Bonds and Gold

By: Sol Palha | Wed, Dec 16, 2009
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"By nature man hates change; seldom will he quit his old home till it has actually fallen around his ears." ~ Thomas Carlyle, 1795-1881, Scottish Philosopher, Author

The Fed has been keeping interest rates very low hoping that both business and consumers will start to spend money they don't have as they used to in the past. In reality, consumers continue to borrow less. Consumer borrowing has dropped for 9 months in a row. The above chart of the 30 year bond indicates that long term yields have been slowly rising. The bond market determines long term rates and not the Feds. Rising rates tend to favour a stronger dollar as higher interest rates make a currency more attractive. And a rising dollar will lead to drop in the value of Gold and many other commodities out there. The dollar is on the verge of crossing a very important threshold, and if it manages to do this then all competing currencies, commodities in general are going to experience large downward moves. Over the long run, a rising rate environment is bullish for Gold; we are, however talking about the short to intermediate term outlook. The dollar has already traded past 75.80 for 5 days in a row so the first confirmation is in place for a possible move to the 80-82 ranges.

The strength in the dollar is not going to be along term development. It will resume its long term down trend and those that use this strength to open positions in bullion and commodities related stocks will do well. As the dollar loses its value, these investments will over inflate and more than compensate for the drop in the value of the dollar. The dollar has lost roughly 40% of its value to date and in the same time Gold has risen roughly 400% from its low and Silver roughly 500%.

Additional factors to consider

The current action in the Gold markets has a lot to do with speculation (traders actually speculating via paper instruments such as derivatives and futures and not by purchasing actual gold bullion); once again, reminiscent of the top oil set in July of 2008. A lot of the current action also has to do with many big gold producers such as ABX finally deciding that its time to close their hedge books. Why now, why not earlier when Gold was trading at say 400 or 500 or for even 800 an ounce. The same question can be poised to central bankers. Why are they buying now when they were almost giving gold for free a few years ago? They are not as stupid as most Gold bugs make them out to be. Remember they have decades of experience when it comes to fleecing individuals and manipulating the currency. Perhaps we should view this action from a contrarian perspective and sell when they buy and buy when they sell.

John Paulson, the guy who made a fortune by betting against the housing industry has decided late in the game that its time to take a huge stake in Gold. His firm has a 12% stake in AU (Ashanti mining) which amounts to over 40 million shares. They also own over 30 million shares in KGC. Paulson also owns over 31 million shares in GLD making him the single largest share holder. He is so bullish he plans on opening up a Gold fund and deploying 250 million of his own money. History illustrates that individuals that strike it big once rarely are able to land a big score again. These chaps fail to understand that luck had a big role to play in their win.

Rising prices, dropping demand, excessive bullishness, and a whole bunch of speculators flocking into the market are usually the perfect recipe for a top.


In the short to intermediate time frames the dollar is projected to mount a rally; it has already mounted a rather decent rally from its lows. Gold and most competing currencies are expected to pull back. We mentioned this in our recent article "The Gold bull; time for a breather or?." Since then Gold has already shed 100 bucks and the Euro has dropped from a high of 151.37 to 145.33 in a few days, a huge move for any currency. The sentiment against the dollar is extremely negative and has hit an extreme note; extreme movements always produce countermoves that are equally extreme if not stronger. Thus the dollar could potentially mount a very strong rally surprising even the most bullish of optimists.

We will examine the dollar- Gold relationship more closely in a follow up article scheduled to be published this week. Gold put in several new all time highs and thus the dollar should have at least put in one if not several new all time lows; this did not occur and it has to be viewed as strong negative development for Gold, at least in the short to intermediate time frames (3-6 months).

Short term to intermediate term outlook

Impulsive traders who jumped in at bought Gold in the 1100-1200 ranges could take quite a wallop in the short term, if the dollar mounts a strong rally. If, for some reason the Chinese stop providing a floor for Gold in the 900-1000 ranges, then Gold could drift even lower. While the long term up trend is still in force for Gold, painful corrections can occur on the shorter term time frames. All this should be viewed as good news for if it comes to pass it will provide the astute investor with yet another lovely buying opportunity. If Gold breaks below the 1080-1100 ranges for several days in a row (3-5), it should lead to a test of the 980-1000 ranges. Ultimately, the correction in the Gold market will be based on how strongly the dollar rallies.

Almost all the sovereign funds took profits on the money they had invested in the financial sector and presumably these profits are still being held in dollar. Holding onto cash is indirectly going long the dollar. Perhaps these chaps are cashing out now, waiting for the dollar to rally and for Gold to pull back.

Long term outlook

Even though the dollar could potentially mount a strong rally in the short to intermediate time frames, its long term outlook has not changed. It's projected to put in a series of all time new lows and could lose up to 60% of its current value before some sort of bottom takes hold or a new currency is issued.

In the 70's the money supply was increased by roughly 12%-14% and to combat inflation the Fed's raised interest rates all the way up to 20% ranges. Helicopter Ben has increased the money supply by a stunning 120%. How high will they have to raise rates eventually to rein inflation? We suspect that rates could one day be trading well past the 20% ranges and might even surge past the 25% ranges. The only reason we are not seeing strong signs of inflation is because the banks are holding all the money that the Fed has lent them. Eventually, this money will find its way to the streets and that's when things will start to heat up. How will this economy deal with such high rates? Forget about rates in the 20% ranges, a move to 10% will have a huge impact and those that did not take the time to prepare could be in for one massive shock. We still think that what we have seen up to now is only a prelude of what lies ahead in the future. We stated before that the next 2-4 years are going to bring about unprecedented levels of change. Gold thrives in such an environment, so the long term outlook remains very bullish for the precious metals sector.

"Learn from the first and be better for the next" ~ Uyen Mai



Sol Palha

Author: Sol Palha

Sol Palha

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at

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