Must-know: Understanding gold price drivers (Part 5 of 12)
What is debt to GDP and why is it important?
Debt to gross domestic product (or GDP) is the ratio that shows how much a country owes versus how much it earns. Investors use this ratio measure a country’s ability to make future payments on its debt. This impacts the country’s borrowing costs and government bond yields.
How high the ratio is dangerous?
Although there isn’t a benchmark to make a particular ratio a cut-off, the higher the debt, the bigger the problem. A ratio greater than 100% would mean that the economy has accumulated high levels of debt compared to its GDP. A ratio below 50% is considered healthy. A ratio above 90% is considered the danger zone. However, it’s also important to remember that it isn’t just this ratio that determines a country’s economic growth prospects. A country with a higher ratio could be doing fine if its growth prospects are good. In contrast, a country with a low ratio could have a poor credit rating and bleak economic prospects.
How does ballooning debt to GDP impact gold prices?
This is where the “fear factor” comes into play. It also shows people’s faith in gold. The above chart shows that as the U.S. public debt to GDP kept increasing, so did the gold price. The main concern regarding ballooning debt is that as it rises beyond a certain point, the country would have to increase taxes and cut spending in productive areas. This would allow the country to service the interest costs. This has a negative impact on economic growth. Investors lose faith in the country’s growth prospects. This causes bond prices to fall and yields soar. As a result, investment flows back to gold.
The negative impact can be studied to determine the direction of gold price and stocks (GDX) like Goldcorp Inc. (GG), Barrick Gold Corp. (ABX), Newmont Mining Corporation (NEM), Agnico-Eagle Mines (or AEM), Yamana Gold (or AUY), and exchange-traded funds (or ETFs) like the SPDR Gold Trust (GLD).
Visit the Market Realist Gold ETFs page to learn more about investing in gold.
Browse this series on Market Realist: