Gold and Bitcoin are having a resurgence. You could even call it an awakening.
- Gold recently broke out to six-year highs above $1,400 per ounce. More importantly, gold has broken out of a giant base-building pattern more than five years in the making.
- Bitcoin, meanwhile, recently smashed through the $10,000 barrier, and soared as high as $13,000 before retracing in a bout of new volatility.
Gold and Bitcoin are not the same thing. But Bitcoin is increasingly seen as a sovereign store of value, with global awareness and borderless acceptance.
That makes Bitcoin a kind of “digital gold,” which explains why many of the factors driving the gold move and the Bitcoin move are the same. Like the global tsunami of negative interest rates, for example, and what it says about the state of the world.
Negative interest rates are a truly bizarre concept. For thousands of years, the concept of finance has revolved around a positive rate of interest, in which the borrower pays the creditor a fixed amount for the privilege of borrowing.
With negative interest rates, the concept is turned on its head. If a bond has a negative interest rate, it means the buyer pays the borrower for the privilege of lending them money.
To put it another way: If you put $100 into a bank account with a negative 1% interest rate, in a year you will have $99. As a creditor, you pay the bank (or the bond issuer) to hold your money.
Relative to how finance is supposed to work, this makes no sense at all. Ten years ago, the possibility of a world awash in negative interest rates would be dismissed as absurd.
And yet here we are. As a result of dovish messages from the European Central Bank and the Federal Reserve, the amount of sovereign debt with negative interest rate yields — where the lender pays the borrower — rose above $13 trillion for the first time.
$13 trillion is a lot of money. It is more than China’s annual GDP.
Negative interest rates are especially common in Europe and Japan. One year ago, the yield on 10-year German bunds was 0.5%. It recently dipped to minus 0.32%. Last week, bond yields in Austria, Sweden, and France turned negative, too. In Denmark, the possibility exists of the entire yield curve turning negative — another never-before-seen event.
Why is this happening? In part because some entities, like pension funds and banks, have a mandate to own large quantities of sovereign bonds no matter what. The total supply of sovereign bonds is limited, until and unless governments decide to borrow more. Germany, for example, has less than $2 trillion worth of government securities outstanding. The U.S. in comparison has $16 trillion.
It’s also possible to make money from price appreciation, even if the yield is negative. If you buy German bunds at a minus 0.32% yield, for example, and the yield falls even further to, say, minus 0.99%, you can make money by selling the bunds at a higher price. (Bond prices rise as yields fall.)
The scary thing, though, is what $13 trillion worth of negative interest rates says about the global economy. When buyers are hungry for “safe” government bonds with a negative yield, it indicates little to no growth on the horizon.
Most of the banks in Europe, for example, would rather sit on negative yield bonds than lend their capital to consumers or small businesses. That isn’t good for anyone, and it creates the risk of a dangerous feedback loop. As lending-starved economies get weaker, the growth outlook gets worse. This causes banks and consumers to pull back even more, which leads to recession or depression.
The ugly scenario is the one in which the world becomes like Japan.
The Japanese economy has struggled with deflation and a lack of growth for decades. Ever since the huge real estate bust Japan experienced in the early 1990s, the Japanese government has borrowed huge amounts at near-zero or below-zero rates to try and stimulate the Japanese economy back to life — and nothing has really worked.
As of this writing, Japan’s debt-to-GDP ratio is estimated at 236%, meaning Japan’s debts are more than 2.3 times the size of its economy. In comparison, the U.S. debt-to-GDP ratio is 108%. The eurozone’s debt-to-GDP is 82%.
What this means is that, if the U.S. and Europe follow the path of Japan, U.S. borrowing could double and Europe’s borrowing could triple — and the world could still be stuck in a funk. If that happened, the pile of negative interest rate bonds could double in size yet again, to $26 trillion or more.
That prospect scares the daylights out of central bankers, and there are increasing signs the “Japanification” forecast is coming to pass.
That is why expectations are high for new “QE” style stimulus in Europe and aggressive rounds of interest rate cuts in the United States. The central bankers don’t have many tools to fight the threat of deflation and molasses-like growth. As a final resort, all they can do is fire up the printing press.
And this leads us back to gold and Bitcoin, and the new bull runs for each.
Gold doesn’t yield anything. You don’t earn a yield to hold it, and there isn’t any cash flow stream. The same is true of Bitcoin, which is why traditional value investors don’t like either asset.
But gold and Bitcoin alike have a valuable “store of value” function, and a crisis insurance function, when central bankers go wild. Sometimes gold goes up aggressively in price — in paper currency terms — because the value of paper currency is eroding.
That is what happens when central bankers go wild, and that is what $13 trillion worth of negative interest rates is pointing toward today. “Zero yield” can be wonderful in comparison with negative yield, especially if you are getting strong price appreciation to boot.
By acting as a form of crisis insurance, gold has retained its store of value for thousands of years, even as countless paper currency regimes have come and gone. In today’s bizarro negative interest world, gold is doing the same thing — and so is Bitcoin, a form of “digital gold” that moves seamlessly across borders.
And, what’s good for gold can be even better for gold stocks. For example, we recently wrote about “the greatest trade of the 1930s,” which involved South African gold mining shares.
It’s perhaps no coincidence that South African mining stocks just hit an 11-year high. In a world with $13 trillion worth of negative interest rates, and central bankers rolling up their sleeves for more craziness, the outperformance for gold and Bitcoin (digital gold) is likely to persist.