While many other investments have better growth potential, gold is viewed as a defensive commodity that protects your assets without offering a higher rate of return. Because it is one of the few assets -- or the only asset -- that won't decline, gold is favoured during recessions or other difficult times.
The World Gold Council asserts that gold will need to get ready for unforeseen events allegedly brewing on the backdrop of unprecedented rate hikes, collapse of small US banks and commercial real estate sector.
"With a US recession still on the cards, growing systemic risk adds to gold’s case," said World Gold Council in its report.
Basically, systemic risk is the potential for a company-level incident to cause serious instability or bring down an entire sector of the economy. Systemic risk played a significant role in the 2008 financial crisis.
In its recent report, World Gold Council stated that while some people could have been disappointed by gold's 'mere' resilience in 2022, there was no actual crisis despite headwinds from unusual monetary tightening and rising inflation. But now there is a greater chance of one.
Let's explore the crisis that the report identifies.
The first cracks appear
With a number of small bank collapses in March, the first downturn in the US economy's armour started to show. The issue with banks is that they are a part of a system that is fragile by nature. Up until a certain point, fractional banking is effective.
The focus is currently on small banks and the industry they are inherently committed to: commercial real estate (CRE). The devil will undoubtedly be in the details, and the outcome of this mini-crisis scenario is still up in the air.
However, for the time being, the Fed and other central banks' actions have stopped bank deposit flight problems from getting worse, and a full-blown CRE doom-loop scenario also appears to be under control.
The most obvious sign of trouble is the excess of office space, which is mostly a result of remote working. This is only a minor portion of the CRE market, making up roughly 4% to 5% of the debt that needs to be refinanced in 2023.
Although valuations in the CRE sector are high, they do not by themselves constitute a systemic problem, unlike defaults. With loan to value ratios at reasonable levels, the CRE sector is still cushioned for the time being.
Markets aren't positioned for a tail event
In addition, there has been a slowdown in the past 12 months despite the fact that tail events have been growing during the past 20 years.
According to the SKEW index, which gauges market expectations for the possibility of tail events, the market's complacency with these risks is concerning.
In the event of a full-blown catastrophe, a little optimism, faith in central bankers, and the resilience of the equities market combine to create an uneasy cocktail. However, since these crises are very impossible to predict, it makes sense to invest gold strategically. As it did recently during the invasion of the Ukraine in February of last year and the failure of the Silicon Valley Bank in March, gold has historically performed well in such circumstances.
