Gold News

Bond vigilantes hooked on gold

Why buy government bonds as a safe haven when gold is outpacing them 5 times over...?

AS COMMODITY AND STOCK MARKETS boom in all corners of the earth, and out-of-control money supply fuels inflation, the global "bond vigilantes" should be reacting by selling bonds and jacking up long-term interest rates.

   But instead, global bond yields have tumbled by anywhere from 50 to 75 basis points since mid-July, when the sub-prime debt crisis was first revealed.

   Now, while the US economy slide towards "stagflation" – that mix of recession plus inflation last seen in the late '70s/early '80s – other economies, including Australia, Brazil, Hong Kong, India, Japan, Russia, and South Korea, are de-coupling away from the US locomotive, becoming more "China-centric."

   They're feeding on the world's fastest-growing economy, which is booming ahead at a 12% annualized clip.

   Federal Reserve rate cuts, therefore, are simply adding more firepower to the "Commodity Super Cycle" which is increasingly fueled by a strong global economy, and no longer just relies on the United States.

   In the $11 trillion Eurozone economy, there are recent signs of an economic slowdown, too. But higher raw material prices are exerting upward pressure on inflation. On Sept 15th, Austrian central bank chief Klaus Liebscher warned that sharply higher oil prices pose a big inflation risk which the European Central Bank (ECB) has to keep a close eye on.

   "Upside risks are prevailing with respect to inflation, oil prices, basic foodstuffs that are getting more expensive, higher wages driven by the good economic situation" Liebscher told the Der Standard newspaper.

   Eurozone inflation rebounded to 2.1% in September against the 1.7% rate in August. That took it above the ECB's target for the first time in a year.

   The Eurozone M3 money supply is also rising, up by 11.6% from a year ago and igniting a rally in Gold Prices from €485 on August 27th to as high as €528 at the start of this week.

   Gold Prices jumped above the psychological €500 per ounce level, after the ECB admitted its hands were tied by the Bernanke Fed and left its repo rate unchanged at 4.00% on Thurs 6th Sept.

   Any attempt by the ECB to tame the explosive growth of its M3 money supply by lifting its "repo" interest rate to 4.25% could catapult the Euro to $1.500 on the currency markets, especially if the Bernanke Fed lowers the Fed funds rate at the same time.

   On October 3rd, Italian Prime Minister Romano Prodi spoke with German Chancellor Angela Merkel about the strong Euro. "There is concern that US monetary policy is very attentive exclusively towards domestic interests," Prodi said.

   "Having crossed $1.40 against the US Dollar and appreciating against the Chinese Yuan and Japanese Yen, the Euro exchange rate has attained a pain threshold for European companies," said Ernest-Antoine Seilliere, president of the lobby-group BusinessEurope, on October 3rd. Yet any attempt by the ECB to lower its interest rate to curb the strength of the Euro could stimulate faster money supply growth and inflationary pressures.

   In today's bond markets, which are plagued by heavy intervention from central banks, it might not be possible for the bond vigilantes of yesteryear to swing the big stick and jack-up bond yields to punitive levels.

   So instead, bond vigilantes must operate via the Gold Market, in order to profit from excessive money supply growth, by simultaneously shorting government bonds and Buying Gold.

   This way, if central banks try to artificially depress bond yields with excessive money supply, the resulting inflationary pressures would ultimately show up in a higher Gold Price.

   For example, since May 2004, the Euro M3 money supply has accelerated from a 4.9% growth rate to as high as 11.6% in August 2007. During that time, German bund prices gyrated up and down, but today, are little changed.

   When measured against Gold Priced in Euros, however, the German 10-year bund has lost 40% of its value to a ratio of 22 cents in the Euro.
   Thus gold has a very special role to play, as a hedge for fixed-income investors from abusive central bankers. It's a mystery why most institutional traders – seeking a "safe haven" during times of financial turmoil, such as the current sub-prime debt debacle – prefer to buy government bonds and avoid buying the yellow metal, especially when central banks are flooding the banking system with cheap money.

To stay ahead of the global markets, including the top dozen stock markets, commodities such as crude oil and gold, forex, interest rates and the central-bank intervention techniques that move markets, subscribe to 44 weekly editions of the Global Money Trends newsletter.

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GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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