Will Gold Survive the Coming Debt Defaults?

Let’s talk commodities

Brent crude, the international benchmark, is trading higher at US$50.36 per barrel. It’s up 81% from the low of US$27.83 per barrel on 20 January.

West Texas Intermediate (WTI), also known as US crude, is trading higher at US$49.74 per barrel. It’s up 91% from the low of US$26.05 per barrel on 2 February. When crude was trading at roughly US$50 per barrel on 6 June, I warned that it wasn’t as strong as it appeared. After closing at a 2016 high of US$52 per barrel on 9 June, it’s down almost 4.5%.

Last week, after surging to a high of US$1,315.48 per ounce, gold edged lower on Friday.

Overall, gold has rallied this month on the back of a poor US jobs report and a dovish US Federal Reserve, which kept interest rates unchanged.

The question is: can it move higher into next month?

Anything is possible. But to suggest a further rally, gold must close above last week’s high on Friday. It’s trading at US$1,287 per ounce today, and there’s significant resistance around the US$1,323 per ounce level. This may prove challenging for the yellow metal.

Will history repeat?
Do you remember the Global Financial Crisis of 2008/09? Having successfully traded those volatile times, I recall it clearly.

Something that sticks out in my mind was gold and gold stocks. When plenty of ‘experts’ were calling for the next Great Depression, they crashed. I was shocked, wondering how these ‘experts’ could be so wrong!

It seems like a distant memory today…

Following trillions of dollars of central bank intervention, negative interest rates and rising debt levels, everyone says this time is different. But, is it really?

Assuming we’re facing another Great Depression, why would gold — and gold stocks — rally into the crisis?

Remember, unlike during the Great Depression, gold is not money today — it’s an asset. I analysed the Great Depression in Resource Speculator in late February/ early March. I explained why I believe that we’re facing another bubble in bonds today, and why gold isn’t as ‘precious’ as gold bugs claim.

If you didn’t know, gold has crashed during nearly every financial crisis since 1971. Despite the countless number of bullish arguments and billionaires buying gold, I expect the good days for gold — and gold stocks — are numbered.

Dark days ahead
With a raft of defaults looming, dark days are ahead for gold bugs. Bloomberg explains,

The job market is grim on Wall Street. Trading desks are shrinking, hiring is flat, even incentive pay is taking a hit. Except in one little corner of the financial world, where managers can’t read resumes fast enough.

The turnaround expert is in hot demand.

With company after company in oil, coal, retail and other industries in distress — the Bloomberg Bankruptcy Index is at a six-year high — business is booming. Banks are assembling or expanding teams, with Lazard, Guggenheim Partners, Perella Weinberg Partners and AlixPartners all hiring, often within a circle of familiar faces. Lazard’s global restructuring head, David Kurtz, just tapped Ken Ziman of Skadden Arps Slate Meagher & Flom; they worked on Millennium Health’s bankruptcy last year. Durc Savini, who’d headed Peter J. Solomon’s restructuring group, recently joined Guggenheim.

Corporate restructuring is booming — which isn’t a good sign, unless you happen to work in that small niche.

It’s not surprising. The number of US bankruptcies in recent months has skyrocketed. You can see this on the chart below.

Click to enlarge

If you’re not prepared for a major financial crisis — and perhaps the biggest of all time — you should get worried. Remember, we’re not even halfway though this year, and the defaults are already at historic highs. Bloomberg continues,

Energy companies made up 80 percent of corporate bankruptcy cases last year, according to data compiled by Bloomberg, tracking companies with more than $500 million of debt. In the past 12 months, a total of 56 companies filed for Chapter 11 bankruptcy with a combined $146 billion in debt, the data show.

During the worst of the rout earlier this year, “if you stayed in Houston’s St. Regis, you ran into everybody in the restructuring business,” says William Snyder, national leader restructuring at Deloitte Transactions and Business Analytics. “People are hanging out in the lobby, baggy eyed, coffee in hand.”

The specialists anticipate opportunities far afield from commodities. “Retail, for-profit education and power companies are among areas that need more turnaround help,” says Lisa Donahue, global leader of turnaround and restructuring at AlixPartners.

Moody’s Investors Service showed energy remains as one of the most distressed industries in its May report. In the next 12 months, Moody’s expects a 10.3% default rate across the energy sector. Moody’s believes this should ‘spill over’ into other sectors, such as metals and mining, durable consumer goods and retailers. You can see this on the chart below:

Click to enlarge

When the defaults start to pile up, do you really think gold stocks will surge higher? If you do, I suggest reviewing some history. It shows something totally different.

Reviewing this week’s events
Before I close, as you probably know, it’s a massive week for financial markets, and much of it will strongly affect gold. To start, we have a Britain’s referendum on its EU membership this Thursday.

Despite the jaw-banging by clueless politicians and a countless number of celebrities who don’t know anything about economics, the Brits would be wise to vote ‘no’. A no vote may indicate the end of the European Commission, which is an anti-democratic and unelected organisation.

The European Commission has already destroyed the UK fishing industry, and implemented a countless number of useless laws on their citizens. For example, the Brits don’t have any say in their borders. They will get fined for rejecting refugees who want to move to London. Moreover, Brussels wants to outlaw short selling in London, which would bring the financial capital to its knees.

As indicated in a few polls, I expect most Brits probably want to leave. Let’s hope democracy prevails, rather than a rigged vote. As Joseph Stalin said, ‘Those who cast the votes decide nothing. Those who count the votes decide everything.

If Britain remains in the EU, the pound and euro may jump initially. This could be good for gold. Still, with the risk of a major contagion event off the table, gold could be heavily sold off. On the other side, if the Brits leave, expect the US dollar to strengthen. This probably won’t be good for gold.

Although, you could argue, punters would flee to safety.

Prior to the referendum, US Federal Reserve Chair Janet Yellen’s monetary policy testimony in Congress will attract the markets’ attention on Tuesday and Wednesday. Yellen’s words should dictate the US dollar’s next move, which will be important for gold.

Adding it up, with a huge amount of defaults looming, I expect gold to crash to US$931 per ounce in the short term. This week’s major events could signal the best days are behind for gold.


Jason Stevenson,
Resources Analyst, Money Morning

Editorial note: Jason has a strong view on gold in the short term, based on his ongoing analysis. And while Jason focuses mainly on gold stocks, Jim Rickards looks at physical gold ownership, and how physical gold reserves factor into international politics. In today’s second Money Morning article, Jim Rickards takes up the bullish case, and explains how gold factors into the world stage. Click here for more on gold.

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