Gold on a Debt Downgrade

Chris Poindexter
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Posted: Aug 08, 2011 12:01 AM

Last week saw gold prices surge again as equity markets cratered for the second time in three years.  Estimates suggest that $2.5 trillion in wealth was erased from global equity markets in the span of a week. 

If the dismal week in equity markets wasn’t bad enough, Standard & Poor’s added insult to injury on Friday when they cut the credit rating of the United States from AAA to AA+.  A downgrade that was more symbolic than substantive, but the S&P went a step further and kept the U.S. on review for another downgrade in the near future.  

What effect this will have on the equity markets is unclear but probably not good.  The downgrade was not unexpected and has been at least partially priced into the market, but it wasn’t expected this soon.

The combination of the U.S. downgrade, political gridlock, and the ongoing debt crisis in Europe is likely going to keep continued upward pressure on gold prices.  There are few alternatives to commodities for parking the massive amounts of cash from the sell off in equities. There’s so much cash floating around right now that some banks are charging big depositors a fee for handling large cash deposits. 

Even though gold prices are high, it’s quite possible there’s still room to run. 

 Demand has remained steady and there’s nothing showing that demand easing.  I believe gold is currently trading with a “fear premium” but there’s so much noise in the numbers, with so many variables to consider, it’s difficult to separate one from another. 

One potential downside to the run in gold prices would be a recovery in equity prices.  Historically, downgrades do not always hurt countries receiving them.  When Canada was downgraded in 1993, yields on their 10 year bonds jumped and their stock market went up 15 percent the next year.  Japan got a downgrade in 1998 and their stock market went up 25 percent. 

The situation in the equity markets is not 2008 all over again.  Most companies are posting healthy profits and sitting on cash-rich balance sheets. 

In turbulent markets it’s good to stay focused on why you’re buying gold and silver.  Even buys during peak demand will even out over time.  The smart money manager has a systematic investment plan and sticks to it.  

Chris Poindexter, Senior Writer, National Gold Group, Inc


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