Which Market has it Right; <b>Gold</b> and the Dollar or Treasuries?

The U.S. 10 year Treasury yield is setting new lows on a daily basis, but the dollar has fallen over 12% since June and the price of Gold continues to hit all time highs. These dramatically unbalanced market conditions are completely antithetical, as Bonds are flashing a warning sign of deflation, while gold and the dollar presage hyperinflation.

But back in the late 70's and the beginning of 1980 those same markets were much more aligned and did not display different signals. During the country's last major battle with rapidly rising inflation due to the Fed's massive manipulation of interest rates and currency, gold advanced higher while the value of the U.S. dollar fell and yields on Treasuries soared. In other words, everything made sense.

In January of 1977 the dollar price of gold began an epic bull market, which ended just prior to February of 1980. Gold soared from $135 dollars per ounce to just under $860 per ounce during those three years. And the Dollar Index lost about 20% of its value in that same time frame. Not surprisingly, the yield on the Ten Year Treasury soared from 7.2% in January of 1977 to 12.4% in February of 1980. So all markets were in accord and reacted appropriately during an environment where the Federal Reserve-- under Arthur Burns--pursued an inflationary monetary policy. During his tenure the monetary base jumped from $62 billion to $114 billion in just eight years.

The situation for the dollar, gold and the Fed's monetary base are similar today with that of 30 years ago, except for the fact that bond yields are plummeting instead of soaring. Since the year 2000, the dollar price of gold has increased from $280 per ounce to over $1,300 today. And the dollar has lost 35% of its value as measured against a basket of our 6 largest trading partners since the beginning of this millennium. But despite the fact that the monetary base has jumped from $621 billion in the year 2000 to over $2 trillion today, the 10 year Treasury note has collapsed in yield from 6.6% to fewer than 2.4%.

However, a country should only enjoy a 10 year note with yields sub 2.4% if it has a significantly high savings rate, a stable monetary policy-along with the low inflation and steady currency that it brings--and very low levels of debt. The U.S. savings rate, which had been range bound from 7.5% to nearly 15% during the 60's and 70's, now stands at just 5.8% today. And that savings rate has only increased recently due to this great recession. The personal savings rate had been negligible and sometimes negative from 1998 thru 2008. Our current annual budget deficit is 9% of GDP and our National Debt is 93% of GDP. And, of course, the Fed-in their own words--has undertaken "unconventional measures" to destabilize the dollar. Therefore, none of those situations that would engender low interest rates currency exists.

So given all this data, which market has it correct; gold and currencies or Treasuries? Clearly, both gold and the U.S. dollar agree that Ben Bernanke will be victorious in his quest to foment a robust rate of inflation. But this time around Treasury investors have been duped into believing that the Fed can force down interest rates for an extended period of time by creating more inflation. To think that Treasuries have it correct one must believe not only that the FX and gold market have it wrong but that the Fed's printing press will lose its power to depreciate the currency.

Remember this; Bernanke believes the Fed was to blame for causing the Great Depression by allowing the money supply to shrink by 30%. And eight years into the Great Depression there was a relapse into economic devastation. A relapse by the way that Bernanke believes stemmed from an attempt to balance the budget and raise interest rates. Therefore, he won't desist until inflation has taken a firm and unbreakable grip over the nation.

Be sure you don't believe the hype you hear about all of Helicopter Ben's money being stuck in the trees and laying fallow at the Fed. M1 is up 6.2% YOY and in the last two months the compounded annual rate of change in M2 is 7.4%. The growth in the money supply has sent the CRB Index up over 13% in the last 12 months. That's certainly not evidence of soaring prices and the increase in those monetary aggregates does not indicate runaway inflation is here yet, but given the Fed's pursuit of an endless series of QE, intractable inflation can't be too far off. And since the Chairman has an unlimited supply of dollars and an infinite will to print them, it would be a perilous mistake to bet against him.

Michael Pento
Euro Pacific Capital
Senior Economist/Vice President Managed Products
mpento@europac.net
www.europac.net
800-727-7922 ext. 235
732-203-1333

View the original article here