Fallin' Bonds and Why They're Good for Gold

By: Greg Silberman | Tue, Jun 5, 2007
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Article originally submitted to subscribers on 3rd June 2007...

Here's a significant story that's not getting much play:

Chart 1 - 10-yr Bonds breaking below support

For over 2 months, Long Bonds have been marching relentlessly lower, breaking key support at 106.50 last Friday. The next downside target is the Jul 06 lows at 104 (which equates to 5.25%).

Here's where is gets curious:

The news last week was decidedly negative, weaker than expected 1st quarter GDP growth and a string of layoffs at some of the nation's biggest employers (Dell, Pulte Homes and IBM).

That's a sign growth is slowing right? That should be bullish for Bonds. As price inflation fears subside, Bonds should rally. Hell, even Gold buys that story and has been moving lower since early May. So what's happening? Why are Bonds tanking?

I know markets discount the future and that news is effectively ancient history. I've been telling subscribers for a while that there are intermarket forces at work pulling Bonds lower and forcing yields higher. That force is a declining US Dollar, where Bonds have been following the Dollar lower with a 2 to 3 month time lag. [The US Dollar bottomed in late April so we have at least 1 more month of Bond weakness ahead.]

But that still doesn't answer the conundrum, why are interest rates rising in the face of a slowing economy?

By the way, since February, the short end of the curve has been dropping precipitously. The yield curve has widened substantially, even righting itself from its previous inversion. Investors are voting with their wallets and they're saying the Feds next move will be to cut interest rates in response to a slowing economy.

So if short term interest rates get it, why don't long rates?

I think they do.

Chart 2 - Nikkei weekly; Gold (behind) and 10-yr US Yields (below)

The major holders of Long-term US Bonds are Japanese investors. A slowdown in the USA is causing Japanese investors to sell US Bonds (raising rates) and repatriate their funds back home to invest in Japanese stocks with offer more promising prospects. More promising because Japan is a net exporter and the weak Yen is a boon to Japanese Corporations.

The upshot for Gold investors (as the above chart shows) is that Gold is very closely tied to rising Japanese stocks. Interest rate sensitive Banks and Housing stands to be the most negatively effected.

A slowdown in growth is causing a shift out of US long-term debt into the Nikkei and by correlation into counter-cyclical Gold. Expect the above trends to remain in place for some months yet.

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Author: Greg Silberman

Greg Silberman CA(SA), CFA

Greg Silberman

Profession: Research Analyst and Newsletter Editor
Company: Ritterband Investment Management LLC

Career Brief: Greg qualified as the youngest Chartered Accountant and Chartered Financial Analyst (CFA) in South Africa in 1998 at 25 years old. After completing his traineeship with Grant Thornton he moved to London where he worked for JP Morgan Chase in their Fixed Income Swaps Division. Sick of the grey skies and cold weather Greg relocated to Atlanta, Georgia where he spent the next 4 years freelancing as a management consultant. His targeted clients were fast growing mid size US based companies and he worked across many industries including credit cards, health insurance and energy trading. Greg has recently returned from Sydney Australia where he spent the last 2½ years working in Equity Derivative Structuring for Perpetual investments a major Australian Asset Management Company.

Greg has a passion for the markets and has been writing Greg's market newsletter for 2-years. A newsletter focused on metal and energy stocks and recently non-resource small caps listed in the US and Internationally.

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

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