Since COVID-19 sent markets into free fall in March 2020, the level of government support globally has produced mounting debt. The size of the current debt piles in the UK have not been witnessed since World War II. The current macroeconomic outlook, with supply shocks, war, and heavy debt burdens has many worried about a stock market crash. These factors could create a lasting bull market for precious metals like gold and silver.
How financial crises are dealt with
During a financial crisis, once an economy enters a downturn, what typically happens is that the country’s central bank will reduce interest rates. This encourages the population to take on debt and spend more, and the economy recovers over the next few years.
As the economy recovers, the central bank can then raise interest rates again, in preparation for the next crisis. Then the cycle repeats. However, over recent years, central banks have not been able to raise interest rates to the same levels as before. As a result, we have experienced ever-lower interest rates.
Too much debt to handle
We are now in a debt trap, with global debt-to-GDP at 360%. As central banks raise interest rates, they increase the likelihood of causing a recession. This is because higher rates would hurt consumers, who will struggle to pay for other goods as their debt repayments rise.
However, because of the high inflation rates witnessed globally over the last year, central banks have no choice but to raise rates in order to reduce demand and tame inflation. This rise in rates is causing a collapse in the bond market and house prices already (due to higher mortgage rates), and stock markets are now following.
Perfect for precious metals
Generally, precious metals perform well when real rates are negative – this means when inflation is higher than interest rates, as is the case in western nations today. Since many of the issues involving inflation are on the supply side, central banks can do little to reduce it. The only option for central banks is to try and ‘thread the needle’ – that is, raise rates enough to limit demand, without tipping the economy into a recession. This will be extremely difficult to achieve.
During times of stagflation (slower growth and higher inflation), physical assets typically perform best, which could be seen in the last bout of stagflation in the 1970s. Corn prices nearly tripled. Wheat prices quadrupled. Does this sound familiar today? Gold was priced at $36.56 per ounce in 1970 and by late 1979, was over $400 per ounce. Silver performed even better, rising from less than $2 in 1970 to more than $30 at the end of 1979.
The benefits of precious metals in my portfolio are twofold: (i) they protect against currency debasement (or inflation) and do especially well during financial repression or stagflation; and (ii) they provide diversification benefits, as their performance tends to be uncorrelated to many other asset classes and does well when uncertainty arises in financial markets.
Due to the current macroeconomic uncertainty, I believe that precious metals are a good way to diversify my portfolio. Therefore, I am buying WisdomTree Physical Gold and WisdomTree Physical Silver for my portfolio.