Insights & Advice

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What do bonds and gold have in common?

U.S. Treasury bonds and the price of gold and silver have plummeted this week. Aside from the losses they have suffered, both securities represent what are called “risk-off” trades. The proceeds of those sales are being invested in the “risk-on” stock market.

How long before the Fed turns off the spigot?

If you follow technical analysis, you should be aware that the ten, twenty and thirty year Treasury bonds have all broken support levels that have been in place for almost a year. Interest rates on the ten-year treasury appears likely to test 2.4%-2.5%

At the same time, gold also broke multi-month support. The precious metal is now trading below its last support level at $1,675/ounce. It appears headed for $1,600/ounce or possibly lower. Is this the beginning of a trend in dumping safe assets and embracing risk as represented by the stock market?

The answer is no. I believe that the siren call of the stock market’s easy gains this year have convinced some investors to abandon their safe haven assets and take a plunge in stocks after months on the sidelines. That, in and of itself, may be a warning sign since that trend usually happens close to a top in the markets.

However, in the case of the bond market, the recent decline could be a warning shot across the bow that interest rates are about as low as they are going to get. The risk in the “super safe” U.S. Treasury market is high, in my opinion, and I believe it is simply a matter of time before Treasury bonds hit a wall.

 In a recent interview, Bill Gross, the so-called bond market king at PIMCO, agrees with that opinion, but Gross said the same thing last year and has been wrong thus far. He isn’t saying that this week’s decline is the start of a major decline but he does warn that a decline in bond prices is coming soon.

Some observers have a different take on the decline in both bonds and gold. They believe that the market’s absolute conviction that the Federal Reserve is about to launch a third tranche of quantitative easing is ill-advised. They argue the gathering of strength in the U.S. economy and the welcome decline in the unemployment numbers has put the Fed on hold as far as any new stimulus is concerned.

If that is the case and QE III is simply a pipedream, then it spells the end of Fed stimulus by June of this year. Investors’ first reaction to this event would be to sell Treasuries and also gold. Why?

 Less stimulus would mean less inflation and therefore less reason to hold gold, a classic inflation hedge. The Fed-engineered cap on interest rates would also disappear, leaving the markets to determine where interest rates should be. And, by the way, if the stock market truly believed that QE III was off the table, I don’t think it would play well with the stock market averages.

Consider that global markets have had a negative reaction each time the world’s central banks signaled a cessation of monetary stimulus. Within weeks, if not days, stocks declined and did so dramatically.

Clearly, stocks are still the flavor of the month, so investors are obviously still convinced that further monetary easing is just around the corner. Just yesterday, I read a strategy piece from one of the most influential brokers on Wall Street who predicted QE III would be announced by the end of the second quarter.

Make no mistake there is still momentum in the market. Despite my caution, I believe the S&P 500 Index is headed for 1,425 or even 1,450. As we move higher, I will take profits.

Posted in A Few Dollars More, At the Market