Please, click here to read this article in pdf format: august-30-2010 If I guaranteed you that I will buy an asset from you, would you go out to sell it like there is no tomorrow? If you did, one would conclude either that you did indeed trust me but are not happy with the price [...]
Please, click here to read this article in pdf format: august-30-2010
If I guaranteed you that I will buy an asset from you, would you go out to sell it like there is no tomorrow? If you did, one would conclude either that you did indeed trust me but are not happy with the price you expect from me, or that you did not trust me at all. On Friday, holders of US Treasuries heard from Fed’s chair Bernanke that the Fed would buy their assets. Bernanke confirmed that the Fed would keep its balance sheet steady reinvesting the proceeds of mortgages paydowns into Treasuries. Yet, the market tossed off the entire curve of the US Treasuries. The reaction was manifestly bearish in our view, and we have no alternative but to turn bearish here. The chart below (source: Bloomberg) tells it all:
This chart shows the price (not the yield) of the active 30-yr Treasury for the last week (Monday – Friday).
On Aug 26th,, we warned that: “…we found it interesting that shortly after the home sales announcement on Tuesday, the 30 yr treasury sold off by approx. 1%. Indeed, it may be seen from the perspective of a flattening move, which is actually taking place since the Fed’s announcement last week. But in any case, the Tuesday’s move, smelled to a “sell with the news” move…” (ref.: www.sibileau.com/martin/2010/08/26 ). Yet, back then, we only intuited the weakness. After Friday’s technical damage, a new game is unfolding, where central bankers (yes, the plural is correct) will coordinate to fight the sell off in sovereign debt. The fight will be cruel, but they can only lose it in the end.
With this in mind, we want to refer back to comments made last August 18th, when we wrote that:
“…those who still see a double dip in the horizon base their forecast on a double dip in the US housing market. Yet, when stocks rise, the resources and materials sector seem to lead and most monetary policy is specifically addressed towards the housing market. Why not base the double dip on a sovereign crisis in the US? Did the government not assume the private sector’s liabilities last year? And if indeed the double dip is finally triggered by a sovereign crisis, why not bet on the sure thing? Why bet on precious metals rather than short Treasuries? The collapse of the Treasuries market looks more certain than the rise in the price of gold. The collapse of Treasuries will precede and fuel the rally in gold and gold shall only rally if it rallies against all currencies, we think. But first, capital must flee from government debt and only then, among other alternatives, it can chose to go to gold…” (refer: www.sibileau.com/martin/2010/08/18 )
This is exactly what happened on Friday, when gold remained flat but volatile, while Treasuries sold off. The intraday chart below (source: Bloomberg) shows it all:
With this view, we come back to our 2009 idea that if central banks are successful at coordinating monetary policy, gold will underperform stocks (refer: www.sibileau.com/martin/2009/04/21 ). That is what happened on Friday and what we think will continue to occur in the first stages of the US sovereign risk repudiation, which is just beginning to blossom. Let’s be clear here: In our last letter, we suggested that the bounce in stocks was a mere bounce. After Friday, we are willing to believe in it, as long as the sell off in Treasuries gains steam.
However, to believe that such a scenario is sustainable is misleading. If the trigger of the appreciation in stocks is a massive repudiation in sovereign risk (still to be tested), the dynamics will neither be stable nor sustainable: It will spiral. In its first stage, stocks can be seen as the logical safe place to be, beginning with energy and basic materials, and ending with financials. But as the challenge falls down to the sustainability of central banking and relative price distortions begin to affect production (stagflation), gold will be the natural last beneficiary of the collective fear.