Gold has had a choppy couple of months.
The yellow metal needs some direction.
That would be nice. Trouble is, it doesn’t look like happening anytime soon.
Yesterday, I explained what happened to gold during the US banking crisis of 2008.
Gold — a popular hedge against uncertainty — dropped by about 34% during the crisis.
Will the same thing happen to gold next time? And will there even be a next time? After all, a banking collapse couldn’t happen again, right?
Don’t be so sure about that.
A year from now, investors could be talking about Deutsche Bank [FRA:DBK] in the same way that they talk about Lehman Brothers in 2008. In my opinion, Deutsche Bank is by far the riskiest bank in the world.
So risky, I believe the financial giant could go bankrupt in the months ahead. If that happens, it could well be the trigger to set off a European banking crisis that would bring down the entire global financial system.
It’s a big claim, so how can I justify it?
Simple. Deutsche Bank boasted a notional derivatives exposure of €41.9 trillion (US$46.53 trillion) in its 2015 annual report. That’s about 10% of the US$493 trillion total global derivatives market. It’s also five times the size of the European Union’s GDP, and 14 times Germany’s GDP!
Source: Deutsche Bank; Bloomberg
Click to enlarge
In comparison, the current market cap of Deutsche Bank is €15.74 billion. In other words, Deutsche Bank is leveraged 2,662 times. Put another way, it’s the equivalent of promising to buy a house for $266,200 with a deposit of just $100!
While a fair chunk of these derivatives are hedged (i.e. there’s a buyer and seller for each contract), that doesn’t make it a risk-free position. What happens if one side can’t pay up? This is exactly what happened during the US sub-prime crisis of 2008. For this reason, the IMF notes that Deutsche Bank ‘appears to be the most important net contributor to systemic risks’.
If Deutsche Bank goes under, it could bring down the entire global financial system.
The central banks won’t be able to save the world this time.
Central Banks are leveraged through their teeth and out of options. And it’s hard to imagine governments bailing out the banks. They are dead broke. Bloomberg reported over the weekend:
‘Chancellor Angela Merkel has ruled out any state assistance for Deutsche Bank AG in the year heading into the national election in September 2017, Focus magazine reported, citing unidentified government officials.
‘The German leader also declined to step into the Frankfurt-based bank’s legal imbroglioem>with the U.S. Justice Department, which may seek as much as $14 billion in sanctions against Deutsche Bank’s mortgage-backed securities business, the magazine said.’
How will Europe’s largest bank pay for its US$14 billion fine — more than 70% of its market capitalisation? And how will it refinance about €2.5 trillion worth of derivatives within the year?
It’s hard to see how it can.
Especially when you consider that last year the bank booked its first loss since 2008.
If I’m right about this, the days are numbered for Europe’s largest bank, and the global financial system. But, where does that leave you as an investor?
Who or what can you trust in this market?
If you can’t trust the government or central banks to bail out the system, and you can’t trust the banks to keep your savings safe, who or what can you trust?
In times like these, many investors turn to one thing: Gold.
The spot price of gold has been volatile recently.
Gold remains locked within a two month range, spanning from about US$1,300 to US$1,359 per ounce. The range is marked with the black lines on the weekly chart below.
Source: Tradingview.com, Resource Speculator
Click to enlarge
It’s a dangerous market for investors and traders. Traders can get ‘faked out’ on the downside or upside, buying when the price appears to turn one way, only for it to abruptly shift the other way.
Buying gold is an option. But as always, I recommend caution. During times of financial chaos, shrewd gold investors can come out on top.
But it can take patience and a certain amount of guts.