Gold's Fear-Based Trade

Imagine if you ran your finances like Washington runs the US...

JULY DIDN'T produce much in the way of excitement for stock-market investors, writes Dan Denning in his Daily Reckoning Australia.

But we have found out a few interesting things...

One, so long as sovereign debt woes in Europe persist, then US Treasury bond yields can go lower. Investors seeking a haven from Europe don't seem to have any problem buying US debt at near record-low yields. This is bizarre.

Of course, at a superficial level, if you were concerned that the European bank stress tests were a sham and that interest rates in Europe could go much higher unexpectedly, you might view US Treasury notes and bonds as "safe". This is only possible in a world of utter relativity.

After all, the US government ran a deficit of 9.9% of GDP in 2009. The Congressional Budget Office in Washington reckons next year's deficit will be $1.47 trillion. That forces the US government to borrow 41 cents of every Dollar it spends. Imagine if you ran your finances this way.

But it's a strange old world we live in. Europe's problems have been America's blessing. Demand for US Treasury bonds and notes is the highest on record, according to the Wall Street Journal. On July 23rd, the yield on two-year notes – a kind of near cash fight-to-safety proxy for big money – feel to 0.5516%. Ten-year notes briefly yielded less than 3% earlier this month, and for the entire month of July, the US Treasury managed to flog off $173 billion in bonds to investors.

This is an important development. As long as global savers – for whatever reason – are frantically bidding for US debt at auctions, US borrowing costs should stay relatively low. It should also allow the Federal government to run its absurdly large and reckless deficits. And most importantly, if investors are buying US debt it means the Fed doesn't have to, at least not yet.

This last point is the most important, we reckon, because it averts the dreaded hyperinflationary scenario in which Fed money printing leads to an inflationary shock. So far, investors (who may have gone wobbly on stocks) have decided there is safety in numbers in the US bonds market. We'll see how that works out for them.

All this has taken some starch out of the Gold Price. You will have known about this if you read the latest salvo in Michael Pascoe's increasingly strange vendetta against gold in today's Age. He points out that spot Gold Prices are at three-month lows in New York and down 8% from the June highs.

It's pretty obvious by now that Pascoe either doesn't understand gold's role as money or simply believes gold is an anachronism in which "money" can be created by central banks. Frankly it's a pretty unserious and mildly embarrassing argument to make given the last few years of economic events. But each to his own.

The bigger issue is what will happen with the Gold Price from here. Yesterday we spent an hour on the phone chatting about this and other things with Greg Canavan, the editor of Sound Money. Sound Investments. Greg pointed out that the Gold Price doesn't normally perform so well during the North American summer.

Our view? We'd be pleased to buy more gold on dips, even if for the year gold doesn't make a new high. Gold is insurance against financial disaster. And if you think there aren't any more financial disasters lurking, you're not thinking hard enough.

Yes, this is a fear-based trade. We are worried that bad fiscal and monetary policies worldwide can wipe out savings, depress share markets, and destroy purchasing power. Totally wacky of course. But there you go.

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