The Impact of Global Stimulus and Looming Inflation on the Precious Metals Market

Jon Deane
Updated: Jul 17, 2020, 06:15 GMT+00:00

A global recession is clearly underway at this point. But worse still is the looming potential of stagflation.

Mounting global debt — both sovereign and corporate — accentuated by life-preserving stimulus packages and rock bottom interest rates could eventually lead to a general hike in the price of goods and services coupled with negative growth. But while this prospect holds grave consequences for the health of the economy, it’s likely a boon for the precious metals markets.

The next global recession will have no brakes.

That was the word of the World Economic Forum (WEF) back in October 2019. In its annual Global Competitiveness Report, the WEF warned that while a looming recession wouldn’t be “as severe as the Great Recession of 2008–2009,” policymakers have fewer options now than they did back then. In other words, there’s no safety net this time around.

In the time since the WEF sounded the alarm, global debt has run up a tab close to levels witnessed during the Second World War. In the US alone, national debt surpassed $26 trillion in May — up $1 trillion from a month prior. In the main, this mounting debt is a symptom of covid stimulus packages, of which the US has rolled out approximately $3 trillion to date. To make matters worse, unemployment is rapidly escalating — necessitating further relief.

If we look back 30 years, we’ve gone through ebbs and flows of leverage going into the sovereign balance sheets. In my opinion, along much the same lines as that of the WEF, we’ve been pushing toward a situation that leaves fewer levers to curb a recession, and, in turn, inflation. Our ability to control the next economic cycle with monetary/ fiscal/ economic policy is becoming increasingly limited.

Turning to Gold

Not only is gold seen as a store of value during times of economic chaos, but it’s also historically used as a hedge against the kinds of inflation we’re likely to soon face.

During the 1970s, costs and services in the US more than doubled amid crippling inflation. At the same time, gold prices went almost vertical—rising by an almost inconceivable 950%. Moreover, gold’s parabolic run was realized in terms of both nominal price rise and inflation-adjusted standards.

Not only did gold establish itself as a reliable way to hedge against severe inflation, but it also exceeded expectations as a fundamentally sound investment.

Gold’s finite supply and resistance to government intervention contrast dramatically with unabated global money printing and stimulus—something that could speed up the rate of inflation.

In May shortly after the US federal reserve committed to buying bond exchange traded funds (ETFs) for the first time ever, the price of gold rose by nearly 1%. As usual the more stimulus being pumped into the market the greater the effect on gold, and it’s clear the fed isn’t done deploying the helicopter money just yet.

As cases of coronavirus spike across America, further stimulus looks like a surefire bet. With lawmakers scrambling to negotiate another package before the month-long recess in August, it’s fair to assume that gold prices will continue to rise.

Fortunately, there’s already a precedent set on the stimulus impact on the precious metal market. The trillions that flooded the market back in April were responsible for piling gold to a 7-year high. The money had to go somewhere and thanks to the trickle-down effect of stimulus—especially amid a pending economic catastrophe—most of it went to the safest asset of them all: gold.

Why? Because, as noted, precious metals are a unique way to protect against potential inflation. That’s not to say that inflation is coming back today. But, we are seeing many more investors allocating to the market as speculation around inflation and further macro risk bubbles to the surface.

On top of this, contrary to reason, stimulus measures are also responsible for accelerating the global wealth divide. To put it another way, the rich are getting richer and the poor are getting poorer.

While the governmental responses to the crisis have been praised, they are likely widening income inequalities. Wall Street sits on sturdy stabilizers, receiving tax benefits that are unlikely to run out any time soon. By contrast, measures brought in to aid the low/middle class are reaching the end of the road. Coupled with inflation and high rates of employment, this issue looks only to worsen the global economy—creating a perfect storm for stagflation; a storm that gold can weather very well.

As a result of economic fallout, we’re seeing a large number of investment banks and private banks putting out recommendations to add gold to one’s portfolio. It’s not quite filtered through to retail or high net worths yet, but, on a break high, I would expect they’ll be looking to follow once more institutional investors have increased their position.

Is Inflation Already Here?

To some extent, we’re already seeing inflation through asset inflation. The amount of stimulus we’ve seen through both monetary and fiscal has created a significant move high in underlying assets. If we look at equities, for example, their performance under zero to negative rates shows a considerable contrast to pre-rate cut performance. In real terms, this could push headline inflation to rise as well. With interest rates encouraging purchases of assets such as real estate—farmland, for example—returns could be substantial. The cause and effect of this is a boost to the underlying product to higher levels, with inflation filtering through as a result.

Beyond inflation sits an even more prevalent risk: market instability. The stock market, propped up by infinite stimulus, presents a false narrative when it comes to market stability. However, as discussed, monetary policy can only stretch so far. Lackluster global responses to the pandemic, and the threat of a second peak, could very well shake up market volatility. Other macro risks such as Hong Kong’s new “far-reaching” securities law similarly look to add fuel to the fire. The administrative region’s status as one of the world’s foremost financial hubs could soon change.

As ever, gold positions itself as a safe haven amid such macro risks, enabling investors to bunker down and ride out the storm.

In essence, in any form of an inflationary environment, gold has a proven track record as a defensive asset. And being able to have some sort of exposure to a hard asset that isn’t jeopardized by economic conditions can have a beneficial impact on an investor’s portfolio.

For a look at all of today’s economic events, check out our economic calendar.

About the Author

Jon Deanecontributor

Jon Deane is CEO of InfiniGold, technology partner to The Perth Mint who have digitalised their gold reserves via the GoldPass app and Perth Mint Gold Token (PMGT)

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