As noted, this week’s letter was a difficult one because it raised a lot of questions, many of which seem to have opposite implications. Going forward I will try to be very clear in focusing on individual aspects of the macro picture as opposed to throwing everything up against the wall the way I think #255 did.
The individual aspect nagging at me from #255 is the yield spread issue. Here is a chart of gold and various yield curves, with the 30-year (TYX) as the constant, being divided by various other durations.
It had been established through gold’s bull market that the price of gold tended to rise with a rising yield spread, until the relationship went off course last year during the Operation Twist phase, when the Fed sold short-term bonds while buying long-term bonds. During that phase, inflation expectations were ‘sanitized’ right out of the picture, even though they were inflating. It was almost by magic.
As noted in #255, somebody is now selling short-term T bonds more aggressively than long-term bonds and I have been in this racket just long enough now to at least have suspicions that this is not an arbitrary situation. My more paranoid self wonders about potential back room agreements as to the structure of large T bond sales by big macro economic partners.
To put it plainly, I wonder about the potential that US policy makers and Chinese Central planners are on the same page as to how the process of China’s disgorgement of bonds may play out. The Fed used up its supply of short-term bonds and terminated Twist. By then damage had been done in the precious metals and momentum, media PR and whatever manipulation employed by the ‘boyz’ (it’s no secret, there is manipulation of the gold market; it’s just a fact… but never an excuse) probably helped push them to the lows registered in June.
In late 2012 gold had been following the yield spreads down during a routine and what looked like a healthy post-Euro crisis correction/cyclical bear. Then the curves turned up (I assume this was due to the Fed’s exhaustion of short-term bonds to sell) but gold and silver disconnected and crashed I assume for the reasons noted above, but also because it was simply time for them to take a frightening decline, which had not yet happened in the secular bull.
The curves then tanked as well and I assume this is due to short-term durations being sold more heavily than long durations by China and/or Japan. Can I prove it? No, not with the data available currently that I know of.* In the last couple of weeks this condition has intensified even as the precious metals rallied.
* Please forward if you have additional data that looks into the structure of Chinese/Japanese bond sales beyond the raw TICs data, which simply notes “T-Bills, T Bonds and Notes” with no discrimination about durations.
The bottom panel of the chart happens to be rising fairly aggressively. That is because the Fed is holding ZIRP while free(er) interest rates rise. That is the ultimate yield spread as policy is absolutely loose while inflation expectations (at least as implied by rising yields) creep upward. If indeed there is strategy behind how US creditors are unloading T bonds, the 30-T bill spread is probably the only honest one in play. But will that matter?
In the past we likened Op/Twist to a macro parlor trick. Well, trick or not it played a roll in the precious metals cyclical bear market and it appears that sellers of Treasury bonds are Twisting once again.
I would be flat out guessing if I pretended I could tell you the why’s and what for’s with respect to how this could benefit China, but one thing is for sure; a similar dynamic benefited the US greatly over the last year. Parlor trick or not, people believed in its signals. And is this not a market and an economy that is all about confidence?
At the moment I don’t think this development as a panic issue, but speaking for myself I am not going to tolerate much additional downside in the gold stocks. As it is my personal speculative portfolio is 77% cash with the balance in precious metals stocks roughly per the model portfolio here at the site; quality only.
There is a reason I do this weird and I guess complicated work and it is because I hate losing and in this macro game we are playing the stakes are high and as the last year showed us, anything is possible. So please, if for fundamental reasons you are secure in your orientation understand that it is my job to disturb things and ask hard questions. Even maybe to make you feel uncomfortable at times. But it is never my intention to try to influence you beyond a reasonable and balanced approach.
The above work could be much ado about nothing, with the ZIRP spread being the key. But I trust that in these times many of you would rather have too much information (to sift through with your own b/s detectors) than too little.
I personally remain ready to gear further in to the precious metals or get the heck out (aside from real gold). Meanwhile in the regular personal portfolio I hold several equities (US and global) with charts and businesses I like, but also offsetting puts on the S&P 500. Part of what I’d like to flesh out going forward is the effect another Twist (instigated by foreign sellers this time) might have on US and global markets.
Bottom Line
When you don’t fully understand something (as I do not with the current yield spread status) caution should be the default. My friend Mark at Inca Kola News quoted something in his newsletter* last week that I wrote a few months ago: “It is time to be right by not being wrong” or something along those lines. I had actually forgotten about that, so thank you for the reminder Mark. I think that given the situation in T bonds and the fact that the inflation case is not yet proven, it’s a good way to go until some things clear up.
* IKN Weekly continues to be what I consider the standard for ethical, grounded and hard working quality analysis of the mining sector.
