Is the U.S. Credit Downgrade Good for Gold?

From Peter Reagan at Birch Gold Group

This week, Your News to Know rounds up the latest top stories involving gold and the overall economy. Stories include: U.S. credit rating and de-dollarization, China boosts official gold reserves for 9th consecutive month, and South Africa’s gold mines are under heavy stress.

What does the U.S. credit downgrade mean for the dollar, and for gold?

This recent analysis of the Fitch downgrade of U.S. credit neglects a few key points. This most recent episode was neither the first time the U.S. debt ceiling was raised after a Congressional circus. Nor was it the first time the nation’s credit rating suffered. While debt ceiling standoffs have become business-as-usual in Washington, it’s useful to reflect on the previous downgrade.

The last U.S. credit downgrade happened by 2011, courtesy of Standard and Poors (also known as S&P). This was the first credit downgrade in U.S. history, at the tail end of a global financial crisis. In case you’ve forgotten, although the crisis was indeed global, the U.S. took center stage.

The last point is of particular importance as we analyze the latest downgrade. In 2011, gold had reached heights simply unimaginable to many. The consensus view was the global monetary system was on the brink of failing completely. Today, though, the Federal Reserve has spent over a year trying to restore the dollar’s credibility and convince everyone things are fine. So the timing stands out foremost.

Then we get to Fitch’s wording on the downgrade, voicing “a steady deterioration in standards of governance over the last 20 years,” in economic affairs as their reason. So, unlike 2011, it seems more like a permanent fixture than a temporary slap on the wrist. (Kind of like high inflation, for that matter.)

Fitch also mentioned the already-massive and still-growing debt of $32 trillion. By “still-growing,” I mean $1-trillion-a-year deficits as “the new normal,” when it takes a $2 trillion annual deficit to get attention… While not all analysts are convinced this credit downgrade will change the demand for U.S. debt, there’s one audience that’s paying attention: Central bankers.

The quantity of U.S. dollars owned by central banks fell to the lowest level in 25 years back in May of 2021. (It’s down another 4% since then.) Those same central banks have been rebalancing their holdings with gold – a record quantity of gold in 2022, and so far 2023 is on track to surpass even that. (The sole reason we might not see another record-breaking year is because Turkey, crushed by 9.5% monthly inflation, sold 81 tons of gold.)

Global demand for dollars is down – and global demand for gold is strong. Even in Turkey, where the WSJ tells us citizens are “pouring their money into assets that they hope will be a safer bet.”

Fitch’s downgrade of U.S. credit ratings will inevitably weigh on the U.S. dollar – during a time when the whole world is scrambling to dump dollars. With the Fed’s rate hiking cycle seemingly at or near its end, there’s not much likelihood that the dollar will strengthen.

Gold, as ever, stands to gain from the dollar’s loss.

China gold reserves officially rise for the 9^th consecutive month

If it was any other of the numerous countries buying gold by the ton in recent months and years, the purchase itself might be the story. In this case, however, it’s the announcement itself that we should consider.

With a significant addition of 23 tons in July, China’s official gold holdings rose to 2,136 tons. It’s the ninth consecutive month of gold purchases, or should we say, announced purchases. During the stretch, the country has added a total of 188 tons to its central bank gold reserves.

If we go back to something like 2014 or 2015, there was no shortage of pundits who suspected that China’s gold holdings are closer to 4,000 tons than the “official” 2,000 tons. Despite its obvious inclination towards gold, the official sector seemingly never purchased any gold. There is the whole debate of whether gold on the Shanghai Gold Exchange is to be viewed as partly state-owned, which we don’t need to get into right now (details at the link for the curious).

These days, we’re hearing speculations that China could have as much as 20,000 tons of gold while simply reporting a figure 10 times lower. Whatever the case, as we have previously pointed out, China’s decision to suddenly be open about its official gold purchases has to be interpreted as deliberate.

Why the policy shift? What’s behind the sudden about-face from “Chinese gold is our business, not yours” to its opposite?

Here’s a theory: As we approach the BRICS meeting in South Africa on August 22, some things will become clear. We’ll learn whether a gold-backed BRICS currency really is imminent. (Russia says yes, India and South Africa say no.) Regardless of the outcome, it’s clear that developments among BRICS nations as well as the rest of the world are powerful incentives to own gold. The U.S. dollar, not so much…

A deeper look at South Africa’s troubled gold mines

The gold mining industry‘s spiral started after the post-2011 cost-cutting. Between closed mines, difficulties of opening new ones and dried-up exploration, it seemed like things couldn’t get worse for the long-term prospects of gold production. But latest news coming out of South Africa, a key miner of multiple precious metals, tell us that’s not the case.

Henk Langenhoven, chief economist of the Minerals Council of South Africa, said that getting back to 2019 production levels has proven “unsustainable” so far. In May, production was down 7.8% compared to pre-pandemic times.

The key issue have been electrical outages, along with railway problems. While the trains are operating well enough in terms of engine function, they’ve encountered a slight problem in the form of regular cargo theft.

Besides gold, another key precious metal that has been impacted by this is platinum. We’ve seen platinum show the kind of recovery investors have been waiting for years recently, and were quick to attribute it to a common-sense revaluation of platinum’s supply and demand picture.

But the report ties the surge in platinum prices to these mining difficulties. South Africa produces 70% to 75% of the world’s platinum, and one major mining company in the region expects production to fall by an additional 20% this year.

This is news for the precious metals investor for obvious reasons. We all know how supply and demand work – we can all anticipate the effects of further supply disruptions on prices.