Gold Prices and the "Bond Bubble"

If investors turn their backs on Treasurys, Gold Prices could benefit...

LONG TERM gold bull Christian Magoon is perhaps best known for heading Claymore Securities, now Guggenheim Investments, where he led the charge marketing a number of successful niche funds—as well as a few flops, as he is quick to point out. These days, he leads Magoon Capital, a consulting firm that helps asset managers develop, launch and market ETFs. ETFs.

When he visited recently with IndexUniverse correspondent Cinthia Murphy, Magoon was quick to warn that the herd like flight to safety into bond funds recently looks like an accident waiting to happen for wary investors in search of a safe haven.

Murphy: You launched many ETFs in your days at Claymore and now you not only offer advice to asset managers, but you're on the blogging circuit as well. You write a lot about gold. What do you make of the recent gold slump? After an 11-year rally, has the gold market reached the end of its run?

Magoon: The main issue with gold is demand. Supply is very limited and costly to obtain, so the question about gold's future centers on demand. The two largest consumers of gold in the world today are China and India, and both economies are in a slowdown. China has been proactive with interest rate cuts and other measures to address its lagging growth, but it is still slowing. India has seen its currency lose 20 percent of value in a short time and GDP growth drop materially. All that curbs demand for gold.

Last year, the No. 1 category of consumption of gold was jewelry. Investment came second and usage in electronics was third. Jewelry is a discretionary purchase and jewelry consumption happens in good economic times, not bad.

Finally, you have the flight-to-safety phenomenon. The US Dollar and Treasurys have benefited the most from that flight to safety during the most recent crisis, not gold. And because gold is denominated in US Dollars, the strengthening of the Dollar has hurt Gold Prices too.

In the short term, a big question is whether China and India can rebound. I think they can.

Murphy: Taking China and India out of the equation, then, what do you see happening with this mad race into bonds? Where do you stand in this debate about a possible bond bubble?

Magoon: I think the flight to safety in US debt will ultimately prove to be a short-term trend. In the longer term, the US financial picture doesn't look very good unless tough decisions are made to correct the US debt profile.

Just because the US is the "best of the bad" in the debt-ridden developed world, doesn't mean that investors will stick with US debt as a safe haven forever. When the attractiveness of US debt unwinds, safe havens like precious metals will benefit, and gold is at the top of that list. But for now, I expect Gold Prices to be range-bound until a significant development in the EU or in global liquidity occurs. 

Murphy: One of the things we seem to be waiting for is whether the Fed will serve up another round of quantitative easing. Do you see QE3 in the cards?

Magoon: Well, QE3 would definitely be good for gold. Theoretically it would devalue the Dollar by increasing supply, which tends to also increase appetite for risk—both bullish for gold. It's worth noting that it wasn't until the FOMC indicated that no QE3 was expected back in February that Gold Prices started their downward momentum. A reversal in that posture would be significant.

Ultimately, something has to be done to encourage the US economy, so it seems likely to me that the Fed will step in with action other than "Operation Twist" because all the global economic turmoil—BRICs are slowing down, Europe is facing the debt crisis—will negatively impact the US economy. I wouldn't be surprised to see the Fed take action, but I'm not sure what form that action will come in.

Murphy: There's definitely an enormous amount of uncertainty in the air, which might explain, again, why investors seem so keen to pile into bonds even though US equities right now are yielding more than 10-year Treasurys, something that doesn't happen very often. How long will investors ignore these potential risks?

Magoon: It's troubling to see the amount of asset inflows, particularly coming from retail investors, going into fixed-income funds recently. Given the extremely low interest rate environment, piling into fixed income does not appear to be a good recipe for future investment success.

I see more opportunity in stocks than bonds, moving forward, but I understand it's easier to follow the crowd into bonds. Based off the last several years of performance, there's a tremendous amount of fear about the volatility of stocks. The fear of loss is dictating many investment decisions today.

This interview was republished at Hard Assets Investor.

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