Corporate defaults and Gold

(May 3, 2016 - by Arkadiusz Siero?)

So far this year, 46 companies across the world have defaulted on their debt (worth $50 billion), the highest number since the recent financial crisis, according to a study by credit rating agency Standard & Poor’s. The rise in defaults is caused by declining corporate revenues and earnings. Indeed, corporate earnings have fallen 18.5 percent from their peak in late 2014 and are estimated to decline 8.5 percent in the first quarter of 2016 on an annual basis. The trend has been led by the plunge in commodity prices and a slowdown in economic growth, which has made it harder for many companies to repay their debts. For example, Peabody Energy, the world’s largest privately owned coal producer and the second biggest on earth, filed for U.S. bankruptcy protection in April. Analysts warn against the tidal wave of corporate defaults. Moody’s expect that corporate defaults will rise 30 percent in 2016. Deutsche Bank believes that the worst is still ahead of us, as the default cycle will peak in 2017 and 2018.

One might now ask why the stock prices are soaring if corporate earnings are falling while defaults are rising. It would be an excellent question without a good answer. One possible solution is that corporations are issuing debt in order to buy back their shares. Anyway, the current situation is rather unstable in the long-term, especially if the Fed hikes interest rates further, which would put additional pressure on the companies’ ability to service their debt.

The key takeaway is that global defaults are on the rising track. We also see a deterioration in credit quality as the number of corporate debt downgrades is increasing. It implies that companies are facing problems with paying their debts. Therefore, the number of stock buybacks financed by debt is going to be limited. The curtailed share buybacks may pull a prop out from under the stock market. Such a scenario would be positive for the gold prices as turmoil in the stock market would increase the safe-haven bids for the shiny metal.