This text was written at the end of February, so it does not take into account many developments that occurred since then. More timely analyses you will find in the Fundamental Gold Reports or in the April edition of the Gold Market Overview.

The outbreak of the coronavirus disease (COVID-19), caused by SARS-CoV-2, in China has prompted considerable concern over its impact on the global economy. The scope of opinions is very large as usual. Some analysts claim that the coronavirus outbreak will trigger the recession, while the others tone emotions, arguing that the new virus will be quickly contained and the global economy will almost completely make up all the losses from the Q1. Let’s figure out where the truth lies!

Generally speaking, the economic impact of epidemics comes from two sides. On the demand side of the economy, there is a decline in consumer expenditures. People are either ill or they try to avoid getting sick. So they put themselves in a “self-quarantine”, i.e., they stay at home instead of travelling, going to shopping malls, restaurants, cinemas, etc. Although a drop in the demand reduces the GDP growth in the short term, the compressed spending should reverse when the epidemic is contained (or translate into investments via savings). Moreover, the government can step in, increasing its health system expenditures.

So, it seems that the effects on the supply side of the economy are more important. First of all, the epidemics reduce the supply of labor. In most cases temporarily, as some workers get ill but recover or they simply prefer to stay under quarantine rather than going to work. Investors should acknowledge that almost all Chinese regions have announced extended work stoppage for non-essential enterprises, and that quarantine was imposed on millions of people. The industrial production, thus, declined (in February, coal consumption decreased more than 30 percent annually). And, unfortunately, as some people die, there is also a permanent reduction in the supply of labor, which shrinks the economy.

We can also split the economic costs of a pandemic into three main categories: according to the World Bank, about 12 percent of total costs comes from mortality, 28 percent from high worker absenteeism, and 60 percent of the impact is due to demand and supply shifts driven by people’s avoidance reactions. It means that the new coronavirus does not have to be very deadly to be economically costly.

Moreover, during a severe pandemic, all sectors of the economy face disruption, potentially leading to shortages and higher inflation – the resulting stagflation should be supportive for the gold prices. It is important to remember that leading Japanese and European carmakers have factories in Hubei province, where the new coronavirus originated, which has already negatively affected the global production of vehicles.

The reduced economic activity generates lower tax revenues. As it happens precisely when the government increases its spending, the effect is wider fiscal deficit, which may lead to fiscal stress and also support gold prices. As a reminder, the China’s general government debt has already increased from 27 percent in 2002, at the time of SARS, to 51 percent in 2018.

In total, the estimates in the Bulletin of the World Health Organization place the cost of a severe pandemic (similar to the 1918 Spanish flu) at 0.6 percent of global income. The Congressional Budget Office estimates the costs of a potential influenza pandemic at 4.25 percent of GDP in the severe scenario (similar to the 1918 Spanish flu) and about 1 percent in the mild scenario. The World Bank argues that it could reduce world’s GDP even by 4.8 percent, or roughly $3 trillion, in the severe scenario, 2 percent in the moderate case, and 0.7 percent in the mild scenario. It seems a lot, but the aggregate cumulative GDP losses for Guinea, Sierra Leone and Liberia in 2014 and 2015 caused by the Western African Ebola are estimated to amount to more than 10 percent of GDP, although the death toll was “only” around 11,300 people. The influenza pandemics of 1958, although far less deadly than the Spanish flu of 1918, is estimated to cost 3.1 percent of the global GDP.

Moreover, pandemics can have significant social and political consequences, such as heightening social tension, rising discrimination and protectionism. In particular, a Chinese regime hit by the COVID-19 could be tempted to find an external scapegoat and adopt a more aggressive stance toward Hong Kong, Taiwan or the US.  

So, a severe pandemic on the scale of the 1918 Spanish flu could cause significant and lasting economic damage. But – and luckily! – the COVID-19 is not similar to the Spanish flu. It should rather be compared to the SARS outbreak, which was also caused by the coronavirus and originated in China. The SARS pandemic slowed China’s real GDP from 10.5 percent in the Q1 2003 to 8.9 percent in the Q2 2003, but the GDP growth has rebounded in the next quarter. Overall, the economic costs of SARS for China’s GDP are estimated to be somewhere between 0.5 to 1 percentage point (counterfactually, as one cannot practically see any damage in the annual GDP growth).

However, the economic impact of the COVID-19 might be significantly higher than in case of SARS. This is because the role of China in the global economy has significantly increased. In 2003, China represented only about 8.3 percent of the world economy, while it now represents about 19.3 percent, as the chart below shows.

_{Chart 1: China’s share of world’s GDP (based on the PPP) from 2002 to 2019.}

The country is also more linked with the rest of the globe. For example, China’s international air traffic rose from only 5 million in 2000 to almost 55 million currently. Importantly, China has also become a major part of global supply chains, which could have important repercussions for international companies, as the Apple’s announcement highlighted. Another difference is that China has much higher debt: the total private debt (loans and debt securities) ballooned from 102 percent of GDP at the end of 2002 to 208 percent of GDP at the end of 2018. Last but not least, the recent coronavirus outbreak occurred during the economic slowdown. At the time of SARS, China’s GDP was expanding by about 10 percent annually, while its growth has been reduced to just over 6 percent currently, as one can see in the chart below.

_{Chart 2: China’s annual real GDP growth from 2001 to 2019.}

For these reasons, the GDP growth in China could slow down by about 2 percentage points in the Q1 and by 0.5-1 percentage point in the full year. And what about the US? Given the links between Chinese and American economies, it suggests that the economic growth in the US could slow by about 0.4 percentage point in the first quarter, although some analysts expect even a reduction of a 0.8 percentage point. The growth in Europe in general and in Germany in particular may decelerate even more, as it is more dependent on trade with China.

What does it all mean for the gold market? Well, the economic impact of COVID-19 will be larger than in case of SARS. It still may be temporary – after all, shocks are temporary by definition – but even temporary disruptions may be too much for the already fragile global economic growth. Although still a lot depends on how the COVID-19 will evolve, the spread of the new coronavirus outside China implies that its effect will not be a two-month issue that would be followed by strong growth, as the analysts predicted earlier. It means that the chances of global recession in 2020 have increased. Gold likes it!

If you enjoyed the above analysis and would you like to know more about the links between the coronavirus epidemic and the gold market, we invite you to read the March Market Overview report. If you’re interested in the detailed price analysis and price projections with targets, we invite you to sign up for our Gold & Silver Trading Alerts. If you’re not ready to subscribe yet and are not on our gold mailing list yet, we urge you to sign up. It’s free and if you don’t like it, you can easily unsubscribe. Sign up today!

Thank you.
Arkadiusz Sieron, PhD
Sunshine Profits – Effective Investments Throuh Diligence and Care