The effect of banking failures on gold is difficult to measure – in 2008, the long-term impact was muted with just a 5% return for the year
Gold has always held a unique position in the investment world. It is known for its resilience and reliability in tumultuous times, and gold does some of its best work for a portfolio when the economy is not cooperating.
We have some of that going on right at this moment. Most recently, we watched the debt ceiling debate play out in Washington.
We are also dealing with regional banking failures. So far in 2023, three banks have made the FDIC Failed Bank List, and they are Silicon Valley Bank, Signature Bank and First Republic Bank.
The Debt Ceiling Fallout
First, let's explore the relationship between debt-ceiling issues and gold prices. Congress and the White House agreed to a compromise in May that suspends the debt ceiling – or the total amount the government is allowed to borrow – for two years. Congress has raised the debt ceiling 78 times* since 1960. Debates around raising the debt ceiling can create a cloud of uncertainty over the economy, sparking fears of a potential default like we saw recently.
It’s still too early to tell which direction gold will ultimately go, but we can look to a previous example for some insight. In August 2011, Standard & Poor's downgraded the United States' credit rating from AAA (the highest possible rating) to AA+ due to concerns over the country's debt levels and gridlock over the debt ceiling. This led to a jump in market volatility and a surge in gold prices. The price of gold at the end of July 2011 was around $1,615 per ounce. By the end of August 2011, it had increased to approximately $1,825 per ounce, a 13% increase. That's a respectable monthly jump, especially considering the average annual return of gold from 1971 to 2022 was about 7.78%.
In this case, gold acted as a safe-haven asset, and investors perceived it as a store of value to help preserve wealth during times of instability. In addition, concerns about a possible decrease in the value of the U.S. dollar also drove investors to gold, as they've been inversely correlated historically.
We saw this again immediately following the announcement of a debt ceiling deal at the end of May. The dollar weakened, 10-year treasury yields fell and gold rose. Gold futures at CME Group closed at $1,995 on May 31, up $52 from a week prior when uncertainty over the debt ceiling dominated headlines. Gold retreated slightly in the two weeks following the news. A pause in rate hikes at the Federal Reserve’s June meeting may have signaled to investors that another rate hike will come at a future meeting, which would be unfavorable for gold prices.
Banking and Gold
Next, regional banking failures can also influence the price of gold, although the impact is generally more indirect and depends heavily on the circumstances.
Bank failures can lead to lost confidence in the financial system. As trust melts, investors may seek safer options to protect assets. As we've seen, gold often benefits from such scenarios. For example, during the 2008 financial crisis, numerous bank failures and economic instability led to a significant rise in gold prices.
That being said, the specific impacts of regional banking failures on gold prices can be influenced by a wide range of factors, including the size of the banks in question, the overall health of the economy, the response of regulatory bodies and how effectively the situation is managed.
Again, looking back at 2008, gold futures began the year at $837.55 per ounce and rose above $1,000 for the first time by the middle of March to $1,033.90, a 23.4% jump. It didn't continue higher from there, however. As liquidity became a problem for investors, selling winning assets to raise cash became a regular occurrence, and by the end of 2008, gold futures had dropped back to $879.50, leaving investors with only a 5% gain on the year.
While gold tends to perform well during periods of stress or crisis, it's essential to remember that numerous factors can influence the price of gold, and it doesn't behave the same simply because a crisis has been identified. Gold is, however, a traditional safe-haven asset, and looking at long positions in gold during times of uncertainty should be considered value protection first, performance second.
