More on bonds

19/11/2009 by Philinje.

The reasoning behind the dollar rallying if bonds fall is based on the scenario that bonds losing value could cause unwinding of carry trades, which will cause borrowed dollars to be returned.

However, there is a related scenario of bonds falling that would also be coincident with the dollar falling. This is the currency crisis that so many people have talked about. In this scenario foreign countries see no hope for the dollar and refuse to purchase more Treasuries - ie, countries like China would stop loaning money to the US.

There is already a trend getting started of countries purchasing less Treausries than before, at the same time that the Fed is buying Treasuries - aka Quantitative Easing. Initially the news that the Fed would do this caused bonds to rally, but then they dropped nearly to the 112 level, which is now the neckline of a Head and Shoulders top formation. Lately, 30-year Treasuries are staying high, near 120, but if they were to drop below 112, that would be a bad sign.

In the article below, the author notes that the Fed is currently buying almost half of all Treasuries that are auctioned, while countries like China are buying a lot less than they used to. So the Fed is propping up bonds by printing dollars, while forex traders are “selling” dollars to buy other things. In an extreme case, foreign owners of dollars and US bonds could flee the dollar, which would cause it to collapse. So many people are warning about this that it seems a tad unlikely.

Nevertheless, flight from the dollar would cause bonds and the dollar to sink together. But I suspect in the initial stages the dollar would rally, before giving up the ghost.

Here is the article:

http://www.gold-eagle.com/editorials_08/summers111109.html

The author is really saying that a collapse of stocks is actually more benign than a currency crisis or a country crisis. But there are intermediate stages where things may look different than he outlines.

Please note that in the stock crisis, the dollar will likely rise and gold may suffer, at least for a while. But it will suffer less than other assets. And in the currency crisis or country crisis, gold should go through the roof. It might be that we move from one stage to the next, and the transition from the stock crisis to the currency crisis will result in bonds falling while the dollar rises, at least temporarily.

Regardless, gold has the potential to rise even if the dollar is rising, and it can spike easily into the thousands after factoring in inflation from the last time that happened in 1980.

In the short term, gold hit $1150 and it looks like a correction is unfolding. If it holds above $1000, that might mean it has more legs and it could climb to above $1150 in the next few months. Everyone hates the dollar right now which is a reasonably good indication it will probably rise. But after a mild rally it could dive down to its all-time low of 71 and that could put the top in for gold, in the near term.

Or, something catapults the dollar, like bonds breaking below 112 because the Fed decides to ease off the Quantitative Easing. That would set in motion severe problems, like mortgage rates going up, so it’s not that likely, but in the meantime the Fed is monetizing US debt, ie printing dollars to loan dollars to the US, which is clearly dollar-negative and makes US bonds even less attractive.

If you’re trading gold, just keep mind that how the dollar behaves may be counter-intuitive, so stay alert. Otherwise, accumulate gold on dips, preferably physical gold. There is a lot of noise right now about fake gold bars being discovered (filled with tungsten). This is yet another sign that gold demand is outstripping supply, and that people are demanding physical delivery. For the average investor, gold coins and maybe gold at the Perth Mint are two good choices. I am still comfortable with BullionVault, but I know that’s not for everyone.

If a correction unfolds now, let’s see how gold does around $1000 - 1020. It might not even get there.

Posted in Gold | Print | No Comments »