From the Interest Rate team at PFG Best:
Gold is up this week, big. While some media pundit publications are pointing to the inflation boogie man, we don’t think this is the case.
The surge in gold is as more a comment on the US dollar’s fall from international grace and its demise as the world currency of choice than it is a comment on inflation. Here is a simple fact to support this assumption: The Ten Year Note. While gold is surging to all time highs today, the Ten Year Note is still trading near this year’s lows. It is impossible to guarantee anything in the future, but there is a pretty good chance once traders in the treasury complex on Chicago’s trading floors get the slightest whiff of inflation in the air, we will see a surge in interest rates so fast high frequency trading programs may not be able to keep up.
Let’s first go back to our comments from our 9/25/09 posting:
“We believe the past year has created a fundamental shift in the way investors and nations view the global market, as comments from this week’s G-20 meeting alluded to, and this means that the world’s “leaders” will have to begin to share even more of their power/influence with developing nations such as China, India, etc… With this change in sentiment, we will be moving into a much less “US-centric” world where new standards and common ground will need to be agreed upon. One outcome of this new thinking will be the USD’s place in the world and whether one currency or a basket of currencies or even a basket of commodities will be the most appropriate currency for the world to “utilize” as a foundation.”
It is our belief that the price of gold is almost entirely being pushed higher by the concern for the US Dollar; the world’s currency. We feel that instead of gold being used as an inflation hedge, it’s actually being used as a hedge against currency “instability,” such as the weakness surrounding the US Dollar. We feel the price movement over the past two days exemplifies this trend, especially given 10 Year T-Note Futures and Cash Yields are essentially unchanged over the same time period.
Additionally, we do think that other economies tied closely to commodity production may be experiencing higher levels of inflation, i.e. Australia, than the US as the US is still continuing to experience deflationary pressures. Given that Australia has moved interest rates within the past 24 hours up 25bps to 3.25%, it will be interesting to see if any other nations follow suit over the coming weeks. If the US continues to hold the course they have communicated (extended low interest rates), the US Dollar will continue to come under pressure as other currencies will become even more attractive given their yields; this will bring about an even larger resurgence in the carry trade – borrowing US Dollars to buy other currencies.
With the continued US Dollar weakness and bond yields at a relatively low level for the year, look for continued pressure from this week’s auctions to weigh even more on the US Dollar. Also, the media is already calling for bullish data in the soon-to-be-released 3rd quarter earnings, which as of now is continuing to push the US Equity markets up. We feel a major factor for the current stock rally, especially given the amount of cash of the sidelines, is that yields on stocks substantially outweigh potential yields from fixed income and money market investments; a reach for yield in a low risk-free rate environment. This is one reason why with economic fundamentals still not painting a rosy picture, stock markets have been able to push higher. As long as US rates are kept at the current levels, look for this market conundrum to continue.
PFGBEST Research Team
Eaven Horter, firstname.lastname@example.org
Mark Melin, email@example.com
Source: PFG Best
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.