Friday, October 9, 2009

Are U.S Treasuries and Gold in Conflict?

Gregor Macdonald

As a number of observers watch both Gold and Treasuries go higher in price, they’re concluding that one of these asset classes must be wrong. I can certainly understand that view. Over the past year, I have written several times that the 27 year bull market in US Treasuries most likely ended in December of 2008. However, a great portion of my skepticism on the prospects for further US Treasury price appreciation arose not only from supply, but, from the collapsed capital flows associated with depression.

My reasoning, starting earlier this year, was as follows: in a world of reduced trade, less dollar reserve building would ensue–thus less sovereign support for US Treasuries. In addition, I also reasoned that Americans, now trapped by debt and job losses, would also not be able to support Treasuries through savings. Each of these conditions have come to pass. Trade did collapse. Less dollar reserve building did ensue. The Agency market and the long end of the Treasury curve have largely been abandoned by foreign reserve managers. Equally, in a world of 1.5-2.0 trillion dollar deficits, the year-to-date savings rate of Americans at 446 billion while an increase over previous years is not enough to support our government spending. Not the last fiscal year, nor the fiscal year to come.

My current view is that Gold and US Treasuries are both partaking of the same surge in liquidity, now washing over most asset classes. Again, had this been a standard recession, I would have been happy to be bullish on US Treasuries right from the start. But my central thesis was that US Treasuries were a dangerous asset class as rising supply met crushed trade flows. The Federal Reserve can claim, and people are free to accept, that their 1.25 trillion purchases of Agencies and 300 billion purchase of US Treasuries are simply monetary and liquidity operations. But that doesn’t make such a restrictive, narrow claim true. The FED actually had to make those purchases to avert a funding crisis.

Are U.S Treasuries and Gold in Conflict?

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