This week, gold rose slightly on balance, while silver maintained its climb out of a deep pit. In early-morning European trade today (Friday) gold was trading at $1199, up $7 from last Friday’s close. Silver was unchanged on the week at $14.50, but as can be seen on our headline chart, silver’s relative performance since the mid-September lows is encouraging.
For fiat currencies, things are hotting up. US Treasury yields going through the roof, illustrated by this immensely bearish chart of the 10-year US Treasury bond yield.
This represents a yield breakout to the upside the bond bears can only dream about, indicating it has much further to run, possibly quite quickly. This matters because all the world’s debt is priced with reference to this market. In other words, the next credit crisis will be associated with higher bond yields and falling asset prices and looks like happening sooner than generally expected.
The strength of the US economy should not come as a surprise, given the size of US budget deficits and the bad timing of the Trump stimulus. There can be little doubt that traders view rising US bond yields as a headwind for gold and silver, which explains why, despite their unprecedented oversold condition, prices remain subdued. However, it is worth pointing out that at times of rising price inflation, these conditions can turn out to be extremely good for gold. The 10-year UST yield rose from under 5% in 1967 to peak at over 13% in 1981. During that time, gold rose from $35 to a high of $850, a twenty-four-fold increase.
The dollar’s strength and the prospect of higher T-bill yields is putting downward pressure on the euro and yen, because the carry trade, whereby banks and hedge funds borrow at negative rates in these currencies to buy US Government paper, is immensely profitable. The opportunity is created by the policy dysphasia principally between the ECB and the Fed. It is forcing the EUR rate lower, and since this is roughly 50% of the dollar’s trade weighted index, it is driving a dollar rally, as illustrated by the next chart.
By borrowing euros (one-month Euro LIBOR is -0.4%) and buying 13-week T-bills, yielding 2.17%, a bank can gear up ten times its base capital for a return of over 27%, and until the ECB addresses this issue by raising rates significantly (Mr Draghi is reluctant to do) the euro will continue to weaken against the dollar. In short, an interest rate crisis for the euro is being brought forward by market forces, which threatens to destabilise Eurobond markets and potentially the eurozone’s banks.
Meanwhile energy markets are strong, with crude oil up 12% in the last month and natural gas up 17.5%. In base metals, copper is up 7%, aluminium 9% and zinc up 17%. While these inflationary prices are at the far end of the price telescope there is no doubt about their direction.
A perfect storm for financial markets appears to be brewing. If in doubt about the financial meteorology, it may be best to seek shelter in the safe havens of gold and silver.
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