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LAWRIE WILLIAMS: Gold, equities and COVID-19 – a potentially apocalyptic scenario?

Quite frankly we are a little puzzled by the lack, so far, of a severely adverse reaction by global equities to the worst downturns – perhaps for hundreds of years – in global economies and why precious metals, primarily gold, have remained relatively price-static so far.  All past logic suggests markets should be crashing and gold soaring, but this doesn’t seem to be the case – at least not yet.  Will this all change?  Over time we think it will but it is certainly taking longer to come about than we had anticipated.

For example the following questions are highlighted in Grant Williams’ latest Things that make you go hmm... newsletter which follows the general theme of there being more unanswered, or unanswerable,  questions than sensible, or satisfactory, answers:

  • Why are markets rallying when the data is so universally appalling?
  • Why the hell are markets rallying so hard?
  • Given the unemployment and economic activity during The Great Depression, what does last week’s unemployment print at 14.7% mean for today’s markets?
  • Why doesn’t the market seem to care about economic fundamentals anymore?
  • Will economic fundamentals ever matter to the markets again?
  • Does a sharp fall in consumer borrowing not matter?
  • Is a huge fall in credit card debt similarly inconsequential?
  • Is the decline in global manufacturing not worth worrying about?
  • Why are equity and bond markets sending different signals and which is correct?
  • Will stocks catch down to earnings or will earnings catch up to stocks?
  • Is this strange disconnect idiosyncratic to U.S. markets?
  • Are central banks more powerful than governments, judicial bodies and, especially, market forces?
  • WWWD? (What would Warren do?)
  • Will any of this matter?

To these we might add our own perhaps unanswerable precious metals-specific questions as follows:

  • Why is the gold price not booming given the parlous state of the global economy?
  • When will the gold:silver ratio come down to historical levels – if ever?
  • Will we see a mega-correction in PGM prices?
  • Where will the gold price be in 1, 2, 5 or even 10 year’s time?

Grant ends his question list with the following note: “By the time the answers to the questions I’ve posed this week are known by everyone, it’ll be too late to do anything about them, so be sure to keep asking them. The sooner you can find the answers, the farther ahead you’re going to be.”

While Grant describes his listing as unanswered questions – at least by himself – he does intersperse most of them with comments from ‘expert’ sources which try to make sense of some of them.  But to this writer some parallels with the Great Depression are perhaps the most relevant to the current economic situation.  The Great Depression which saw Wall Street prices fall to such an extent that they only managed to regain their 1929 highs by the early 1950s is only matched – possibly even exceeded – by the current COVID-19-inspired global economic meltdown.  And the virus effects on the global economy could well drag on for several more years, dependent on how long the pandemic effects persist.  It has not yet really impacted the so-called Third World and this sector is perhaps less well equipped to cope with it than the most highly advanced economies which it has primarily struck to date.

One potential parallel which is well worth pointing out was specifically noted in the TTMYGH newsletter.  It noted that the Dow Jones Industrial Index lost over half its value in its initial fall in late 1929 – the first Wall Street Crash – but then it rallied by 44% over the following four month period and saw unwary investors flood back into the equities markets picking up what they saw as stock bargains. But from its rebound high, in March 1930, the Dow then fell back some 86% over the next two years before bottoming in June 1932. Could history be repeating itself here?

It is also perhaps worth noting that Warren Buffett, probably consistently the smartest investor of the current time, after seeing several major buying opportunities in the 2008/9 Great Financial Crisis, which proved to be a very smart move, has publicly stated that he is sitting this latest downturn out given its likely prolonged duration.  As one observer of the latest Berkshire Hathaway annual junket noted, Buffett seems to think we are in for a generational bear market.  He may yet invest, but only when hedge funds and institutions start unloading stocks at hugely depressed prices down the road.  Meanwhile his company will be sitting on its enormous cash pile, thought to be around $130 billion, until he sees an end to the likely bear market – if he lasts that long – he is 89 years old after all!

As to precious metals, back in the 1930s U.S. held gold was confiscated, and then revalued, as an aid towards reducing U.S. debt and supporting the dollar and the ability of the US Federal Reserve to increase the money supply during the Great Depression.  (The Federal Reserve Act (1913) required 40% gold backing of Federal Reserve Notes issued. By the late 1920s, the Federal Reserve had almost hit the limit of allowable credit [in the form of Federal Reserve demand notes] that could be backed by the gold in its possession, notes Wikipedia.)  We doubt this kind of procedure could be re-enacted today, but it does also demonstrate the role gold has played over the years as a currency backing of last resort.  Since 1971, when President Nixon took the American dollar away from its gold backing, gold no longer fulfils this particular role, but remains in the eyes of many around the world as the ultimate safe haven investment.

What this should mean is that as the economy is seen to deteriorate further, and successive unemployment statistics and Q2 economic forecasts suggest the economy is moving ever further into recession/depression, gold should start to come into its own as the currency of last resort.  This should start to happen this year, although price rises could yet be suppressed by the big money which could have an alternative motivation tied to enormous potential losses if their short positions in the precious metals ever have to be reconciled.  Gambling with money they didn’t actually have was the downfall of so many in the Great Depression years and the same could be coming true now.

Central banks are fighting an ever-continuing battle to try and soften the potential blow for investors.  But they could prove to be as unsuccessful in this long term as King Canute's possibly apocryphal attempt to turn back the tide!

If the pattern seen in the Great Depression is repeated we should see the period of reckoning begin in the late northern hemisphere summer, after the likely horrendous Q2 figures become apparent.  The financial fall-out could be apocalyptic as could the dawning of the realisation that there will be no quick or easy recovery.  The time for stock bargain hunting may yet be a long time away.  Safe haven investments like gold could come to the fore, assuming investors have any money left with which to protect themselves and their families.  As we’ve said before we hope this terrible scenario does not play out to the extent we're contemplating here, but it is wise to be prepared in case it does.

12 May 2020 | Categories: Gold

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