EDITOR: | January 25th, 2013

Gold – A Warning from Wall Street.

| January 25, 2013 | No Comments
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Both Bank of America and Goldman Sachs Group Inc.  President Gary Cohn have warned of a potential drop in fixed-income prices. The return of confidence and belief in the start of a sustainable US recovery, has both fretting over the possibility of a US Treasury bond crash, once the Fed raises interest rates and bond prices collapse. Interest rates and bond prices are inversely connected.

From Bloomberg:

Debt markets that have seen junk-bond yields drop to record lows may face a “substantial repricing” if interest rates spike or investors begin pulling money out of fixed income, Cohn, 52, said in an interview yesterday with Bloomberg Television’s Erik Schatzker at the World Economic Forum in Davos, Switzerland.

From the UK’s Telegraph on Bank of America:

This happened in 1994 under Federal Reserve chief Alan Greenspan when yields on US 30-year Treasuries jumped 240 basis points over a nine-month span, setting off a “savage reversal of fortune in leveraged areas of fixed income markets”.

—- A similar shock this year is “likely” if the US economy continues to gather strength. “The moment we hear the first rhetorical talk of exit strategies by central banks this could turn,” said chief investment strategist, Michael Hartnett.

—- Bank of America said the “Great Rotation” under way from bonds into equities closely tracks the pattern of 1994, with bank stocks leading the way.

While their warnings were specific to bonds, from our precious metals perspective, it’s a warning to precious metals too. If US interest rates rise, it’s likely that global interest rates will follow, and in a normal market that makes precious metals less attractive to hold, since the precious metals don’t pay out any interest. Equally troubling, how would investors in precious metals Exchange Traded Funds react? If they pulled out significant amounts of cash, the precious metals ETFs would be forced to begin selling precious metals. Under the scenario forecast by both, gold and silver futures would become unstable to the downside. Buyers would pull their orders as professional traders attempted to go short.

But there’s an old saying on Wall Street “never fight the Fed,” meaning that you’ll always lose. The Fed has unlimited resources to back up its policies. Yet that is what both BOA and Goldman’s President are suggesting the market does.  The Fed is on record that it will keep its 85 billion a month quantitative easing program running through at least the end of the year and until US unemployment declined to 6.5% from 8.5%. In a normal market that would take about two years, as many who’ve dropped out of looking for work re-enter the jobs market, slowing down the speed with which unemployment falls.

But we are far from a normal market. The US is far from a sustainable recovery, and were a sustainable recovery really to get underway, a massive burst of 1970s inflation is likely, as banks and hedge funds put all the QE money now parked at the Fed for nominal interest, back to work in the economy. Trillions from all the QE programs over the last few years, would surge out chasing the limited supply of goods and services. While bonds would drop in price anticipating the Fed eventually ending its zero interest rate regime, gold would likely soar in a scramble to protect purchasing power against the ravages of the giant inflation.

In 1980, in a far more benign age just starting out in the billions, it took Paul Volker and a 20 percent Fed interest rate, to get 10 percent US inflation in check. Taming a multi trillion dollar inflation in our new casino derivatives gambling age, is probably now impossible without destroying the fiat currency system. BOA and Goldman are thinking in a 1994 way. But we long ago left that 1994 market. Bond prices will indeed go down at some point ahead, although to me that doesn’t look like being anytime soon. But in our abnormal times, precious metals are likely to soar. Perhaps that’s why neither strayed on to the subject of gold.

Bank of America issues `bond crash’ alert on Fed tightening fears
Link.

Credit Bubble Seen in Davos as Cohn Warns of Repricing
Link.


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