CREDIT COLLAPSE AND THE GOLD BULL / MACLEOD FINANCE

Credit collapse and the gold bull

Recession, commodity-driven inflation, and higher interest rates all point to a crisis undermining stocks, bonds, and even currencies. It’s why gold is ready to rise again.

ALASDAIR MACLEOD

Introduction

Markets are asleep, affected by a general summer torpor. 

But in the background, there are growing signs that all is not well. 

Precious metals are in early-stage bull markets for good reasons. 

CPI price inflation is not going away, and market expectations of lower interest rates are in retreat. 

It is increasingly evident that bond markets are reluctant to absorb medium and long maturity debt, signalling a destabilising preference for near-cash.

That is the evidence from Wall Street. 

Anecdotal evidence from Main Street not reflected in official statistics are of small and medium sized businesses struggling outside the major cities, retail outlets closing, and rural communities in trouble. 

In the shops, food prices and those of other consumer necessities appear to be rising more quickly than government statisticians admit. 

The term “stagflation” is increasingly used to describe current conditions.

In this article, I examine the common driving forces behind G7 economies and their outlook. 

The dominant features are a new bull market in commodities, increasing credit risk in bond markets undermining wider financial values, and a deepening recession. 

I shall consider each in turn.

Commodity outlook

Most important for humanity is energy, and despite the move to more expensive non-fossil fuels crude oil is the basis of all economic activity. 

Its price matters. 

Measured in real corporeal money without counterparty risk, which is gold, it is exceptionally cheap.

It is also the most political commodity. 

In the past the price in dollars has been manipulated by the OPEC cartel, wars, and sanctions against various producers. 

New technologies such as fracking have contributed to supply, and environmental policies have impacted on demand. 

But that is just one side of the price equation with gold. 

Gold itself has been suppressed, firstly by US Treasury sales to keep the Bretton Woods $35 gold standard intact, and subsequently by the creation of gold derivatives to absorb demand which otherwise would have driven gold prices higher relative to dollars. 

Furthermore, the US treasury’s immense anti-gold propaganda effort all but drove it out of the monetary system.

Much, if not most of the volatility in the oil/gold price is due to these factors rather than supply and demand. 

But with the fiat currency era ending, gold is beginning to be rehabilitated as the risk-free escape from increasingly dodgy dollars. 

And we know that while commodities and wholesale goods can and do vary priced in gold, over the long-term gold’s purchasing power is remarkably stable. 

It is in this context that we note since 1950 WTI crude’s price in gold has fallen by 75%.

Gold’s inherent stability of value means we can expect a rebound towards 1950s gold standard levels, implying up to a 300% increase in the oil/gold ratio. 

How long it takes depends in turn on the relationship between gold and the dollar along with the other G7 fiat currencies.

We see the same situation in base metals, illustrated next.

In this chart, I include the basket of base metals priced in dollars, illustrating how it increased substantially between 2002—2008, principally due to increasing Chinese manufacturing demand and the expansion of dollar credit, initially under Greenspan and then Bernanke. 

The subsequent reaction to end-2019 changed with the inflationary covid lockdowns, imparting a new round of price inflation which peaked in 2022. 

And since last year, base metals priced in dollars have begun to rise again.

Valued in gold, base metals tell a different story. 

Their most recent value is only 14% of that in 1950, the lowest ever. 

To an extent, this reflects gold rising against the dollar front-running base metals and commodities generally.

However, as is the case with crude oil, monetary, geopolitical, and economic factors have combined to suppress base metals measured in gold. 

On the basis that this index can be expected to return towards its gold-standard average, price increases of five or six times in gold alone might reasonably be expected.

Since 2019, food prices have been rising as well, indicated by the chart of Invesco’s DB Agriculture fund — the largest ETF in the sector:

To summarise, irrespective of opinions on the economic outlook, consumer price inflation is going to become a significant problem again sooner rather than later. 

The implication is that any reduction in interest rates will be short-lived if they occur. 

Instead, in accordance with their inflation mandates central banks will be forced to raise interest rates unless they are prepared to let their currencies slide. 

That is, until the debt overload on the private sector leads to or threatens widespread bankruptcies.

Inflation and financial asset values

The correct way to look at price inflation is that it represents loss of a currency’s purchasing power. 

In order to compensate creditors, the interest on bonds must incorporate compensation for the use of a creditor’s funds and risk to the purchasing power of final repayment. 

