This week has not been a politically or socially turbulent week. At least not as much as I feared seven days ago. But let me confess; gold is spoken everywhere. Last week I had a lot of talks about why gold isn’t doing any better. I wish I had a clear answer!
Some Opinions on Gold
As even a coup attempt in Washington derailed the markets, there were those who had gold as insurance against uncertainty selling.
Treasury returns rose 23% in the first 11 days of the year before returning to a touch when bond traders sold (pulling prices down and thus increasing returns) in anticipation that Biden would mean $ 2 trillion in new spending.
I think this – rising bond yields – will continue to be a problem in the short term, but it’s not a wind that will continue.
The Fed cannot allow rates to move much higher, because the enormous corporate debt burden means that a real and sustained increase in debt service costs will result in enormous damage. The problem can settle on its own (as a price investment, US bonds regain interest in the midst of growth) or require Fed intervention in line with yield curve control.
Real Interest Rates
Real interest rates increased. Because inflation expectations did not rise as much as bond yields. Inflation expectations are moving upwards, but the increase in this bond yield created a small increase in real interest rates in January.
Weak retail sales numbers in December and large increases in weekly unemployment demands added to questions about growth in the near term.
Reflation trading – buying things that perform when the incentive causes inflation – relies on incentives that generate growth. Because this is what creates inflation.
This is what happened. So what’s coming? This situation depends entirely on inflation. Or, if you prefer the term denoting inflation due to incentive, it depends on reflation. It is very difficult to know how this will develop. Many economists are confident that all incentive spending will generate inflation. I hope they are right. But there is the opposite data point: the speed of money.
The exchange does not think the incentive will create inflation this year because;
- There is no wage inflation pressure.
- GDP measures take into account growth but don’t account for wealth destruction and so it gets too rosy.
- The multiplier effect resulting from the incentive is “highly negative”, defined as the central government debt exceeding 60% of GDP. Of course, most of the world’s major economies meet this bar! The United States has doubled that at 127%.
- Finally: as the chart shows, the pace of money dropped 17.7% in 2020 so that the pace of the year was 1.2, the lowest level since 1946. ,
If money is not moving, it cannot create inflation. Hoisington and Hunt conclude that bond yields will continue to decline (which is a pro-gold outcome) but inflation will not occur (which is not helping gold).
As a result, it is bonds that rise for price increases. This game has worked well for several decades. As they stated in their last quarterly letters: “The 30-year US Treasury achieved a 20% return in as little as 12 months, compared to 18.4% for the S&P 500.” And the game works fine for gold.
If investors continue to buy bonds for return, bond prices will continue to rise and yields will fall. When I talk about real rates, I refer to nominal interest rates minus inflation. However, the market is watching closely, if not more, of actual returns.
These mean bond yields, minus inflation. Hoisington and Hunt may not think inflation is coming to help, but they are seeing returns continue to decline, which still supports the gold argument.
I’ve touched on all of this because I spend a lot of time thinking about whether inflation will actually rise in 2021.
I think differently. Fortunately, arguments like this reinforce that it doesn’t really matter. Of course, inflation will help the gold argument. But interest rates have already bottomed out, so while real rates are already pretty negative, real returns are falling steadily.
The fact that investing in bonds has become more of a price game than a game of returns changes the odds argument for gold slightly. Negative rates pushed investors away from bonds because the reason for buying bonds was for the yield. Now nobody buys bonds for return, so this argument is less convincing.
Instead, the argument is that the massive debt issues and debt burdens that have changed the bond game create a different need: hedging in a crisis situation. I’m not on doomsday, but today’s big picture doesn’t make much sense. There are very high stock prices in a recession. Zero when debt burdens are already too large
The demand for yield bonds is high.
Central government debt stands at 127% of gross domestic product in the region that hinders growth. Small business bankruptcies caused by COVID continue unabated on the right and left.
The markets can remain unreasonable for much longer than I have remained solvent so I am not betting an imminent crisis. But I can’t help but wonder if, when and how a reed will break this camel’s waist.
Gold is an answer to this concern. And while the logic of the yellow metal being perfectly inversely proportional to the actual proportions is weaker today than it was 20 years ago, the relationship remains very strong.
The bond has definitely been a price game since the Great Financial Crisis and yet the match remains strong! Going back to the first points I listed
I don’t think politics will be garbage. The economy will be somewhat similar to how the overly leveraged housing market triggered the Great Financial Crisis. And political safe haven seekers always come and go like the tides.
I really don’t think the Fed will allow Treasury returns to rise too much. And if Hoisington is right, they won’t have to worry about it. In other words, the pressure on gold will not continue from this increase in real return.
I don’t know about inflation.
The gold argument still makes a lot of sense. Real rates and real returns support this now and looking ahead. Diversifying it against the irrationality of today’s market supports it.
Gold miners make a lot of money and offer some of the strongest balance sheets and dividend returns on stocks. Inflation magnifies all of these, but this is not necessary.