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Default Concerns Underscore Perceived Value of Gold as a Hedge

Isaac Nuriani    |
May 26, 2023
  • Janet Yellen says default “X Date” is approaching fast.
  • J.P. Morgan says “hedging would be key” in the event of default.
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Uncertainty has been a prominent economic theme this year, with no shortage of underlying drivers.

Two of those drivers are inflation and worries about an economic downturn. For more than two years, inflation has remained well above the Federal Reserve’s 2% target level. The Congressional Budget Office doesn’t expect inflation to return to the 2% level until 2026.[1]

With regard to a possible downturn, there are many recession forecasts worth examining. Federal Reserve economists are projecting a recession to begin later this year.[2] The Conference Board says a recession could start as soon as next month.[3]

Inflation and recession concerns have served as something of a backdrop to more acute stressors. One of those is unease about the stability of the banking system, which perhaps has been the most prominent catalyst of outright economic unpredictability so far in 2023. In fact, three of the four largest bank failures in U.S. history have occurred in just the last two months.[4]

Another stressor has proved to be the possibility that there won’t be a debt-ceiling agreement in time to prevent the federal government from defaulting on its obligations for the first time in history. As the workweek drew to a close, reports indicated progress had been made on striking a deal, but “major issues” were still to be resolved.[5]

Against the backdrop of all this, there’s been a good deal of public discussion recently on the topic of hedging savings and other financial reserves. And while inflation, the prospect of recession and concerns about the underlying stability of the financial system are among the driving forces of these discussions, attention is being paid right now to how one should prepare to withstand the fallout that could result in the event of a debt default.

I’ll jump straight to the punchline: It turns out gold is a popular choice to help get the job done.

We’re going to talk more about that – but not just about that. We’re also going to discuss how the preference for gold specifically as a prospective default hedge underscores what seems to be the growing preference for gold as a hedge against fiscal and economic uncertainty more generally, regardless of the specific reasons for it.

We have a few things to unpack here; let’s get started.

Bloomberg Survey: Professional and Retail Investors Say Gold is Asset to Own If U.S. Defaults

At the beginning of the year, it seemed unlikely that the federal government would come as close as it is presently to defaulting on the national debt.

You may be familiar with the “broad strokes” by now. If not, here they are: The nation can’t continue to honor its obligations unless the debt ceiling is raised from the present limit of $31.4 trillion. Republicans say they’re adamant this time around about receiving a commitment for spending cuts before they agree to a ceiling hike. Democrats insist the ceiling should be raised without conditions.

It’s unclear when, exactly, “X Date” will be reached. That’s the actual day the government begins defaulting because it finally has run out of available cash. Treasury Secretary Janet Yellen now says that day could arrive as soon as June 5.[6] The consequences of default could be “catastrophic,” Yellen has warned.[7]

Recently, some have turned their attention to the precautionary measures that might be taken to strengthen savings in the face of potential impacts of a default. And it seems there’s a bit of a consensus opinion forming in support of gold as the asset to own should a debt default come to pass.

J. P. Morgan agrees with that consensus. Suggesting “diversification is the best defense” to default, the world’s leading investment bank earlier this year cited gold as one of the few assets with the potential to provide that benefit if a debt crisis come to pass.[8]

In a separate piece on debt-ceiling preparation published just a handful of days ago, J. P. Morgan reiterated that “hedging would be key” in the case of an actual default, and “precious metals such as gold could provide” some help to that end.[9]

Analysts at another global investment bank, RBC Capital Markets, said just last week that “gold looks like one of the few likely candidates that would bear the burden of resulting market flows” which could be triggered by default concerns.

“In the near term,” they added, “we believe gold looks like the best hedge.”[10]

It’s not just investment banks that are concluding gold is the place to be in the event of default. The results of a Bloomberg survey conducted earlier this month found that gold is the top choice of professional investors, as well as household savers, as the asset to own if the country default.

Specifically, Bloomberg asked both asset managers and retail savers this question: “What will you buy if the U.S. hits the debt ceiling?” By a substantial margin, both categories of respondents answered “gold:” 46% of retail investors and 52% of asset managers.[11]

Commenting on the survey results, the Financial Times had this to say: “One hopes that this is all simply theoretical. But even if a default is averted, it is worth noting the answers.”[12]

The Times goes on to clarify its point, effectively saying that despite a broad perception of gold as an outdated asset, it nevertheless now seems to be a preferred choice during periods of turmoil – regardless of the precise reason for that turmoil.

“A couple of decades ago, investing in this asset seemed bizarrely retro,” the Times suggested.[13]

If that’s true, it no longer appears to be the case. Strong signals continue to emerge from a variety of corners that gold not only belongs among the holdings of those with a great deal at stake, but that it actually is a necessary component to an overall savings regime.

And as it turns out, it seems that no less important players than the world’s central banks believe it as much as anyone these days.

