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How Gold Could Benefit From Soaring U.S. Debt

Gold

It's barely a decade since the last financial crisis ended, and Americans are already hooked on debt, again. Credit card debt and other types of consumer credit have hit all-time highs and experts have been warning that ballooning debt levels might soon explode rather dramatically. 

But maybe Americans have been getting their inspiration from good, old Uncle Sam …

The Fed has been taking on mountains of debt like it's the Great Depression again, with sovereign debt now exceeding $21.2 trillion, or 106 percent of GDP. That ranks as the 12th highest level in the world and the highest by the country since the aftermath of the depression.

(Click to enlarge)

Source: TradingEconomics

If you think the current debt levels are pushing the limits, then brace yourself for even more debt. The Fed has been raising the debt ceiling in order to meet its ever-growing appetite for more money and so far, no caps are in sight. Granted, the government is keen to close the fiscal deficit but trade wars with China and Europe are hardly a lasting solution even if they work in the short-term.

Further, the Treasury plans to borrow another cool trillion dollars in the current fiscal, a good 84 percent higher compared to the previous financial period. Throw in tax cuts and the U.S. trade deficit is likely to continue widening, meaning the debt spiral will continue unabated. Related: China And India Could Send Goal Soaring

In fact, the U.S.' debt-to-GDP ratio is expected to continue widening over the next five-year period—and this is the only major world economy expected to do so.

So how will this debt conundrum affect gold prices? Read on.

Good News for Gold Bulls?

Many investors are probably aware of the inverse correlation between gold prices and the trade-weighted U.S. dollar. What they might not be privy to is how gold prices are affected by U.S. debt.

Unlike the dollar, debt levels have been showing a strong positive correlation with gold. In fact, gold and debt have displayed an impressive 87.7-percent correlation in the period 2000-2018. That includes the divergence period in starting 2012 when gold prices hit an all-time high of $1,920/oz.

(Click to enlarge)

Source: BMG Group

The correlation between debt and gold prices was strongest during the 2003-2013 stretch when public debt increased from $6 trillion to $15 trillion. The divergence happened when the Fed unveiled a massive $1-trillion QE program with the extra liquidity flowing to equities (equities are negatively correlated with gold). If gold prices were to correct to align with the previous trendline, they would have to climb to well past  1,900/oz.

Secular Trends Support Long-Term Gold Bulls

While gold's short-term outlook remains subdued due to rising rates, the long-term secular trend supports higher prices.

Advanced economies that own the biggest reserves have not been keen to grow their gold reserves, but this might not affect long-term prices. For example, the U.S. owns the biggest reserves (8,134 tons). The country has, however, increased its reserves by a mere 0.5 tons over the past decade, while Germany, the second-largest holder, cut its holdings by nearly 50 tons.

Related: The U.S. Industry Losing Billions In The Iran Fallout

But that is hardly the direction the rest of the world is taking. In fact, many emerging economies have not only been dramatically growing their gold piles but are also looking to re-couple the yellow metal with a multilateral currency basket in order to minimize their exposure to the volatile U.S. energy and commodity markets.

A good 90 percent of gold reserves are held outside the U.S.

Meanwhile, central banks around the world bought 117 ton of gold in 2017, a huge 42-percent increase compared to the previous year. Russia (1,858 tons) has nearly quintupled its reserves, while China (1,843 tons) has tripled its own.

These positive secular trends, together with the Fed's insatiable appetite for cash, could provide a nice boost for gold in the long run.

By Alex Kimani for Safehaven.com

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