Suddenly Emerging Danger
At first glance, the current environment seems quite favorable for a wide range of investments:
- Trump appears to be brokering some kind of truce in the Middle East, reducing the risk of escalation and pushing oil prices lower;
- The Federal Reserve has made it clear that it intends to cut interest rates and prevent a recession;
- Corporate earnings surged again last quarter, and so on.
It is therefore understandable that equities are reaching new highs almost daily. But why then are gold and silver prices rising so sharply? The common explanation is that inflation is expected to pick up, yet if that were the case, long-term interest rates should be rising—not falling, as they have been recently.
To understand what’s really going on, let’s briefly outline the broader background:
Decades ago, central banks decided to focus their monetary policies on keeping inflation low while promoting the highest possible level of economic growth—without paying much attention to debt accumulation. These goals made sense after years of high inflation and weak growth.
However, from the early 1990s onward, the situation changed. The fall of communism and the rise of the internet allowed countries such as China to develop rapidly into major producers of goods and services. Globally, this caused the supply side of the economy to grow much faster than the demand side. The result was rapidly declining inflation and even the first signs of deflation.
Since deflation combined with high debt levels—like those built up during the 1960s, 70s, and 80s—is toxic for an economy, demand had to be stimulated to prevent a deflationary spiral.
This was achieved by expanding government deficits, but mainly through extremely loose monetary policy: keeping interest rates low and creating large amounts of new money. This encouraged borrowing rather than saving.
Naturally, this approach has its limits. Borrowing cannot increase indefinitely while savings continue to decline. As a result, interest rates had to be pushed ever lower, and more and more money was created—far beyond what the real economy could absorb. A growing portion of this excess liquidity flowed into so-called asset markets, such as equities and real estate.
This also caused interest rates, relative to inflation, to fall everywhere, leaving investors with little reward for taking on additional risk in the bond market.
In practice, asset prices—equities, real estate, and bonds—became increasingly detached from the real economy. Normally, these are priced according to economic fundamentals, but now the relationship has reversed: central banks have been artificially inflating asset prices to stimulate demand and avoid deflation. This has led to increasingly risky lending at ever-lower risk premiums—something that is now starting to surface in the U.S. private credit market.
In this market, loans are issued directly from investors to borrowers, bypassing banks to save costs. Many of these loans are then bought up by other investors using borrowed money.
This has created a market in which even a small wave of defaults can trigger a cascade of bankruptcies. In recent weeks, several U.S. companies have unexpectedly gone under, leaving some regional banks—with heavy exposure to private credit—facing substantial losses.
This explains the sharp rise in gold and silver prices, as well as the recent short-term decline in yields on 10-year U.S. Treasuries.
Despite inflation still being too high, the Fed may soon be forced to cut rates and expand liquidity again to prevent a financial crisis. This would likely mean higher inflation down the road. Normally, that would push long-term interest rates up, but at present, long-dated Treasuries are being viewed as a “safe haven,” causing long-term yields to fall in tandem with short-term rates.
Will these developments continue and put downward pressure on equity markets as well? No one can say for sure whether the problems in the private credit market will spread further or remain contained.
However, we anxiously await the U.S. Supreme Court’s ruling on November 5 regarding import tariffs. If the ruling turns out negatively, what we are witnessing now in the markets may only be the prelude.
If the decision is favorable and credit issues do not escalate, markets may currently be pricing in too many Fed rate cuts. In that case too, equities remain vulnerable—and gold and silver could face a sharp correction.
