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Second Stimulus Speculation Submarining Bonds and Supporting Gold

Posted by Larry Doyle on November 3, 2009 3:09 PM |

What are the biggest stories in the market today? Consider the following . . .

1. Warren Buffett makes his single largest acquisition ever with the $34 billion purchase of Burlington Northern

2. Ford posts surprisingly strong auto sales

3. Royal Bank of Scotland becomes the biggest banking bailout yet with another injection of capital

4. Johnson & Johnson announces plans to layoff 7% of its global workforce

Each of these developments is truly meaningful. Interestingly enough, numbers one and two are decidedly constructive while numbers three and four are clearly quite bearish about global prospects. Despite the magnitude of these stories, in my opinion, they pale in comparison to developments in the precious metals and bond markets today. What is happening? Let’s navigate.

The Treasury yield curve is steepening dramatically today with yields on longer term notes and bonds rising by 6 to 8 basis points, while shorter maturities are unchanged. A snapshot of the Treasury market is provided by WSJ Market Data.

Why is the curve steepening? What does that mean? What are the implications for other markets? All great questions. Let’s navigate further.

In my opinion, the Treasury yield curve is steepening as hints of a second economic stimulus package work their way through Washington. I definitely sense growing unease and anxiety over the state of the job market. The story about layoffs at Johnson & Johnson only adds fuel to the fire.

A second stimulus will only build upon the already out of control fiscal deficit which will need to be funded by increased government borrowing. As our borrowing needs increase, the demand for the funds will drive the price for the funds ever higher. The price is the interest rate on Treasury notes and bonds.

Why would the curve be steepening, though? Why aren’t rates on short maturity bills and notes also going up in sync with the longer term notes and bonds?  The rates on shorter maturity Treasury bills and notes is most heavily influenced by Federal Reserve policy. It just so happens Fed governors are meeting today and tomorrow and assuredly they will leave their current policy unchanged. That policy is one of very easy money with a Federal Funds rate of 0-.25%.

The prospects of (1) another economic stimulus package; (2) a continued policy of very easy money supported by an accomodative Fed; and (3) a steepening curve with a rise in long term rates, all collectively point towards a greater likelihood of inflation. What segment of the market gives us a hint as to inflation? Gold.

What is gold doing today? Rallying in a big-time fashion. Gold is up 3% on the day as Bloomberg reports, Gold Climbs to Record as India’s Central Bank Buys IMF Bullion:

Gold jumped to a record after India’s central bank bought 200 metric tons of the metal from the International Monetary Fund, heightening speculation that there may be more official purchases.

Gold futures for December delivery rose to a record $1,087 an ounce on the New York Mercantile Exchange’s Comex unit and traded at $1,084.20 at 1:28 p.m., up $30.20, or 2.9 percent. A close at that price would be the biggest gain for a most-active contract since March 19.

“This will encourage other countries and other investors, especially Indians, who are big buyers anyway, to jump into the market,” said Leonard Kaplan, the president of Prospector Asset Management in Evanston, Illinois.

The Reserve Bank of India paid $6.7 billion for the bullion, which it bought from Oct. 19 to Oct. 30. It was “the biggest single central-bank purchase that we know about for at least 30 years in such a short period,” said Timothy Green, the author of “The Ages of Gold.” “The only comparable event was the U.S.’s steady purchases in the 1930s and 1940s.”

Now what was going on back in the 1930s that would have prompted steady purchases by the U.S. government?

Oh, no. I’m not going there. That thought is a little too ‘depressing.’

What do you think?

LD

  • Harry Oppenheimer

    Gold is not and has never been a good inflation hedge, though. Look it up, the correlation is surprisingly low. It is, however, a reliable stoe of value.

  • whoisjohngalt

    It is hard to support inflation when you do not have a job. It is difficult to invest in a business when government regulations and taxes are increasing to punish producers. Why buy expensive real estate when you know the government will tax you to death to pay for welfare bums?

    What about a gold bubble? High prices mean more mining for gold. The actual cost of production for finding an ounce may be about $200. People are turning in old jewelry at a rate the equals the need for gold for new jewelry. The supply of gold is probably well above the actual demand for industrial and jewelry purposes. The demand that is increasing the price of gold is driven by the fear of monetary collapse. Is that something you want to bet on?

  • Nigel

    It’s amazing the resistance out there to Gold as a store of wealth or as Money itself. OK mindless masses… hold on to your Federal reserve paper notes of debt, believe in equities based on a thoroughly corrupt, over-valued stock market, or (here’s the biggest joke) … hold US Treasuries … backed by the “full faith & credit of the US Government” ….ah, excuse me…..HAHaHaHa, snort,barf.

    Gold…. a sure thing. Nobody is printing it up (at least not the physical stuff). Fiat currencies worldwide are being watered down daily. FACT. Gold isn’t.
    Got gold…. too bad if you don’t…’cause you’re about to be left standing when the music stops.

