"The repression of Gold has now reached the stage where the US government has - wittingly or unwittingly - put at risk the markets for their life blood - their debt paper"
(The Privateer - Recent Events - Number 498 - Published on April 4, 2004)
Here is the record of the increase in Treasury debt yields in the five weeks since that comment was published:
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Please note that the far right column - "Percent" - simply shows the linear percentage increase in the yield over those five weeks. For example, the 0.77% (77bp) increase in the two year paper yield starting from a base of 1.85% gives a "percentage increase" of 185/77 or 41.62%.
And lest you get the impression that this bloodbath in the Treasuries markets was unique, US agency (GSE), corporate, and junk bond spreads all WIDENED over the week ending on May 7.
A large proportion of the damage done to the Treasury markets (and the other debt paper markets) was done on Friday, May 7, the same day that spot future Gold plunged $US 9.40 to a new 2004 low of $US 379.10, US stock markets slid closer to VITAL support points (the Dow closed down 124 at 10117) and the $US index rebounded upwards by 1.22 points to close just below its 2004 high.
The FOMC met on May 4 and did nothing except change the wording of their press release, but it was quite a change. Here's the last sentence: "At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured."
In other words" "Yep, we'll raise 'em, but not too fast". How fast is "too fast"? Well, only the Fed knows that for sure. The thing we noticed is that the T-Bill (three month) yield is now ABOVE the Fed Funds rate, and that hasn't happened since early (March - April) 2002 - when everybody KNEW that the US economy was "in recession".
Early 2002 was also notable for three other things. First, official Treasury debt was FROZEN - it had reached its "debt ceiling" but the Congress had not yet passed the legislation required to raise that debt ceiling. Second, the US Dollar bear market was just getting started. Third, Gold finally moved above the $US 300 level to stay after having spent almost all of the previous four and a half years pinned below that level.
The 2002 adventure proved to be a "hiccup" as far as Treasury debt markets were concerned. The debt ceiling was duly raised in April 2002 (and again to its present level of $US 7.384 TRILLION in May 2003) The Dollar continued to fall but Japan and China MASSIVELY increased their buying of Treasury paper. The T-Bill yield slipped back below the Fed Funds rate and there it stayed - until May 7, 2004.
One day does not a trend make, but the trend on Treasury yields is clear and unmistakeable. The US Treasury bubble popped in June 2003. Since then, there have been two HUGE increases in yields. The first took place from mid June to mid/late August 2003. The second got started in Mid March 2004 and is gathering steam. On May 7, it broke into new ground as the yields rose above their 2003 highs. With this going on, it must be pointed out that if the Fed waits until their next FOMC meeting on June 29-30, they will have left the Fed Funds rate at its 48 year low of 1.00% for over a year. At the rate Treasury yields are rising, who knows where they will be by that time.
The argument is now on in full force on two fronts. In general: What does the potentially imminent prospect of higher OFFICIAL US interest rates portend for the US economy and (paper) financial markets? In particular: How will Gold react to HIGHER Treasury (and agency and corporate and junk) paper yields?
The consensus answer to the first question is that higher yields will be "good" for the Dollar and that, in turn, will be "good" for the US economy. After all, it was the "strong Dollar policy" of Treasury secretaries Rubin and Summers in the second half of the 1990s which helped to pave the way for that fabulous era of "low inflation" and booming markets, wasn't it? The answer to the second question is unanimous. Higher Treasury yields are VERY bad for Gold (and silver). Why would anyone want to own these dust collecting metals when "safe and secure" US government debt paper is paying a HIGHER yield?
Washington doesn't want anyone thinking back to what happened in the era between the late 1960s and the start of the 1980s. Wall Street doesn't want anyone to do that either. We are already hearing on a regular basis the feverish denials that what is going on in Iraq now bears any resemblance to what went on in Vietnam in the 1970s. We are yet to hear any denials about any resemblance to the financial situation in the 1970s and today. To this point, both Washington and Wall Street are preserving the attitude that any such comparisons are ridiculous, frivolous, and downright idiotic. Funny, we remember the exact same attitude about comparisons between Iraq and Vietnam not very long ago.