Central Bank Gold-Buying Remains Aggressive Following Record 2022

It’s difficult to imagine central banks and fiat currency existing without one another. Yet despite the symbiosis of this relationship, central banks seem to have developed a strong attraction to another asset in recent years: gold.

In 2022, central banks purchased 1,136 metric tons of it. That is the highest calendar-year purchase total of gold on record. Not only that, it was the 13th consecutive year that central banks have been net buyers of gold.[14]

Perhaps just as notable are the reasons central banks cited for why they’ve been buying gold.

According to the most recent edition of the World Gold Council’s Annual Central Bank Survey, these factors were among those cited as most relevant by central banks:

  • “Performance during times of crisis”
  • “Long-term store of value/inflation hedge”
  • “No default risk”
  • “Effective portfolio diversifier”[15]

And in case you’re wondering, there’s been little letup in the pace at which central banks accumulated gold last year. As a matter of fact, central banks purchased more gold in the first quarter of 2023 than they bought during any previous Q1.[16]

Should the central-bank record of gold-buying be interpreted as a primer for gold-buying behavior right now on the part of everyone else? Not necessarily. But given the important role of central banks in helping to steady financial systems and manage economies, it may not be inappropriate to attribute some measure of significance to both the quantity and pace of their gold-buying over the past decade, as well as the reasons cited for it.

Gallup: Number of Americans Who Say Gold Is the Best Long-Term Asset Nearly Doubles in Past Year

According to central-bank gold-buying patterns over the last 13 years, gold enjoys a broader-based support than specifically how the metal might help hedge against default.

Central banks acquired record amounts of gold over the last decade-plus, which goes beyond the U.S. debt default as a driver. And what about record-level Google searches for the phrase “how to buy gold” in April?

On the other hand, even though people were talking about debt default last month, until just the last couple of weeks there had been little discussion about buying precious metals as a hedge for default (anyone interested in gold was talking about it for other reasons, which indicates a deeper interest).

A recent Gallup poll that found a sizable uptick in Americans who said gold is the best long-term savings asset. The question asked by Gallup wasn’t the same as the one asked by Bloomberg (“What’s best asset to own in the event of debt default?”) but rather, “What’s the best asset to own over the long haul?” Nearly twice as many answered, “gold” this year as said it last year.

It’s important to point out that, even though analysts agree the chances of debt default right now technically are greater than in some time, the chances of it happening are still relatively minor. And the odds continue to drop as the players make progress toward an agreement.

But, as the Financial Times suggested, even if the nation succeeds in avoiding default altogether this time, the fact that so many say gold is the asset to own in a worst-case scenario is something to think about. Not just in the context of national-debt concerns, but also because gold seems to be embraced right now by a broader audience, from individual savers to central banks.

…….
[1] Congressional Budget Office, “The Economic Outlook for 2023 to 2033 in 16 Charts” (February 2023, accessed 5/25/23).
[2] Elizabeth Schulze, ABCNews.com, “Fed staff expects banking crisis to cause a recession this year” (April 13, 2023, accessed 5/25/23).
[3] The Conference Board, “LEI for the U.S. Declines Again in April” (May 18, 2023, accessed 5/25/23).
[4] Luis Melgar and Hamza Shaban, Washington Post, “Three of the four largest-ever bank failures have happened since March” (May 1, 2023, accessed 5/25/23).
[5] Christina Wilkie, Emma Kinery and Kayla Tausche, CNBC.com, “Debt ceiling negotiators make progress on spending, but still have ‘major issues’” (May 26, 2023, accessed 5/25/23).
[6] Ibid.
[7] CBSNews.com, “Yellen: U.S. default would be economic and financial ‘catastrophe’” (May 11023, accessed 5/25/23).
[8] Gillian Tett, Financial Times, “Why investors are going gaga for gold” (May 18, 2023, accessed 5/25/23); Statista, “Leading banks worldwide in 2022, by revenue from investment banking” (May 8, 2023, accessed 5/25/23).
[9] Weiheng Chen and Madison Faller, J.P. Morgan, “What are the possible scenarios for the U.S debt ceiling?” (May 18, 2023, accessed 5/25/23).
[10] Filip De Mott, Business Insider, “Gold could rally to a new record high if the US defaults and investors flee to safety” (May 14, 2023, accessed 5/25/23).
[11] Michael Mackenzie, Yahoo News, “Debt-Limit Default Risk Is Higher Than Ever. How Can You Safeguard Your Wealth?” (May 15, 2023, accessed 5/25/23).
[12] Tett, “Why investors are going gaga for gold.”
[13] Ibid.
[14] World Gold Council, “Gold Demand Trends Full Year 2022” (January 31, 2023, accessed 5/25/23).
[15] World Gold Council, “Annual Central Bank Survey” (June 8, 2022, accessed 5/25/23).
[16] World Gold Council, “Robust central bank buying bolsters first quarter demand” (May 5, 2023, accessed 5/25/23).
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