    • TeakWoodKite

      If you visit Columbia California, you should remember that the town was originally 11 feet higher than it is now. The Hydraulics used washed all that dirt in the delta.

      I can pan for it quick enough.
      I was hitch hiking outside of the entrance of Mt. Denali park heading back to Anchorage, when a guy in a school bus stopped and gave us a ride. Turns out he had found a mine that the river had washed out and he found the original timber of the tunnel entrance in the river bed. He had a bunch o gold. I was amused when pulled over to cook some bacon which he said he sorely missed ’cause it would attract the grizzlies.
      Is this a Klondike economy?

    • whoisjohngalt

      Industrial, dental & jewelry demand is down:

      http://www.research.gold.org/supply_demand/

      Hording is up. You know that at almost $1100/oz, mining will be up. Come on Nigel, use your brain. You know what happens when supply outstrips demand. Gold has been a great investment for some time, but it will not continue.

      By the way, America rejected socialism & the Goldman Sachs candidate last night. You better start thinking about this.

    • Harry Oppenheimer

      I don’t think the resistance to gold is that great, its just that there is resistance to the wild-eyed gold bug doom-sayers who promote it like pirates as the great financial saviour. This has been going on for over 100 years (at least) here in the US. And if you only held gold over that period, I’m afraid, you are far less wealthy than someone who owned just about any other financial instrument – treasuries included. However, it just takes a calamity in the markets or war to remind people that gold is a very safe, reliable store of value. The problems, as I see them, are several: the “average” investor will pay 5% commission up-front to buy gold and then pay 5% again when they sell it. In the meantime, you’ll need to transport it and store it securely (not cheap to do). Also, while you hold gold it pays you no income. As I said earlier, it is a reliable store of value (the oldest) but its real correlation to inflation is much lower than most gold-bugs will tell you. It seems to me that there are other hard assets out there that easier to buy, hold and that will also pay income while you hold it. Just IMHO.

  • TeakWoodKite

    LD, what’s up with Aussies raising ther rates so as not to “overheat” their economy?

    • Larry Doyle

      TWK….Australia’s economy never went into much of a recession to begin with and thus the powers that be are trying to ward off any hints of inflation. In the process of raising rates, though, they will further support their currency and attract even more capital.

      We have already seen Norway raise rates, as well. Poland (this surprises me . . . I had no idea Poland was this strong, especially in the midst of other problems in eastern Europe) and Brazil may not be far behind.

      What have these countries been able to accomplish? Lessened reliance on exports. Amazing what a degree of fiscal prudence and discipline can accomplish.

      • Harry Oppenheimer

        I have to respectfully disagree a bit. Norway and Australia are commodity-rich nations. They haven’t accomplished anything much greater than being geographically (minerally and petrochemically) lucky. I will grant that Aussie banks are very well-regulated and financially sound. Norway’s banks were nationalized about 2 decades ago during their last banking crisis.

        • Larry Doyle

          Harry,

          I need to be more judicious in my responses. Clearly Norway is an oil based economy.

          In regard to Australia I think they are benefiting from discipline in their banking system and consumer spending. Less of a boom previously and thus less of a bust currently.

          Thanks for providing further insights for all of us.

  • Nigel

    The thing is…I don’t consider myself a “gold bug”.
    However, when I looked for a method to escape the whore’s in the US Gov having ME pay for their & their pimps sins…well Gold cropped up first and foremost. Every time I researched it, it came down to Gold as an out.

    Nevermind the past 100 years or whatever. We live in a period where Governments around the world think that QE (money printing) will buy them time or even an escape route. Of course they choose that, it’s the expedient way out & they always choose the path of least resistance. Only the world has wised up. Gold is rocketing for two primary reasons:
    1) the naked short selling of “paper” gold is becoming less effective in throttling the real physical thing
    2) folks worldwide are realizing that governments and central banks are ruled by a narrow minded,greedy financial oligarchy

    Once the common investor realizes the game is hopelessly rigged there comes a stampede for the exit. Crowd psychology in practice.

    Physical Gold is an exit that can’t be gamed, hence it’s one of the few avenues available to the common person worldwide. The issue is that the world (and especially the US) is awash in deceit and corruption, and yes, it even extends to our smooth talking, telfon coated (bought by GS) President.

  • therooster

    Gold is a currency. It’s use as a currency was muted after Bretton woods for a good reason. There was a new logistical problem.

    The ending of the fixed peg was good in order to be able to reflect supply fundamentals between dollars and bullion, but when the relationship was allowed to float (as it should), there was no efficient way to “split the enhanced value of gold weight”. Now there is. Fully gold backed payment systems allow one to buy a stick of gum in Timbuktu with fully backed digitized gold title (the currency). Debt-free store of value has married with instant global liquidity. Gold can now be monetized by the market. It’s still “finding its monetary value” in this bull market , however. Liquidity will be enhanced as it draws closer.






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