October 10, 2019
Last week I wrote that “downside risks
remain” and specifically cited the chart below showing what happened to Gold in
2008. What occurred then was real yields rose (TIPS fell) significantly on
plummeting inflation expectations in line with the crash in the stock market,
even though nominal bond yields remained relatively stable and the Fed was
cutting short-term rates aggressively towards zero. Being highly correlated to
real yields, Gold dumped ~30% at the same time.
The risk now is that we get a similar spike
in real yields when Gold is near perfectly correlated to real yields on an
inverse basis, but for slightly different reasons.
I posted the following tweets on September
The 10 -Year (“10Y”) yield hasn’t been
lower since. In fact, it looks like it is in the process of an ABC correction
to at least 1.98%, where C=A, or perhaps as high as 2.28%, where C=A*1.618.
Higher nominal bond yields mean higher real
yields, assuming inflation expectations are constant. We have seen this
recently since the triple “B” bottom at 1.51% and the rise to 1.65% so far.
Real yields have climbed from a low of zero this past weekend to 13 basis points
today. If the 10Y does continue to rise to 1.98% or higher, real yields will
also continue to rise.
But didn’t Fed Chair Powell just announce
plans to buy U.S. Treasury securities? Shouldn’t that reduce yields? Powell’s
announcement of permanent open market operations to address recent volatility
in repo rates only focuses on short-term rates. In fact, we are seeing a
steepening of the yield curve as short-term rates fall and longer-term bond
Note how I said “assuming inflation
expectations are constant” above. What if they fall at the same time as nominal
yields rise? The truly awful ISM data on October 1 and 3 dramatically increased
fears of recession, and the S&P has dumped from 3000 since. Recessions
combined with stock market sell-offs (or worse, a crash) are deflationary, so
it is fair to assume that inflation expectations could fall too. A combination
of rising nominal yields and falling inflation expectations could cause a spike
in real yields just like that in 2008. I don’t expect this to happen, but it is
a risk and real yields could certainly rise further.
Real yields are equivalent to the yield on
Treasury Inflation-Protected Securities, “TIPS”, as shown above. This means
that real yields are the inverse of TIPS prices, i.e., if TIPS fall, real
yields rise and vice versa. Below is the chart for TIP, an ETF that tracks TIPS
prices. Note how it bottomed in November last, the same time Gold and Silver
began their spectacular rallies. Now it is on the verge of breaking trendline
support (purple line) since November. This could cause TIPS to fall hard and
real yields to spike higher. My targets on the downside for TIP are more
modest. Like the 10Y Bond but a mirror image, I believe TIP is undergoing an
ABC correction with targets on the downside at ~114, where C=A, and ~112, where
C=1.618*A. Then we head higher again. Only a decline below 112 would increase
the probability that a scenario like 2008 is playing out again.
Why am I talking about bond yields and real
yields instead of Gold and Silver? Because Gold is near perfectly correlated to
TIP, which is perfectly correlated to real yields on an inverse basis. Silver
is also near perfectly correlated to Gold. Simply put, unless the correlation between
Gold and TIP breaks down (and it has on occasion in the past), then higher real
yields, lower TIP prices, mean lower Gold and Silver prices. This is why this
is so important.
My primary scenario is for a continued rise
in nominal and real bond yields and further declines in Gold and Silver to
targets I provided weeks ago at ~1423 and ~16.50 respectively, then a new rally
to begin to higher highs. A 2008-type spike in real yields and dump in precious
metals is far less likely at this point, but it remains a risk to monitor,
especially if the 10Y yield breaks 2.30% and TIP falls below 112.
Even if the 2008 scenario does play out,
this just means that you get to buy Gold and Silver at even cheaper prices
given the monetary insanity that will follow, imho. Gold rose almost 200% in
less than three years from its low in October 2008, Silver closer to 500%. I
believe the gains after the next low in both will exceed those numbers,
especially in the mining stocks.
For those of you interested in buying the
physical metals, I recommend you check out
sprottmoney.com for the best
prices, customer service, storage, and delivery services. I use them
exclusively for all of my purchases of physical precious metals.
David Brady has managed money for over 25 years for major international banks and corporate multinationals both in Europe and the US, with experience in Bonds, Equities, Foreign Exchange, and Commodities
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