What is the debasement trade and why is everyone on Wall Street talking about it?

Investor jitters over a weakening U.S. dollar, rising government debt and central bank monetary policy have fuelled discussion and debate on Wall Street about what JPMorgan Chase & Co. analysts coined “the debasement trade.” Here, the Financial Post explains what it means and how investors can protect their money.

In a nutshell, the trade is a reaction to the belief that inflation, deepening government deficits and monetary easing by central banks are devaluing traditional fiat currencies and sovereign bonds.

Fearing that purchasing power is disintegrating before their eyes, some investors are parking their cash in assets untethered to dilution, such as gold, silver and other precious metals, stocks, real estate and cryptocurrency.

“The value of the U.S. dollar in regard to what it’s able to purchase has become steadily worse since the 2008 financial crisis,” said Martin Pelletier, senior portfolio manager at Wellington-Altus Private Counsel. “As the de-dollarization accelerates, investors bid up hard assets, and those hard assets go up in value.”

Gold, the safe-haven poster child that investors turn to as a hedge against economic uncertainty, is a prime example. The precious metal’s spot price hit an all-time high of US$4,381 per ounce in October before pulling back. It has risen more than 60 per cent over the last year and is on track for its “strongest performance in a calendar year since 1979,” according to the World Gold Council. Prices for silver, platinum and palladium have also spiked.

Central banks are a driving force behind gold’s meteoric rise, having beefed up their reserves to over 1,000 tonnes annually over the last three years — from an average of 400 to 500 tonnes annually in the previous decade, according to the council’s 2025 central bank gold reserves survey.

“They’re consistently buying because they see what’s going on,” said Paul Wong, market strategist at Sprott Asset Management. “Think of central banks as the ultimate insider for the U.S. dollar and fiat assets. They see the dilutions and they have front row seats to all this.”

Examples of governments debasing currencies to fund spending date back to the Roman Empire, when Nero set a precedent by gradually reducing the content and purity of gold and silver in coins. King Henry VIII made similar moves between 1544 and 1551, a period known as “the great debasement.”

Wong said the debasement trade has been happening “forever” and goes through phases. In a report, he noted that the price of gold rose from US$35 per ounce in 1971 to more than US$800 per ounce by 1980 as “loose fiscal and monetary policy, combined with the oil shocks of 1973 and 1979, drove inflation sharply higher, weakened the U.S. dollar and contributed to an extended period of stagflation.”

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That period “established the foundational precedent for modern hard asset investing in environments characterized by currency debasement and inflationary pressure,” he said.

More recently, Pelletier said the debasement trade narrative has picked up steam as investors lose confidence in the value of the U.S. dollar and the U.S. government’s “persistent” deficit spending.

“When you expand money supply to finance very, very large deficits, it erodes the purchasing power of the currency. That’s exactly what’s happening in the U.S., through quantitative easing and through the Federal Reserve printing money to buy U.S. debt,” he said. “The U.S. is running a deficit equivalent to or maybe even larger than the 2008 financial crisis, despite the economy and the stock market doing okay.”

While there’s a particular focus on the U.S. dollar due to the greenback’s status as the world’s primary reserve currency, Pelletier said sovereign debt risk extends to other countries with high government debt-to-GDP ratios, including Canada, Japan, France, Singapore, Greece and Italy.

Pelletier said the falling interest rate environment of the last 30 years has been good for bonds, which performed well during market corrections and went up in value because of their perceived safety. But that has now changed — and so should the traditional portfolio allocation strategy of 60 per cent equities and 40 per cent bonds.

“We’re moving away from the traditional 60-40. We replaced our bonds with structured notes with embedded downside. We’ve added some commodities into our portfolio, specifically gold and silver and some gold producers,” said Pelletier.

Investors want to own assets that “cannot be printed or inflated away,” he said, including gold and silver, high-quality commodity producers, stocks and infrastructure assets.

“As an investor, having a little bit of gold in your portfolio is probably not a bad thing to protect yourself, especially if you don’t own assets like a house or stocks,” he said. “Stocks will do well because they will be inflated by the increase in money supply,” which is another reason owning a basket of commodities is good protection.

While bitcoin has been grouped into the debasement trade discussion as it reached an all-time high in October, Pelletier said cryptocurrency volatility and drawdown exposure make it a riskier bet compared to other financial assets.

“I can’t live with a 60 per cent or 70 per cent correction, and I don’t think most people can either,” said Pelletier. “Until that changes, I don’t think bitcoin will be mainstream. It may be more along the lines of a speculative asset among younger people, and that’s okay. But we have to see some stability in its downturn during a market correction, and we haven’t seen that yet.”

• Email: jswitzer@postmedia.com

What is the debasement trade and why is everyone on Wall Street talking about it?

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