Thursday, May 21, 2020

Demand to rise as global debt soars to unprecedented levels

NBHM Research Team

The price of gold has moved relatively sideways in the past thirty days as the market continued to focus on the reopening of the world economy. Investors have also been focusing on the actions of central banks including the Federal Reserve and the European Central Bank.

The world economy

A number of events have taken place affecting the world economy in the past month. The earnings season was relatively disappointing, with most companies missing their revenue and earnings per share (EPS) guidance. According to Factset, the second-quarter EPS estimates declined by a record 28.4% as companies continued to be affected by the coronavirus pandemic.

Economic data has been disappointing. In the United States, more than 33 million people have filed for unemployment benefits while the unemployment rate has soared to more than 14%. Similarly, retail sales, manufacturing and service activity, and the housing market have gone through their worst periods in recent years. The story has been the same in Europe, Asia, and in other emerging markets.

In response to these issues, central banks and governments have launched their biggest stimulus package in history. In the United States, congress has passed a stimulus package worth more than $2.6 trillion and there is chatter about another $3 trillion package. In Europe, the European Commission is discussing plans of a longer-term fund worth more than $1.2 trillion. Other governments have raised trillions of dollars to cushion their economies.

Equally, central banks have been as busy as ever. In the US, the Fed has been implementing an open-ended quantitative easing program, that has seen its balance sheet soar to more than $6 trillion. The ECB has removed the cap on its QE while the Bank of England is set to expand its asset purchases in the June meeting. Other countries like New Zealand, Australia, and Canada have implemented their own QE.

With monetary policy being stretched, there has been talk of negative interest rates in the United States. This idea has also been promoted by Donald Trump, who believes that negative rates would be a “gift” to Americans. While the Fed chair has said the bank is not considering negative rates, anything is possible in these extraordinary times.

Meanwhile, countries have started to reopen. In Europe, countries like France, Germany, and Italy have started easing the previous restrictions. A similar story is seen in China, New Zealand, and Australia. In the United States, several states have started doing the same. The obvious risk is that of a second wave of infections.

How gold fits in all this

Gold is not viewed as other “ordinary” commodities. It is viewed as a currency of the last resort. That is why most of the gold that is mined every year is bought by investors and central banks. Indeed, the biggest buyers of gold in the past few years were central banks in Russia and China.

Therefore, as the central banks “print” unlimited amount of money, most investors believe that it is a good thing for gold prices. Indeed, the price of gold reached its all-time high in 2011, when the Fed was implementing its first quantitative easing program.

Investors have been buying gold at a fast rate. According to Bloomberg, inflows into gold ETFs has been on an upward trend throughout the year as investors cushion their portfolios against perceived risks.

These investors are mostly worried about the debt that has been added to the global economy and the fact that the world economy is facing its worst recession since the Great Depression. For example, in the United States, the national debt has soared to more than $25 trillion. The debt could reach $28 trillion this year if congress passes the $3 trillion package being supported by the democrats. Add this to the trillions the Fed is adding to its balance sheet.

Japan is doing worse. The country, which was in a recession before the crisis, has added trillions of dollars of debt to its already stretched national debt. And, the BOJ balance sheet is now bigger than the Japanese economy itself.

In Europe, several important countries are currently strained. For example, Italy, which had problems before the crisis has continued to load more debt. Analysts believe that the next euro crisis is getting close.

The emerging markets are not doing well either. In a recent interview, Angel Gurria, of the OECD said that: “We are going to be heavy on the wing because we are trying to fly and we were already carrying a lot of debt and now we are adding more.”

The world economy will take a longer period to recover. Many analysts now believe that the world could have a U-shaped recovery. For example, while countries have started to reopen, most of them will not allow foreign travellers before quarantines. As a result, industries like airlines, hotels, and casinos will take more than a year to recover.

As such, many investors believe that gold – and Bitcoin – provide a good hiding place in a period of low growth. Peter Grosskopf, the CEO of Sprott told Barrons:

“There is too much debt at all levels. We have borrowed from the future, and there is not enough economy to pay it down. That equation requires much more financial repression going forward, and gold is a great hiding place from that process.”

Gold technical outlook

Gold outlook

Gold price is also bullish from a technical standpoint. A longer-term chart shows that gold price is in the midst of a cup and handle pattern, which suggests that the price may hit the all-time high in the near term. On the daily chart below, we see that the price has formed a bullish pedant pattern, which is usually a bullish continuation pattern.

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