Every investment portfolio should include a portion of “safe-haven” assets like gold as an investment to counter the riskier assets the portfolio may have. While many people saw stocks like Apple or banking stocks as “safe,” the first quarter of 2020 challenged the stock market and canceled out the gains the markets had so proudly shown since the beginning of the year. Many analysts were right when they warned that the market is overvalued, that a new bubble—more severe than the housing bubble of the Great Recession—built up and is ready to burst. With the ongoing pandemic and economic uncertainty, there is no sense of security for your assets.
With an economy in recession for an indefinite period of time, it is critical to re-evaluate and look for the best safe-haven asset that will increase in value while providing peace of mind to the investor having to deal with the recession’s effects on their portfolio and income. The question is therefore which safe-haven assets investors should seek in 2021. Will they look to the US dollar or US Treasuries, or will they choose precious metals and consider gold as an investment?
To answer that question, we must examine the likely flows of money in the economy for the next few years and determine where we are in the credit cycle.
The normal credit cycle
With its 10-year run, the current credit cycle is one of the longest in history. Typically, at the late stages of the cycle, money starts flowing from financial assets into the real economy, causing the real economy (home values, jobs) to improve. However, when the real economy improves, interest rates increase. We saw such a rate increase in 2018 when 10-year Treasury yields jumped from 1.385% to 3.227% over three months. The interest rate increase pushes stocks downwards. But in our current cycle, after many years of historic stock market gains such as our 10-year-long run, a severe and “historic” correction is expected. This is a “normal” credit cycle.
So, with the stock market expected to implode at some point in the near future, mainstream analysts assume the US Treasury market is the only safe haven. Can we take that for granted? Absolutely not.
There’s no “normal” anymore
After a major market crash—such as when the housing bubble burst and when the market dropped in March 2020—the Federal Reserve initiates a new round of money printing to stimulate the economy. Typically, that will start a new credit cycle. However, we are currently in a huge debt bubble—the largest global debt bubble ever—so we cannot assume the Fed will create US Treasury bonds from thin air, nor can we assume global central banks would buy US bonds like they did after the Great Recession of 2008.
Government debt is only credible if we assume the lender has confidence in the government’s ability to repay the debt and thus allows the borrower to roll the debt over in the form of a bond instead of asking the government to repay the debt. Twenty-seven trillion dollars! That’s the current US debt. Over $100 trillion dollars if you count Medicare, Medicaid, and Social Security.
Although no one believes this debt will ever be repaid, the assumption is still that it can always be rolled over and the Fed will be able to kick the “debt can” down the road, through the next cycle. While this may happen, it is more likely at this point that our current “debt can” is just too large since the debt-to-GDP ratio is at historical highs, and the global confidence in the US’s ability to roll over the debt will be nonexistent and thus will not allow the cycle to reset.
A replay of the 1970s?
The US went through a similar situation in the 1970s when President Nixon withdrew from the gold standard and the Fed started printing mountains of dollars. The confidence in the dollar was lost as the Fed failed to hold the economic system together. Towards the end of the decade, both stocks and bonds imploded while confidence in the dollar was lost, and gold took a massive jump from $35 to $850. Yes—when confidence in the US dollar disappeared, gold went up 25 times its value within just a few years.
The chart shows US debt over the past 60 years. Note how fast debt is growing compared to GDP. With the exponential growth in debt and with relatively low growth in GDP, loss of confidence in the US economy is right around the corner. This should be evident to all of us; yet, we keep on piling up debt and push the already unsustainable debt-to-GDP ratio to a breaking point.
This is where we are now. Interest rates have been kept artificially low since the Great Recession, but rate hikes are inevitable and will create a growing cost of servicing the debt, which cuts the available income we can use productively.
As a result of income dropping, future debt can only be serviced a) by increasing interest rates to satisfy lenders, which leads to a depression, or b) by engaging in massive printing of money, leading to hyperinflation and the destruction of the fabric of society.
The 1970s saw double-digit interest rates (over 21% at peak) to slow down the rapidly growing inflation. Treasury rates exceeded 12% to keep the consumption in check that was spurred by government spending and weak monetary discipline. But, the problems the Fed faced back then pale in comparison to the challenges of today—Federal debt then was just a few hundred billion dollars, nothing compared to the $27 trillion today.
To further put today’s debt in perspective: a 1% increase in interest rates will lead to $270 billion in additional government expenses! And our government’s debt is continuing to soar due to military excursions and aging baby boomers. US debt is expected to reach $50 trillion in about three decades.
So far, we’ve been able to get away with living beyond our means since China and Japan have eagerly bought US Treasuries. That began to change a decade ago, partly because of how US bankers treated foreign investors by selling them sub-prime mortgages as prime assets. And we’ll continue to see countries turn away US Treasuries. Just recently, Russia and China cut down their US Treasury holdings, and they are expected to continue doing so.
We’re at the breaking point
Today, the severe volatility in stocks is pushing us into a dangerous bear market. We have already seen that the Fed has lowered its interest rates, and they will continue to print money to keep the economy afloat—exactly like they did during the Great Recession. We must take into account that it will eventually become clear no one wants US Treasuries printed from thin air, at which point the Fed will create money so fast that other countries will abandon the once-trusted dollar. The result? Hyperinflation. This is where we’re headed.
We’re at a breaking point. Either the Fed can keep the dollar system from falling apart for another credit cycle, or the system itself shatters and forces us into a new global monetary regime.
The optimist in our economy will predict a “typical” recession, which will cause gold to mirror its behavior from one or even two decades ago, meaning gold prices will rise for several years (we saw a roughly 200% increase between 2008 and 2011). The pessimist (or, some might say, the realist) will expect a crash so hard the frantic counteractions of the Fed will cause the dollar to be replaced as the world’s reserve currency, making gold as an investment the only safe-haven asset and pricing it at levels beyond our wildest imagination.
Put simply: The dollar is becoming near worthless, setting gold to soar astronomically. Note that, either way, both the optimist and the pessimist will see huge gains in their portfolio by diversifying it with gold investing. In my many years in the financial industry, I have rarely seen an opportunity like there is in gold as an investment today.