The correction that began on October 21st not only caused the prices of gold and silver to plummet. Shares of gold and silver producers and mine developers also recorded massive price losses. Looking solely at the magnitude of the percentage losses, it can easily appear that investors have dropped this sector like a hot potato.
However, delving deeper into the matter reveals a completely different picture. One of the individuals who possesses this deeper insight and openly shares her findings in interviews is Danielle DiMartino Booth. She served as an advisor to the former President of the Dallas Fed, Richard Fisher, from 2006 to 2015 and warns of underlying tensions within the system.
While major US stock indices like the S&P 500 are trading just below their all-time highs and stock market sentiment remains excellent, the bond and commodity markets are currently sending a very different signal. Danielle DiMartino Booth interprets the tensions emerging from this unusual discrepancy as a sign of a systemic liquidity crisis. It could force the US Federal Reserve to abandon its fight against inflation.
Memories of March 2020 Resurface
If this were to happen, it would not be because the fight against inflation has been won, but because the financial system itself threatens to collapse. “It looks very much like the system is running out of liquidity and that the Fed will be forced to retreat,” said Booth, who is now CEO of QI Research, a macroeconomic consulting firm, in an interview with Kitco News.
Specifically, she expects the Federal Reserve Bank to end its current policy of “quantitative tightening” and revert to a significantly looser monetary policy. The ongoing tightening program withdraws liquidity from the financial system by removing up to 95 billion US dollars in Treasury bills and mortgage-backed securities from the Fed’s balance sheet each month.
The current situation strongly reminds her of March 2020. That was the moment when the financial market became aware that the emerging Corona crisis would be more severe than market participants had initially assumed. At that time, there was also a “flight to cash” that affected all markets and was not limited to individual ones.
Are Gold and Silver Being Sold off so Massively Today Primarily Because They Have Performed so Well?
Many investors at that time received one of the dreaded margin calls from their brokers. Positions built with borrowed money were therefore immediately sold, and investors first dumped precisely those securities from their portfolios that had previously performed particularly well. At this point, a striking parallel emerges with the current developments in gold and silver.
Both precious metals look back on a very successful recent stock market history, yet this week they were swept out of portfolios with such force, as if the impending apocalypse were at hand. “I think that’s what we’re experiencing right now. I think we’re seeing a repeat of what we saw in March 2020,” Danielle DiMartino Booth explained to Kitco News. “When investors get margin calls and liquidity becomes an issue, they tend to sell their winners.”
The resulting volatility was not a good sign for the asset, she warned. “You never want to see gold behave like a meme stock.” Yet, signs of such a movement have been observed in recent days in gold and silver and in the shares of gold and silver mines. Paper profits in the commodity sector were realized to procure short-term liquidity.
The “Cockroaches” in the Credit Market are Cause for Concern
Danielle DiMartino Booth is currently not the only warning voice to be heard in the financial markets. Andrew Bailey, the Governor of the Bank of England, also recently testified before the British Parliament and drew a direct parallel between the recent collapses in the US private credit market and the 2007 subprime crisis.
In addition, financial stability reports from both the Fed and the International Monetary Fund (IMF) have highlighted the rapid growth of this opaque market as a potential systemic risk. Jamie Dimon, the CEO of JP Morgan Chase, echoed this sentiment, speaking of more and more “cockroaches” being found in the financial system. In this context, “cockroaches” refer to private sector loans that have been granted too carelessly.
As in the years immediately preceding the bursting of the subprime bubble, this sector has once again grown explosively to a volume of over 1.7 trillion dollars. Since this area is less regulated than traditional banking, a significant systemic risk lurks here, stemming from overly lax lending standards and excessively high loan amounts, which were granted primarily during the era of zero and negative interest rates.
Not Isolated Cases, but a Profound Systemic Risk
Danielle DiMartino Booth does not believe these are isolated cases, but that the problem is systemic. She points out that US household debt, according to the latest data from the New York Fed, has now reached a record high of 18.4 trillion dollars. Particularly alarming is the fact that delinquencies on credit cards and auto loans have risen above pre-pandemic levels.
The market appears stable and is driven by optimism, but the data available to the Fed undoubtedly shows that US consumers are under severe pressure. Recent reports from Vanguard and Empower, for example, indicate that hardship withdrawals from 401(k) retirement plans have risen to their highest level in two years. One reason for this increase was the recent resumption of student loan repayments.
At the same time, the US economy is performing weaker than generally assumed and than the Fed’s data initially suggest. What is still missing is a general warning signal that the market cannot ignore. Such a signal could be sent by the Collateralized Loan Obligations (CLO) market if the spreads for collateralized loan obligations begin to rise here. Such a signal would mean that problems in the private credit sector are beginning to spill over into the public sector.
Riskier tranches with lower ratings are already showing initial signs of stress here. If this development also spreads to the less risky segments, the financial market will not be able to ignore this signal, as it indicates that the fear of defaults and a general loss of confidence has significantly increased.
