The "crazy rise" of gold indicates that "bigger things" are happening

The historic rise in gold prices indicates that some changes are brewing that are far more fundamental than inflation or deflation.

On October 16, gold continued its upward trend, reaching a historic high for the fourth consecutive trading day, breaking through the $4,300 mark for the first time. Gold has risen over 60% since the beginning of this year.

(Gold has increased by 64% this year, as of October 17)

Bloomberg macro strategist Simon White points out that the key message conveyed by gold is that it is not only a hedge against currency depreciation but also a hedge against the entire financial system—from severe credit recessions to large-scale monetization of fiscal deficits.

Simon believes that as the risks of government debt and various credit products increase, gold held in physical form, as it is not a liability of anyone, becomes the ultimate collateral that cannot be questioned.

Therefore, regardless of whether the market faces inflation shocks or deflation crises in the future, the demand for gold may continue to soar.

Gold is More Than Just an Inflation Hedge

Simon states that the biggest misunderstanding in the market regarding gold is viewing it merely as an inflation hedge and a means of protecting against currency depreciation. However, historical data shows that gold performs best in both extremely low and extremely high inflation scenarios.

If gold were merely an inflation hedge, its returns should increase as inflation rates rise. But the reality is different.

During the severe deflationary period of the 1930s, even after the U.S. government forced private holders to sell gold at $20 per ounce and then revalued it to $35, gold still achieved an increase. Had the market not been closed at that time, the increase might have been even greater.

The U.S. government's confiscation of gold was precisely because the public began hoarding gold during the Great Depression, exacerbating the deflation crisis. Whether in inflation or deflation, both are merely symptoms of rising pressure in the financial system.

(Gold performs well regardless of the level of inflation)

The real solution is high-quality collateral, which is precisely what the market urgently needs and is driving gold prices higher.

The Credit Market Hides Crisis

One of the risks the market is betting on is a significant credit recession.

Russell Napier, an analyst at Orlock Advisors, believes that the rise in gold prices mainly signals an impending credit crisis. Although the spreads between high-yield and investment-grade credit have recently narrowed, this does not mean that risks are decreasing.

Spreads are measured relative to the yield of "risk-free" government bonds, but against the backdrop of massive fiscal deficits in the U.S. and other parts of the world, the "risk-free" nature of government bonds can no longer be taken for granted.More importantly, if we adjust using interbank swap rates (swap spreads), we find that the actual credit spread (the interest rate difference between corporate bonds and government bonds) is actually higher.

This indicates that the cost of borrowing in the private market has increased, and the cost of risk borne by banks has also risen—simply put, borrowing is now more expensive and riskier.

(After adjusting for interbank swap rates, the credit spread is higher)

However, the situation is changing. Reports indicate that with the resurgence of global trade tensions and the bankruptcy of a company, First Brands, which has over $10 billion in debt and reportedly has more than $2 billion in funds "missing," credit spreads have recently widened again.

As JP Morgan CEO Jamie Dimon warned:

When you see one cockroach, there are likely more nearby.

The performance of the gold market aligns with Dimon's perspective. In a deflationary credit event where cash flow is interrupted or severely impaired, holding a non-financial asset that does not belong to anyone will become one of the few viable hedging options.

Government Debt Risk is Also Severe

In addition to the repayment capacity of the private sector, increasingly extravagant governments have also become a major source of market unease.

Governments around the world are facing unprecedented massive fiscal deficits during peacetime and non-recession periods. Unlike corporations, sovereign governments can print money to escape their predicaments, which is another core concern for the market.

The expectation that large-scale fiscal deficits will ultimately be "monetized" is undoubtedly another force driving gold demand. This behavior will severely erode the real value of fiat currency.

Federal Reserve Chairman Jerome Powell hinted this week that quantitative easing (QE) could return at an astonishing pace after the end of quantitative tightening.

Signs of weakening confidence in government collateral (i.e., government bonds) have already manifested in the rise of term premiums—over the past year, this has been almost the sole reason for rising yields in most major developed market countries.

(The rise in term premiums has driven the increase in yields of government bonds in most major developed markets last year)

Common Winners Under Two Types of Shocks

Currently, the U.S. Treasury market is at a critical juncture, where low volatility often signals that yields are about to experience greater fluctuations. Regardless of whether future shocks are inflationary or deflationary, gold will be in demand.

If an inflation shock occurs, gold will play its well-known role as a hedge against currency depreciation. But if a credit crisis and deflation occur, the market's demand for high-quality collateral will become more urgent.In a credit recession, non-government debt will be hit hardest first, but ultimately government debt will also be difficult to escape unscathed. Faced with massive deficits and an economy trapped in debt deflation, the monetization of sovereign debt will become inevitable.

At that time, the nominal value of government debt may be guaranteed, but its real value will be destroyed, leading to widespread damage to various traditional collateral.

In this scenario, gold will continue to maintain its "real value" unless it is confiscated by decree again. This is precisely what its historic price increase tells us