What Could a Mass Default Mean for Precious Metals Investors?

Earlier this month, Switzerland was in the spotlight when it became the first country to sell 10-year government bonds with a negative yield.

Many investors wondered what the news would mean for the gold space, and Resource Investing News took a stab at answering that question, ultimately determining that it’s tough to say what the impact might be. Indeed, HSBC’s Stephen Major likely summed it up best with the statement, “[w]e have unconventional central bank policies at work so you have to expect unconventional outcomes.”

A similar topic came to the fore this week, and while it’s just as complicated, its impact for precious metals investors is a little more clear. Here’s a breakdown of that topic and what its impact could be.

Negative yields spell trouble

The Guardian’s Jeremy Warner states in an article published Tuesday that over 30 percent of all government debt in the Eurozone is trading on negative interest rates. That’s a total of about 2 trillion in securities, and Warner believes that part of the reason that percentage has risen so high is that since 10-year Swiss yields turned negative, “investors have thrown caution to the wind” in a bid to find “safe assets.”

Essentially, their desire for safety has led them to “pay governments for the privilege of lending to them.” That might sound counterintuitive, but as Russ Koesterich of BlackRock has outlined previously, there are a couple of reasons investors might be interested in that type of scenario:

1. For one, “negative yields may make sense of you expect a significant decline in prices,” Koesterich states in a recent article. Essentially, the idea is that in a deflationary scenario “real (or inflation-adjusted) yields could be positive even if nominal yields are negative.”
2. Secondly, he notes, “yields may become even more negative, which allows for profit potential for those willing to sell before maturity.”

Those points help explain why investors are turning to bonds with negative yields, but as Warner points out, that doesn’t mean the situation is a good one. “What makes today’s negative interest rate environment so worrying is this; to the extent that demand is growing at all in the world economy, it seems again to be almost entirely dependent on rising levels of debt,” he states in his article.

Elaborating, he notes that while the financial crisis “was meant to have exploded the credit bubble once and for all,” that hasn’t happened at all. In fact, “the wake-up call of the financial crisis has gone largely unheeded.”

In looking further at the situation, Warner raises the question of whether central banks are the main cause of the interest rate collapse or if they’re “merely accommodating wider forces in the global economy that they are powerless to influence — persistent sluggishness in demand and productivity growth.” Whichever is true, Warner is fairly confident in what the upshot will ultimately be: “[t]he bond market bubble is just the half of it; since most other assets are priced relative to bonds, just about everything else has been going up as well. Eventually, there will be a massive correction, in which creditors will suffer sickening losses.”

Investor takeaway

When that happens of course remains to be seen. However, even at this point, the potential impact for previous metals investors is fairly clear. As those involved in the space well know, investors tend to turn to precious metals as a safe haven in times of turmoil. The type of mass default being described by Warner seems to fit that bill, so it’s possible that if it does indeed come to pass it will spark a rush in demand for metals like silver and gold.

Certainly food for thought for investors as debt continues to mount and gold and silver prices remain low.

Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article.

Related reading:

What Do Negative Bond Yields Mean for the Gold Price?

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