Gold Vs Treasuries - Which Do You Believe?

Gold Vs Treasuries - Which Do You Believe?Any psychoanalyst looking at the behavior of investors today would see clear strains of schizophrenia in a comparison between the markets for gold and US Treasuries.    
Currently, the 10-year Treasury yield is setting new lows on a daily basis. In the financial models all economists were taught at school, this would be an indication of an economy with low inflation expectations and a strong currency. But the dollar has fallen over 12% since June, and the price of gold continues to hit all-time highs. These results are completely antithetical. Bonds are flashing a warning sign of deflation, while gold and the dollar presage hyperinflation.
During the last period in which the US experienced significant economic stress, the late 70's and early 80's, the markets in gold and Treasuries showed a much higher degree of harmony. At that time, the Fed's extreme depression of interest rates led to rapidly rising inflation, a weakening dollar, and a massive spike in the price of gold. More significantly, yields on Treasuries soared as investors demanded higher rates as compensation for the added inflation risk. In other words, everything made sense.
Beginning in January of 1977, gold began an epic bull market which ended just prior to February of 1980. In that time, the metal soared from $135 per ounce to just under $860 per ounce, and the Dollar Index lost about 20% of its value. Yields on the 10-year Treasury soared from 7.2% in January of 1977 to 12.4% in February of 1980. This occurred in an environment where the Federal Reserve - under Arthur Burns - pursued an inflationary monetary policy. He increased the monetary base from $62 billion to $114 billion in just eight years.
Today, the environment is similar to what the country confronted 30 years ago. Like then, our monetary base has surged - but this time even faster. Instead of merely doubling in eight years as it did under Burns' watch, Alan Greenspan and Ben Bernanke have tripled the base in twelve years (from $621 billion in 2000 to over $2 trillion today). Accordingly, the dollar price of gold has more than quadrupled, from $280 per ounce in 2000 to over $1,300 today. Over that time, the dollar has registered a 35% drop in value. However, in stark contrast to 1980, the yield on the 10-year Treasury note has collapsed from 6.6% in 2000 to less than 2.4% today.
A nation should only be able to enjoy ultra-low interest rates if it has a high savings rate, stable monetary policy, low inflation, and very low levels of debt. The US savings rate, which had been range-bound between 7.5% and 15% during the '60s and '70s, now stands at just 5.8%. And that rate reflects recent belt-tightening in the wake of the credit crunch. The personal savings rate had been negligible and sometimes negative from 1998 thru 2008. Washington's current annual budget deficit is 9% of GDP and the national debt is 93% of GDP. And, of course, the Fed has - in its own words - undertaken "unconventional measures" to push up inflation. Therefore, none of the conditions that should engender low interest rates currently exist.
Clearly both gold and the US dollar agree that Ben Bernanke will be victorious in his quest to foment robust inflation. But Treasury investors seem to believe that despite its current inflationary disposition, the Fed will be able to either: A) hold down interest rates for an extended period or B) withdraw its liquidity before things get out of hand. To take this position, one would have to not only believe that the forex and gold markets have it wrong, but also think that the Fed's printing press will lose its power to depreciate the currency. This is a seriously misguided set of assumptions.
Bernanke asserts that the Fed brought on the Great Depression by allowing the money supply to contract by 30% after the Crash of 1929. He has also written that the Depression relapse of 1937 stemmed from Washington's attempt to balance the budget and raise interest rates. Therefore, I can reasonably assume that he will not stop the presses until inflation has a firm and undeniable grip on the American economy.
Many currently believe that 'Helicopter Ben' has yet to ignite inflation on the ground because the money he dropped from the sky is still stuck in the trees. In other words, the funds are caught in the banking system and not spreading among the populace. Yet, M1 is up 6.2% YoY; and, in the last two months, the compounded annual rate of change in M2 is 7.4%. Although these single-digit increases do not yet indicate runaway inflation, a program of relentless quantitative easing has a conclusion as predictable as driving 100mph around an icy mountain turn. Since the Chairman has shown no will to hit the brakes, you'd have to be mad to ride the yield curve alongside him.

Michael Pento

Senior Market Strategist
Delta Global Advisors, Inc.

Delta Global Advisors : 19051 Goldenwest, #106-116 Huntington Beach, CA 92648 Phone: 800-485-1220 Fax: 800-485-1225

A 15-year industry veteran whose career began as a trader on the floor of the New York Stock Exchange, Michael Pento recently served as a Vice President of Investments for GunnAllen Financial.  Previously, he managed individual portfolios as a Vice President for First Montauk Securities, where he focused on options management and advanced yield-enhancing strategies to increase portfolio returns.  He is also a published economic theorist in the Austrian school of economic theory.

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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

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