With gold and silver recently moving in parabolic fashion, some financial commentators have been arguing that the precious metals have gone too far and too fast. In the short term anything is possible, I’ll give them that. However, what investors need to understand is the difference between yields on sovereign bonds, and their real yields!
Return-Free Risk? No Thank You, I Prefer Gold!
See below: “real treasury yields,” updated daily on the US Treasury Department’s website:
Subtract inflation from the yield on US treasury bonds, and this is all you are left with. Instead of “risk free return,” US sovereign bonds have turned into “return free risk.”
When you account for the added risk of a US dollar devaluation in the future, investment in US sovereign debt becomes more akin to a drunken gamble. The only way to receive a decent yield on US Treasuries would be to either highly leverage a bond portfolio, or move into the high yield market. Investments in leveraged sovereign bonds and junk bonds each add much greater risk to a portfolio either way. To be clear, most passive managers are supposed to avoid leverage at all costs.
To illustrate my point further, think of how passive money managers allocate capital to fixed-income portfolios. When it comes to bonds, the question is simple... How high is the yield and how much risk does the investment carry? No need for a PHD in finance: deeply negative real yields mean it’s prudent to increase one’s exposure to gold as a safe collateral asset (even with its 0% yield, it still beats treasuries). We can call this the theory of “yield starvation,” and it is also largely responsible for the recent rush into the top names in the Nasdaq, but that’s a topic for another discussion.
Gold (& arguably silver) is the last safe haven standing with true monetary properties. Remember, fiat currencies can be printed to an unlimited quantity by Keynesian-thinking central bankers. Gold is real money because it maintains purchasing power over time, the rest is simply currency, not real money!
Historically, the benchmark 10-year US Treasury has behaved like the “anti-gold.” See the chart below, where I compare the movement between the US 10-year treasury yield and gold since the Q4 2018 liquidity scare:
Forward-looking investors have been moving into gold ever since the Federal Reserve gave up on its monetary tightening policies. The low yields on Treasuries are largely due to central bank manipulation. Even as investors flee US Treasuries in favour of gold, yields remain so low largely because the Fed can simply print up the necessary currency units to buy Treasuries off of investors. They prefer this to the alternative, where investors would sell their Treasuries on the open market (and rates would rise as a consequence).
Investment bankers will often say gold isn’t supposed to fluctuate by more than 5-10% a year. Since 01/01, 2019, gold is up by over 50%! Silver has performed even better over the same period. Times like these are when it pays to anticipate where macro-trends are developing.
So how long could this gold rush last for?
As long as US treasuries are trading with negative real yields, gold should have a permanent bid under it. This means dips are likely to be bought into aggressively by investors, especially since the Fed’s Chair Jerome Powell has even stated the Fed isn’t even “thinking about thinking about raising rates...” My guess would be that we have a while to go before gold loses its luster. The
same goes for silver, see chart, which has a long way to go if it is to match the length of previous bull markets.
The perfect recipe for a lasting gold bull run: Large fiscal deficits in the US and across the modern world, low yields (forced to remain low by central banks globally), money printing at record levels, and geopolitical uncertainty!
Comex Futures: Are We Seeing A Bank Run on Physical Metals?!
For the gold and silver bugs who like to dig deep into the weeds, I encourage you to take a look at the data coming out of the Comex recently, where there seems to be a run on physical silver and gold. With a record amount of deliveries being taken last month, it is no surprise that there was a parabolic move in precious metals. Over one billion ounces of silver traded on the comex in a single day on multiple occasions, which is more than the amount mined yearly!
The question now becomes: how many derivative or “paper” contracts exist in the financial system for each ounce of physical silver or gold held in banking vaults? Let’s say you were the owner of a contract to take physical delivery at a future date: would you trust the metal will be there in say, December? Personally, I’d rather take delivery of my metal right now (just in case). This is exactly why we’re seeing prices being driven so high, market participants are thinking along this same vein.
The demand for physical deliveries in gold and silver will likely continue to drive prices higher in the long run, especially if banks have troubles finding enough physical metal to deliver. In the case that there is not enough physical metal to appease this record demand, the futures market for gold and silver could end up turning into a black swan event akin to a paper (derivative) leverage implosion. The ripple effects would likely mean large losses for commercial banks on the wrong side of the precious metals move, and much higher prices for gold and silver!
As I type this, gold is reaching $2000 an ounce for the first time in the history of spot market trading. The GDX is up over 160% since the March lows, with junior miners (GDXJ) up over 200%, respectively. Yet, all we hear in the mainstream news is a debate on whether or not to buy more tech shares!
This material is based upon information that Bytown Capital INC considers reliable and current, Bytown Capital can and does not assure that this material is accurate or complete. As such it should not be relied upon. Bytown Capital and its staff do not act as personal investment advisors for any specific individual. Bytown Capital does not advocate the purchase or sale of any security listed on any exchange.