Extraordinarily Bullish Fundamental Conditions For Gold and Silver

Two major gold and silver “friendly” events took place on Monday, May 1st. 

The FDIC-JP Morgan-First Republic Bank Deal

First, the government agency Federal Deposit Insurance Corporation (FDIC) announced that it would take over the failed First Republic Bank and sell it to JP Morgan. The second event was the disclosure by Treasury Secretary, Janet Yellen, that the Treasury would be out of cash and would be unable to pay government obligations as soon as June 1st if the debt ceiling is raised.

With respect to the First Republic deal, the phrase “JP Morgan will acquire” is deceptive. Drilling down into the finer details of the deal, it would be more appropriate to refer to the transaction as a deal in which the FDIC will give JPM a five-year, $50 billion subsidised loan to assume FRC’s deposits, $30 billion in securities and $178 billion in loans. Based on the latest FRC balance sheet, the failed bank has $18 billion of book equity.

In exchange, JPM will use that loan to pay the FDIC $10.6 billion and repay the $25 billion put up by other large banks. JPM is thus receiving a $14.4 billion subsidised loan to acquire $18 billion in book equity. 

In addition, the FDIC will provide 80% loss coverage on all of FRC’s single-family mortgages and commercial real estate loans, the sum of which represents 77% of FRC’s loan portfolio. At the same time, JPM will keep all of the debt service payments on those loans. 

JPM could be seen as getting the use of free money to take on cheap capital in the form of deposits and $133 billion of largely risk-free mortgages that generated the majority of FRC’s $923 million in net interest income in 2022. This is why JPM announced that the deal is $500 million accretive to net income, has a 20%-plus IRR and will enable a  $2.6 billion post-tax profit that will be recognised immediately, with $2 billion in restructuring costs to be recognised over time. 

JPM’s stock jumped 2.1% on a day when the rest of the stock market sold off.

Implications for Gold and Silver Prices

This deal is highly supportive of higher gold and silver prices because it essentially is a government-sponsored bailout of the large FRC depositors and a transfer of wealth from the FDIC to JP Morgan. While the FDIC is self-funding in times of economic growth, when a banking disaster hits (1990, 2008), the FDIC requires tax-payer funding. 

Furthermore, given the government’s financial intervention in the depositor bailouts connected to Silicon Valley Bank and Signature Bank, these “deals” are de facto Quantitative Easing (QE) bailouts.

The Federal Reserve’s balance ballooned up $400 billion after the SVB and Signature debacle. While it is starting to decline again, both the Fed and the Treasury have signalled to the markets a willingness to liquefy any big bank problems. As such, even before overt QE restarts – and while not direct bank bailouts but rather depositor bailouts – these deals engender additional moral hazard.

Depositors should treat their demand deposits and CDs like they are loans with default risk. Bailing out depositors removes this crucial element of accountability from the financial system. In that sense, these bailouts further devalue the US dollar and thereby are inflationary and extraordinarily favourable to gold and silver.

The Treasury’s Debt Ceiling Dilemma

With respect to the announcement from Janet Yellen about the potential Treasury default by early June, it’s clear that some type of deal will be negotiated by Congress to raise the Treasury debt limit. The Yellen disclosure reflects both out-of-control government spending and lower-than-expected tax revenues. The latter is a product of an economy that is much weaker than advertised. If a debt ceiling deal is not reached, the U.S. markets will collapse. 

The problem is that one of the largest cohorts of Treasury financiers: foreign sources of capital, will demand much higher rates.

The Role of Foreign Capital and the Fed

Higher interest rates will be required to entice foreign capital into the coming avalanche of new Treasury issuance. But the Government can not afford to pay higher interest costs on an expanded load of debt. The path of least resistance against market forces will require the Federal Reserve to fund a large portion of the coming increase in Government debt – in other words, the Fed will have to print more money – a lot of it. This is extraordinarily bullish for gold and silver.

Resilience and Future of Gold and Silver Prices

Though there has been an aggressive effort by Western bullion banks acting as agents on behalf of the Central Banks and sovereign entities to contain and prevent gold and silver prices from signalling the escalation in system instability, the gold price and silver price have been resilient at $2,000 and $24, respectively. It’s possible that new support bases at those two benchmark prices are forming to provide a launching pad for the move higher.  

In my opinion, gold will be well over $2,100 and silver will be well in the high $20s before the end of the third quarter this year. 

Dave Kranzler is a hedge fund manager, precious metals analyst and author. After years of trading expertise build-up on Wall Street, Dave now co-manages a Denver-based, precious metals and mining stock investment fund.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis. The opinions expressed in this article, do not purport to reflect the official policy or position of Kinesis.