US debt-ceiling deal: Could gold price appreciate by 25 percent?

Now, he sees this dynamic changing and global banks becoming more partial to gold for their forex reserves. He adds that, if the banks increase the share of gold holdings in their balance sheet to the historical average of 40 percent, then the yellow-metal’s price could appreciate by 25 percent to $2,500 an ounce.

Also read: Debt ceiling deal positive but Fed borrowing may prop dollar higher, according to Ritesh Jain of Pine Tree Macros

It all starts with the debt-ceiling agreement.

The factors

According to Costa, whenever there has been a need for a debt-ceiling extension, the Treasury cash balance for daily operations tends to be at extremely low levels, like it is now.

Once the agreement is reached, the government has to issue debt quickly, and this time around Costa expects “an unprecedented surge in the amount of debt being raised in the ensuing months”.

This would cause the price of these securities to fall. While the market would absorb large amount of such issuances in the past, now there are other concerns that may hinder this, pointed out Costa. Now, investors have to consider inflation, bank failures due to these instruments, and the US Fed’s less compromising stand on rate-hikes.

Costa pointed out that long-term interest rates have been seeing upward pressure as debt-ceiling talks are nearing resolution.

“Investors are beginning to recognize that the true risk this time around lies not in the failure to reach an agreement, but rather in the escalating and concerning nature of the debt problem. This problem is further amplified by the diminishing availability of Treasury buyers,” the tweet stated.

The Fed and US banks used to absorb the debt, not anymore, and even foreign investors have reduced their buying of US Treasury.

The Fed may have to step in as the buyer of last resort, according to Costa, like the Bank of England did for UK bonds.

According to Costa, this situation will cause global banks to change the nature of their asset holding in favour of gold.

“Given the dire levels of global debt, foreign central banks are compelled to prioritize enhancing the quality of their international reserves to support their monetary systems,” he wrote.

While central banks continued to buy gold even after the ending of gold standard in 1971, with their holding in the yellow metal touching 72 percent of the balance sheet at its peak, the banks changed their stance when the Fed began to raise interest rates. They began to accumulate US debt.

The interest in US debt was also thanks to a globalised world that “significantly fueled the substantial demand for Treasury instruments”, which then saw 30 years of continuous appreciation.

Also read: The new gold boom: How long can it last?

“Now, foreign central banks have reversed their stance again. They are significant buyers of gold while some have become major sellers of US debt,” stated the Tweet.

If the percentage of gold in forex reserves go up to the historical average, the price of gold could go up by 25 percent according to him.

“In a world where policymakers must inevitably intervene to suppress the cost of debt, irrespective of the potential effectiveness of such actions, gold would likely emerge as a key monetary asset to own carrying centuries of credibility as hard money,” he wrote.