Confusion Over Gold and Treasury Yields

The following article from Marketwatch is a perfect example of how confused market participants are about the recent and current action in gold and Treasury yields:

Gold and bonds do not usually go up or down together.

But try telling that to the markets over the last two months.

Since early August, in fact, gold bullion has risen by around 10% and the Treasury’s 10-year yield, which moves inversely with Treasury prices, has fallen by nearly 15%.

These moves are substantial, in other words, and more than just day-to-day noise in the data.

What’s going on?

Consider first why gold is so strong, reaching a new all-time high this week. One explanation is that this has been caused by a weaker U.S. dollar on the foreign exchange markets. This is certainly plausible, since the dollar has been very weak lately.

Another plausible explanation for gold’s strength is that it is discounting higher inflation in coming months and years. And it is indeed hard to imagine that the trillions of dollars that the world’s central banks have injected into the financial system won’t eventually have an impact on the inflation rate.

Credible as these explanations are, however, they are hard to square with strength in U.S. Treasury securities. A weaker dollar, of course, puts more pressure on the Federal Reserve to raise rates, which would in turn cause Treasury prices to fall, not rise. The same outcome would presumably result from higher inflation, too.

We reach a similar impasse when we consider why Treasury prices have been so strong. The standard explanation is that they are discounting a weaker-than-expected economy and/or deflation, which will cause rates to stay low. But those are hardly the preconditions of a gold bull market.

Either way you look at it, then, we come to the same conclusion: Recent trends are unsustainable. Something’s got to give.

Which will it be?

Several factors are pointing to the bond market as being the more vulnerable right now:

  • The stock market has also performed well of late, and equities would not thrive if the economy were weaker than expected or if deflation were a bigger-than-expected threat. So, in essence, the stock market is betting that gold is right and bonds are wrong.
  • Bond market sentiment is at near-record levels of bullishness right now, and (according to contrarians) the consensus is rarely right. ( Read my September 15 column on bond market sentiment.)
  • Sentiment among gold timers is remarkably restrained, if not outright gloomy, suggesting that there is a strong “wall of worry” for a bull market in gold to continue climbing. ( Read my October 6 column on gold market sentiment.)

The bottom line?

Don’t be surprised if the bond market over the next several months is markedly weaker than gold.

All this confusion regarding gold stems from one false pretense: that gold is an inflation hedge. It is not. Gold and Treasury Notes/Bonds are, as opposed to almost all other assets, up from October 07 levels for the exact opposite reason, deflation.

Read what I have written before, for example in Gold, Silver, Treasurys – A Snapshot.

Monetary commodities, such as gold and silver should act well during a deflation. Why? Because during deflation cash is king. And gold is the king of all cash.

Treasury Notes and Bonds are the ultimate deflation investment. Why? Because during deflation cash is king. And Treasury securities are the safest possible claim to cash at interest. Why? Because the government can always (and will) tax and loot the people to the hill to pay off its debts if it needs to.

Read the whole article, look at the predictions I made in there and look where we are today in terms of gold, silver, and Treasury yields. Market data can only be interpreted, understood, and predicted, when you have a sound economic footing to stand on.

I would like to ask the author: What if in addition to falling yields and rising gold prices, the dollar were to start rallying? How confused would he be then?

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