Thursday, November 26, 2009

Gold- U.S. Treasury Note and Bond Prices-U.S. Dollar

1. Treasury Yields-Gold-U.S. Dollar: Prices for U.S. treasury notes and bonds rose Wednesday as investors were eager to buy seven year treasury notes at auction with yields of 2.835% with the OID. pdf The U.S. dollar continued to slide with the Euro surging to over a $1.51, while gold continued its inverse relationship to the dollar rising $21.20 to $1,188.6 an ounce for the February gold contract on the Nymex. The WSJ had an article saying that gold rose on inflation fears. Well, if that was true, why did treasury notes and bonds rise in price and fall in yield. The 10 year treasury note rose 11/32 to yield 3.279%, and the 30 year T bond increased in price by a similar amount to yield 4.238%.

A lot of explanation can be given for this action. One esoteric rationale is that gold is no longer an inflation hedge, at least in the current cycle, but a quasi reserve currency that has at least temporarily replaced the dollar as a repository of safety. From my perspective, which is apparently shared by many others, the Federal Reserve has embarked on a campaign to debase the value of the currency with its monetary policy and quantitative easing.

A simpler explanation is that the Federal Reserve and other central banks have signaled their intent to keep interest rates at abnormally low levels for an extended period, which causes many investors to take more risks, and that would include borrowing money in dollars and yen and buying more risky assets like gold. There were reports on Thanksgiving, for example, that some large investors were selling the dollar and buying gold.

Another issue is that gold looks expensive to a U.S. citizen but it not as expensive to a European desiring to make a purchase in Euros. While a U.S. citizen could have purchased an ounce of gold bullion for $1192 last Wednesday, the same ounce of gold would have cost only 788 Euros.

Sometimes, prices go up because prices have been going up, which draws more people into the trade, thereby creating more demand, and that in turn causes prices to rise, and so on until it bursts. I suspect that this kind of herd behavior is the main impetus now in the rise of gold and the fall in the dollar. The stories that people tell themselves and others about the reasons for a price rise play an important role in continuing and accelerating the rise.

Lastly, in the current bull market for gold, it is not being bought primarily as a hedge for inflation, but as a hedge for some type of financial Armageddon event. The news about Dubai World, thought to have over 60 billion in debt, asking for a moratorium on debt payments to May of next year stokes this kind of fear which may still be simmering just on the surface of the psyche even now.

Since I am psychologically unable to sell my gold (or silver), sitting in a bank lock box, I am going to continue with my hedge program for the physical bullion as previously scheduled, and I will continue inching into my Euro hedge too. I bought my first gold coin when I was 13 with money received from mowing lawns at $2 per lawn. It cost me $35 for a 19th century five dollar gold piece. Back then, you could not buy gold bullion. I continued buying as an adult until the price exceeded $300 per ounce and then I just stopped. I do not believe that any of the purchases as an adult was as an inflation hedge. The purchases and the current hoarding are more of a hedge against most other assets collapsing in value. It is unusual for gold to have one of its best bull runs during a period of disinflation. The prior bull run occurred during the hyper inflationary period of the late 1970s and early 1980s. While some may fear inflation returning to hyper rates now, and that causes them to buy, the bond market is signaling that there is no serious inflation problem on the horizon. It is therefore hard to visualize inflation concerns being the impetus in the current bull market for gold.

During the prior heightened concerns of financial collapse, between September 2008 to March 2009, the dollar gained in value, as shown in the DXY chart. DXY Index Charts - US Dollar Index Future (a rise in DXY indicates the dollar is gaining strength against a basket of foreign currencies) It will be interested to see how the dollar reacts on Friday to the Dubai news. It is my understanding that a lot of European banks have some exposure to Dubai World.

One correlation, though, makes no sense to me. I am having some trouble understanding why gold is rising without inflation, treasury prices are rising along the entire yield spectrum to produce yields near historic lows, and the dollar is falling into some kind of abyss. The last part of that trade, the fall in the dollar, makes no sense to me with bond prices and gold prices rising.


  1. I'm all for having some gold in your portfolio. Just don't overdo it. People keep repeating that gold is some kind of hedge against inflation but the fact of the matter is that gold has done pretty badly inflation wise. Especially if you compare it against other investments.

  2. Gold did well against inflation during the period from 1973 to 1980, when it peaked at around $850 an ounce, moving up from around $100 in 1973. In 2009 dollars gold would have to rise to close to $2200 an ounce now to equal that 1980 peak adjusted for inflation.

    So, gold was a terrible investment from 1980 until about 2004 when it entered a new bull market: Since then gold has risen from around $400 to the current price of close to $1200 with most of the increase occurring during the recession starting in October 2007. My purchases were at less than $300, mostly in the 1998 to 2001 period, with none made after 2001. If I totaled it up, which I have not done, it might be 2% of my net worth.

    I do not view the current bull cycle in gold to be related to inflation concerns. At best gold has outperformed inflation for limited time periods. The underperformance compared to inflation between 1980 to 2004 means that a holder since 1980 would have to have the price to double from current levels to just about break even adjusted for inflation since 1980.