Derivatives Market Could Send Gold Prices Surging
Fact: gold prices skyrocket in times of uncertainty. This is because the yellow precious metal has been known as a store of value and wealth over time.
With this said, there’s one thing that’s not talked about much in the mainstream media, even though it could cause uncertainty to soar, possibly creating a banking crisis and sending gold prices surging: the derivatives market.
Advertisement
Dear reader, the derivatives market is a $177.0-trillion (no-misprint!) time-bomb that’s ticking.
Let me explain…
You see, if there’s one thing that’s clear from the U.S. Federal Reserve, it’s that it wants to raise the interest rates in the U.S. economy. Currently, the interest rate set by the Fed, the federal funds rate, stands at 0.75%. If you look at the Fed’s own projections, we could see this rate becoming as high as three percent in 2019.
Do the simple math: in percentage terms, interest rates set by the Federal Reserve could increase by 300% in a matter of two years.
In the Fed’s recent meeting minutes, released on February 22, we got confirmation of it, too. The Federal Reserve wants to be aggressive in raising rates.
Now, back to the derivatives market. At the end of third quarter of 2016, there were derivatives outstanding with a notional value of over $177.0 trillion at the top 25 banks in the United States. (Source: “Quarterly Report on Bank Derivatives Activities,” Office of the Comptroller of the Currency, last accessed February 23, 2017.)
Of the $177.0 trillion, $132.0 trillion is made up of interest rate derivatives. Meaning, they are reliant on what happens to interest rates.
To give you some perspective on how big this is, the U.S. gross domestic product (GDP) in 2016 was about $17.0 trillion. Derivatives worth a notional value of $177.0 trillion are more than 10 times the size of the U.S. economy.
One Critical Question Investors Must Ask
Looking at this this, I just ask one thing: if the most basic interest rates are expected to move 300% higher, won’t it impact the derivatives at all?
It can. It might be foolish not to think that. The interest rates derivatives could be the one that could come under fire.
Here’s the thing: I know the $177.0 trillion is a notional value. But even famous investors like Warren Buffett have called them a sort of “financial weapons of mass destruction.”
Just a small percentage of bad calls on interest rate derivatives could cost a lot. This is going to sound bold, but it could quickly impact survivability of some banks. Very quickly, we could be seeing a banking crisis that spreads across the globe.
Mind you, this is the notional value of derivatives at major U.S. banks alone. If you look at the derivatives market globally, it’s several times the $177.0 trillion!
What Does It All Mean for Gold Prices?
Here’s the thing, when a banking crisis happens, it makes investors question the value of money and their wealth. They run toward things that have a long history of holding value and storing wealth. Gold does a great job of this; it has track record of several thousand years.
One of the best recent examples of this was back in the financial crisis of 2008 and 2009. The initial reaction by investors was very negative on the precious metal. But, as time passed, investors came to their senses and rushed toward gold and, in the process, we saw gold prices skyrocketing.
Going forward, interest rate hikes and the derivatives market will be interesting to watch. It could be the trigger that sends gold prices to $2,000 per ounce.
