since Congress estimates that the budget deficit should continue to be in a range of 5-7%. As the risk of default increases when debt increases, investors demand a higher yield to buy the bonds to compensate for the risk. As long as we have a lack of interest from investors (low demand), this puts pressure on keeping rates high. And as long as the bond yield is not sufficient enough, they will favor gold. In addition to this, the FED is not buying back the maturities of the bonds held on their balance sheet because we are still in a quantitative tightening. Therefore, this implies a significant offer.

Gold or bonds to fight inflation?

Both assets are considered secure assets. However, it is rather clear that the 2 assets are not equally sensitive to inflationary and deflationary environments. Bonds are generally not recommended in an inflationary environment but perform quite well in a deflationary environment. Here is an example in the table below:

Gold can perform equally well in an inflationary and deflationary environment even if the return is better under an inflationary regime. This is also what makes it unique, it can adapt to several environments. Here are the details of performance during periods of inflation and deflation for gold:

5 reasons to own gold

Gold is both a raw material used for various reasons such as jewelry but gold is also considered a safe haven. That is, it is used as an international currency for reserve purposes. Beyond the bond market, gold is one of the largest traditional markets. Therefore, the capitalization of gold is much higher than other assets. This can be seen in the graph below:

With such a capitalization, gold cannot be expected to generate similar performance to bitcoin. Moreover, the two assets still have different characteristics. However, gold demonstrates deep resilience across multiple decades, making it a good Source of diversification. Here are 5 good reasons to hold gold in your portfolio:

• Safe haven against geopolitical problems
• Reserve currency versus a currency that devalues ​​more quickly over time
• Gold supply remains limited
• Tangible value
• Gold allows you to diversify your portfolio

It can be inferred that there are several reasons to buy gold.

COSTCO, the gold rush for individuals

The popular large retail chain, Costco, has started selling physical gold online since August 2023. Costco stores are very popular in North America. Therefore, it is an additional sales channel for individuals to purchase physical gold. It seems that stocks are liquidated very quickly to the point of limiting the number of bars per person. So, sales are quite encouraging since Costco sells between 100 million and 200 million per month. However, the fact that store members can benefit from a 2% cashback, this has the effect of reducing profit compared to sales. The timing of Costco’s offer may also be an incentive given the global context with ever-increasing public debt and increasing geopolitical tensions.

The impact of China and the Middle East on gold

Gold is known to serve as a safe haven in times of geopolitical tensions. As we face several conflicts in the Middle East, it can be seen as a stable investment

The other event that could have an impact is the economic difficulties that China is facing. Faced with these difficulties, China has resumed money printing, which implies a decline in the local currency. The accumulation of gold by the Chinese central bank may be a form of protection. Secondly, the continued sharp decline in real estate pushed Chinese investors to head towards gold.

CONCLUSION

It turns out that gold is likely to be one of the most popular assets as we are in a new regime (fiscal dominance). This is also the case since we are in an environment where geopolitical tensions persist. When investors are satisfied with the yield of bonds relative to that of gold, there will be interest in bonds again.