Simplistically, an investor in a currency will require a return which gives him a margin over his expectation of its debasement.

We have seen that commodity prices have only one way to go and that is up. 

Partly, this may reflect falling fiat currency values, but there is no doubt that the G7 nations have cast themselves away from the new dynamic economies of China, Russia, their Shanghai Cooperation Organisation partners, BRICS members, and the wider global south desperate to move away from US hegemony in favour of the Asian superpowers. 

In the old dying G7 economies, the public, including the mainstream media upon which they rely for guidance, are hardly aware of this change which is set to energise fully 70% of the world’s population into a new industrial revolution.

Bond yields and interest rates are therefore bound to rise. 

The importance of this new trend is illustrated in the chart below:

That a 40-year downtrend in bond yields was smashed in 2022 is not trivial. 

And now we face a new round of commodity price rises and currency debasement. 

Clearly, bond yields are on a new rising trend of which the last two years merely represent a consolidation. 

And if economies go into recession, which is almost certainly their trend direction, both private and public sectors will find it increasingly difficult to service their increasing debt as interest rates rise.

The public sector prints, while the private sector goes bust. 

This brings us to the relationship between long bond yields and equities, which is probably more stretched than it has ever been in history.

In the chart below, I have inverted the yield on the long bond (right hand scale) to illustrate the reverse correlation with the S&P 500 Index (left hand scale), indexing both to 100 in 1985. 

As one would expect, it confirms that a falling yield normally accompanies an equity bull market, and a rising yield leads to a bear market in equities.

The reason is that investors will increase their bond allocations by selling equities when yields rise and vice-versa. 

But from time to time, valuation differences can become significant when other factors are present. 

We saw this in April 2020 at the time of covid, when the long bond yield fell to 1.12% while many businesses effectively ceased trading.

That was an aberration. 

But note how the bond’s yield rose between October 1998 and January 2000, before bursting the dot-com bubble. 

The S&P then fell nearly 50%, and the NASDAQ 100 75%. 

In an effort to stop the slide, the Fed reduced its funds rate from 6.53% in early-2000 to 1% in July 2003 bringing the long bond yield back in line with equities.

The dot-com experience was the top of a credit induced bubble exhibiting speculative behaviour seen during the South Sea Bubble of 1715—1720, and the 1928—1929 period on Wall Street.

This time, the valuation disparity is twice as great as the dot-com bubble, almost certainly the greatest in stock market history. 

Market expectations are for interest rate cuts which would reduce the overvaluation of equities. 

But as pointed out above, inflation not only remains above the Fed’s 2% target but will be going higher as commodity prices and Trump’s tariffs bite.

Importantly, there are no offsets to these price pressures this time. 

Base metals priced in dollars soared between 2002 and 2011, but cheap manufacturing of imported goods from China and East Asian nations absorbed these costs keeping consumer price rises relatively subdued. 

This time, the one-off effect of cheap Chinese and east Asian production cannot absorb a second commodity shock, and Trump’s tariffs will add to consumer price pressures.

1929—1932 redux

Few investors realise that the reason their portfolios have been doing well is that stock prices have been fuelled by ephemeral credit, which is the other side of debt. 

Initially, rising bond yields lead to losses in bond portfolios encouraging credit flows into equities, until the valuation disparity described above begins to pop the equity bubble.

We are close to that point, which saw similarities with the US stock market in 1928—1929. 

Furthermore, the Smoot-Hawley Tariff Act of 1930 became a real risk in September 1929, having been ignored by markets when Congress debated it that summer. 

President Hoover signed it into law in June1930. 

The Dow lost 89% of its index value from September 1929 to mid-1932 and 9,000 small and regional banks went bankrupt or closed.

Will September 2025 prove to be a fateful anniversary of events in 1929?

The conditions in today’s credit bubble appear to be more extreme, to which we can add the lack of a gold standard. 

Not only will the lessons from the Wall Street crash and the thirties depression apply, but we can add a currency collapse into the mix.

Our analysis has rightly focused on the dollar, the King Rat of fiat currencies. 

Where the dollar goes, the other fiat currencies will get sucked into the same vortex. 

The other G7 nations share similar debt and overvaluation problems, rendering the entire post-Bretton Woods fiat currency system as unstable as a house of cards.

One puff of wind and it’s all over.