The FACT is, of course, that the comparisons are startlingly obvious. We had the same KIND of situation at the start of the 1970s, and the history of the following decade is stark and clear. The difference today is one of DEGREE. Just as the policy predicament in which the Iraq intervention has landed the US Administration is VASTLY worse than was the Vietnam situation, the situation that the global financial system is in now is VASTLY worse than it was back when President Nixon panicked and closed the "Gold window" in 1971.
The Treasury bond rout which started in mid March didn't really get going until the last couple of trading days of March. Spot future Gold peaked, on a closing basis, at $US 427.80 on April 1. Since April one, the yield on "benchmark" Treasury ten-year bonds has risen from 3.88% to 4.77% - up 89 basis points or - on a purely linear calculation - 22.9%. Gold is down from $US 427.80 to $US 379.10 - down $US 48.70 or 11.4%.
This must surely prove Wall Street's contention that rising Treasury rates are "bad" for Gold, must it not? What it proves, to this point, is that the vast majority of investors, even those who are getting their (highly leveraged) heads handed to them in the bond markets, have only partially awakened to the danger which confronts them. They have firmly convinced themselves that the rise in yields is merely a reflection of the expectation that the Fed is about to start raising official rates. They have also firmly convinced themselves that the only reason that the Fed is about to start raising official rates is to "moderate" what would otherwise surely be a rampant breakout of new economic growth" in the US. The Fed induced "fear of deflation" is ended. There is now, instead, a fear of (price) inflation, which the Fed can control by the simple means of easing official US rates upward.
What they have utterly failed (or utterly refuse) to realise is that the stark jump in ALL US market rates which is gathering steam on a daily basis is a reaction to the concern about both the borrowers of US Dollars and the currency which they are borrowing. This concern has its basis in the obvious fact that US borrowers are in way over their heads (and leveraged to the hilt) at the same time as they are watching the "value" of their "assets" (stocks, bonds, paper claims to commodities etc) fall. Forget about repaying their debt, what if they can't service it. And since any sane investor knows that modern "money" is borrowed into existence, the trailing fear is what will happen to the Dollar if the unquenchable US consumer reaches his/her limit.
In financial circles, this is the great unmentionable. Even thinking about such matters cannot be countenanced. We are, as mentioned in the current issue of The Privateer in the midst of a period of disorientation. For years, an increase in "wealth" has been equated with an increase in (mostly paper) "asset prices" rather than with an increase in GENUINE productive capacity. All of a sudden, it seems, the avenues to such "wealth creation" are drying up because wherever one looks, paper "asset" prices are, at best, stationary and, in most cases, going DOWN.
As this process continues, the pressure to find a way to generate "wealth" in the paper markets will increase. As this search becomes more and more fruitless, the doubt about the whole idea of creating "wealth" through the paper markets will grow. And as THIS happens, the pressure will also grow to protect whatever "wealth" one already has. That is, of course, where Gold will come in, as it always does.
That is precisely the process that the investment world went through in the (very) early 1970s. It took a LOT of convincing, back then, before the VAST majority of investors finally abandoned their "wealth generating" paper "assets" for Gold and real goods. It may well not take as much convincing this time, since the situation in the paper "asset" markets is so much worse now than it was then.
We are in the "teething trouble" stages in the transition from paper "wealth" to REAL wealth. There is no way of knowing how distorted things will get (how low $US Gold will go) before the great "switch" begins to occur. But as we said at the beginning of this article - "...the US government has - wittingly or unwittingly - put at risk the markets for their life blood - their debt paper". They rescued that debt paper at the end of the 1970s with 20% plus interest rates. They can't do that now - it can only be done TO them by the rest of the world running headlong out of the Dollar and Dollar-denominated paper assets.
Even with its recent and sharp correction - which may not be over yet - Gold has maintained its purchasing power MUCH better than has ANY US paper "asset" since the Gold price first breached $US 300 to stay in March/April 2002. The contest is STILL between the US Dollar and Gold. There can be only one winner in that fight.