How are the bond markets and precious metals linked?
Posted on 31 May 2011 with 6 comments from readers
Recent rather extreme forecasts for the future of precious metal prices rely on a bond market crisis to produce an exit to gold and silver as the ultimate in safe currencies (click here). But it is quite reasonable to ask, at the simplest level, how the relationship between bond markets and precious metals works.
This is not only a theory. There have been many crises with paper money at various times in history. The rush to gold and silver has always followed, although to be fair in many cases paper money has been able to stage a recovery in due course, albeit not without huge financial losses and wealth destruction.
Greek tragedy
Look at the present Greek bond crisis for an example of a bond market coming up to default or something that will be a default even if the word used is different. Basically interest rates on Greek debt are now so high that there is no way they can afford to pay this amount, let alone return the original investors’ money.
That has already weakened the euro, despite the fact that the Greek economy is a tiny fraction of the whole European Union. The euro has gone down against the dollar. Gold is priced in dollars and now we have a record high for gold if priced in euros.
Now that is happening just with Greece rocking the bond market. What about when Spain, Italy, Ireland and Portugal join in again? But of course something very similar is occurring on the other side of the Atlantic too.
The Federal Reserve is financing the US deficit by buying up its own treasury bonds. This is what they call quantitative easing but it is money printing by any other name. Now if you boost the money supply in terms of paper dollars, gold which is in fixed supply will be worth more.
Tipping point
But as this process accelerates the bond market will reach a tipping point where investors loose confidence, and demand more interest to stay invested as they have done in Greece.
Bond prices are inversely related to interest rates. If a bond pays more interest it is worth less, and vice-versa. Sharp rises in interest rates therefore mean a sudden loss of capital for bond holders.
In a crisis then there is a rush to pull money out of bonds and one store of value that can be immediately relied upon is gold and silver. But as reserves of gold and silver are limited so the sudden surge in demand sends the price sky high.
When do bond markets tip over? When debts become clearly unsustainable as in Greece. We are clearly going to see a lot more of this over the next few years, and as investors exit bonds gold and silver will rise accordingly. That is why investors in precious metals can be confident about the future.
6 Comments posted by readers:
A noteworthy commentary, Peter.
Your commentary reminds me of the now “hallowed” analyses entitled Gibson’s Paradox, which proves that there is a very strong relationship and strong interconnection between gold prices and interest rates (and by inference strong relationships to bonds as well as inflation).
Based on lots of old and detailed analyses, Lawrence Summers (yeah, that same untrustworthy guy who was Obama’s Chief Economic Advisor and also Clinton’s Treasury Secretary) co-authored another analysis of Gibson’s Paradox. You can read it here:
http://www.gold-eagle.com/editorials_01/howe082201.html
Who was it that said “the bond markets are the most powerful force in the world?” A true statement, that one! Back on subject, I believe the bond markets will finally tip over when the Central Banks, led by the US FED, can no longer continue to massively manipulate it.
But nobody knows exactly when that tipping point will be; perhaps the Central Banks can endure for another six to nine months?
I like this approach, put forth by the editor of “The Daily Capitalist”:
http://dailycapitalist.com/2011/05/30/gold-and-us-treasurys/#more-10955
In a way, he’s saying “have your cake and eat it too, for now…” That is to say, you can find safety in gold AND U.S. Treasuries, because, well, because everybody is flocking to both those assets to protect their… assets.
Sean Egan says Europe is to be a ‘dead zone for 5-10 years, maybe longer’, European banks to be in BIG trouble because, unlike the US ones after 2008, they won’t have access to a LOT of new capital. Greek debt holders will be lucky to get 25 cents on their dollar. (OUCH!) Capital will flow out of Europe to the USA & emerging market. He just said all that on CNBC Fast Money.
A Fast Money guy said no, Germany will carry everyone.
Germany is to phase out nukes. France (nuclear electricity) and Russia (gas) will make some cash on that plan. I heard on the tele that that French are going to run electric cables through the Chunnel to the Brits. Those British millionaires had better quit buying all those nice French farms, or one day the French might pull the plug.
Here in Louisiana we are going to start exporting LNG. How smart we Americans are! We learned nothing by exporting all our oil. Now we will export the only fossil fuel we have left. That is what happens when the greedy super rich control the government in Washington, and the politicians are too busy figuring out how they can steal more, rather than spend any time planning for the energy future of their grandchildren who will be left with no energy, or fertilizer which is made from natural gas. Is the plan food aid from Brazil?
But that is OK because, according to Paul Farrell, the day of reckoning isn’t too far off. He launched another verbal attack on the Market Watch site yesterday. If he lived in Russia, he would have had a fatal ‘accident’ long ago.
Gold will go up, but not to $13,000. The Fed won’t create enough money to let that happen. The USA isn’t Zimbabwe. Washington wants inflation, but not hyperinflation.
Now it is time to unwrap the new pressure washer. I was just going to use bleach to remove all the mildew from my patio, driveways, and sidewalks until I learned that bleach was one of the few chemicals that could destroy chlordane termite treatment. I know it can eat through your skin, as I found out once cleaning the mildew off my house, so as not to paint over it, and have it bleed through the new paint. Mildew sucks, but I will take it over desert dust any day.
The funny thing is that bleach only eats down to the nerves in certain places. You learn the meaning of ‘burn’ wherever it does. You will find fresh water to wash it off very fast.
I will be shocked if gold doesn’t take platinum up with it. Platinum is far more useful than gold. Harder to find and mine too.
Another Congressman has sent out a lewd photo on twitter to some woman. They have their priorities up there in Washington, besides an energy plan and raising the debt ceiling so as to avoid a default on the world’s largest debt.
Syria is starting to spiral out of control. They are lucky Bush isn’t in there because with the picture of the 13 year old boy that they cut up, he might order a armored attack supported by bombing and attack choppers. If you can keep ammo & fuel flowing to them with clean skies above, they can eat up territory faster than the enemy can respond.
james carville,clinton’s campaign manager said “i now want to be reincarnated as the bond market so i can intimidate everyone in the world”
the US being the printer of the worlds reserve currency for now, and the largest economy in the world for years to come, will have a bond vigilante fate way farther down the road than greece, but it will come.
gold takes platinum up with it but not as much….they will not have to print enough money for gold to go to 13,000$…as long as the real interest rate(negative now) is less than inflation gold goes up….period….. no doubt 1oz. of gold buys the DOW in years to come.
dollar has turned over and looking like ‘78?::::
http://www.financialsense.com/contributors/chris-puplava/biggest-inflection-point-of-the-year
@ Boatman:
Yep! Right about Carville. He also said:
“When I die I want to come back as the bond market because apparently it’s more important than the &%#&^ Pope!”
‘nother possible indicator Obie:
http://historysquared.com/