The Race to Negative Interest Rates – Gold and The Global Economy

I usually wake up at 5:30am each day.

It’s not always easy, especially during a Melbourne winter. But with two little girls, having an hour or two of quiet time first thing in the morning to read and write, makes the early start worthwhile.

Unfortunately, the body clock can’t work out when the weekend hits, so I still usually wake up early without the alarm on the weekend.

On Saturday, I ‘slept in’ until 6am. I got up, made a coffee, and went into my home office. I picked up the 28 June issue of Grant’s Interest rate Observer, and started to read…

There are very few issues of Grant’s that disappoint. Jim Grant has been writing it since 1982, if memory serves. This one was a cracker. It kicked off with…

As Grant’s goes to press, almost $13 trillion of debt worldwide is priced to yield less than nothing. Mostly, it’s just a little less than nothing, but, still, even a little less than nothing isn’t much to retire on…

That it is extraordinary, and that it will, finally, stop, we take as a given. In 1752, the Scottish philosopher David Hume wrote, “No man will accept of low profits, were he can have high interest, and no man will accept of low interest, where he can have high profits.” The juxtaposition of 4,000-year-low bond yields with high profits thus constitutes a finance offense against nature.

Indeed it does. But that is the hand you’ve been dealt. The question is, how do you play it?

There are probably 100 answers to that question. And depending on the timing, all of them will contain some truth. You can ‘dance while the music is still playing’ and do well, ignorant of the risks you’re taking. Or you can sit in cash, all too aware of the risks and watch your purchasing power (in terms of assets) disappear.

My answer is the only honest one I can give: I don’t know. To say we’re in unchartered waters is a cliché that doesn’t do justice to the monetary absurdity we are living through.

For us in Australia, we’ve previously viewed this absurdity from afar. Now we’re living it. Our central bankers are just as malevolent as the rest of them.

But let’s not talk in the abstract. Let me give you some numbers, courtesy of Jim Grant.

According to Bloomberg, the world labors under $244 trillion of debt (across the balance sheet from which, to be sure, are $244 trillion in assets of one kind or another). Global equities foot to $72 trillion, gold sums to $8.7 trillion. We interpret the breakout in gold as an early return in a worldwide plebiscite. “Do you trust the money and the central bankers who manage it?” is the question. “Less than we did,” is the way we read the preliminary polling.

Debt, Equity and Gold in relation to Global Economy

$244 trillion in debt…

$72 trillion in equity…

And just $8.7 trillion in gold…

What do these numbers mean? Do they mean anything at all?

Well, the first two tell you why the world is in such a mess, and the third one holds the key to fixing it.

If you think of the world as a balance sheet, on these numbers we have a net debt to equity ratio of 225%. ($244 trillion in debt minus $8.7 trillion in ‘cash’, gives net debt of $235.3 trillion.)

If it were a cyclical industrial stock, you’d have grave fears about investing in it.

But here’s the thing to remember about highly leveraged companies: At the right part of the cycle, they can be very lucrative investments.

That is, when things are going well, the equity holders do exceptionally well. That’s especially the case when debt costs are so low, as they are now. If the assets of the company are generating good returns, the debt holders are paid their measly interest, and the equity holders get the rest.

That’s why, during this global economic expansion cycle, stock (or equity) markets have done so well. The leverage has worked in its favour.

But what happens when the cycle turns?

Leverage works the other way. And given the highly leveraged nature of the global economy, it could get ugly in the down phase.

As far as I can tell, the cycle is now in the process of turning. And central banks are once again trying to stop it. Will they succeed?

Not without unintended consequences, is my answer.

This is where gold comes into it…

How do you repair an overleveraged balance sheet?

You either sell off assets to pay down debt, or do a capital raising to increase equity.

The global economy can’t sell assets to itself. It just ends up on the same balance sheet. So that leaves an equity raising as the only option.

But what does that look like?

It looks like a re-pricing of gold, that’s what.

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Gold to the Rescue

If gold were five-times the price it is now, the value of the global gold stock (based on the number I quoted above) would be $43.5 trillion. In that case, global net debt to equity would be around 180%.

At 10-times the current price of gold, global gearing levels would fall to around 120%, which is much more manageable than what we have now.

With that in mind, perhaps you can see why global central bank gold purchases were at the highest level in 50 years in 2018, and why, in 2019, they are running around 70% above 2018 levels.

Higher gold prices improve central banks’ balance sheets. It’s as simple as that.

I’m not saying gold will rise 10-fold, I have no idea how it will all work out. But the recent breakout in the US dollar gold price is telling you something. It’s telling you that the cycle is turning down, which makes the highly leveraged nature of the global economy very vulnerable.

In such times, gold is a place of refuge. Always has been. And I expect it will be again. But gold in Aussie dollars is already at record highs. Aussie investors therefore need to play it a little differently.

To find out how, please check out my special report, which gives details on the five best ways to take advantage of the global gold bull.


Greg Canavan,
Editor, The Rum Rebellion

PS: Two Aussie Gold Stocks to Watch in 2019 – Download Your Free Report Now

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.

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