Wednesday, August 24, 2011

A Tale of Two "Safe Havens"


As gold sells off sharply today after hitting a nominal intraday high of $1911.46 yesterday, a reminder of the global fiscal and monetary events that powered gold up into this point is useful. The attached chart shows the path of gold compared to another "safe haven," the US 10-year Treasury note (normalized price, inverse yield). Both have a story to tell, and both reflect market uncertainty on issues of inflation, deflation, debt loads and economic growth.

During the fall 2008 market turmoil created by the credit and housing market crises, investors and traders piled into Treasuries and the dollar, while gold sold off in a technical basing pattern. As markets recovered in 2009 due to massive Federal Reserve injections of monetary liquidity (including "QE1"), gold climbed above its previous high of $1011.30 hit March 17, 2008 (the day Bear Stearns died). Fed liquidity drove a selloff of Treasuries and the dollar, with money flowing into equities, commodities and gold.

The late April 2010 flare up of the European sovereign debt crisis from fears of defaults from Greece, Portugal and Ireland sparked a "safe haven" trade into US Treasuries from May-August. In the same period, gold rose less steadily, but put in what market trading technicians call an important "base" by weeding out short-term sellers from the long-term buyers. Gold resumed its climb briskly from $1200-$1400 on inflation expectations following Bernanke's Jackson Hole speech, where he announced Fed plans for more monetary liquidity injections.

Like gold today, the 10-year Treasury has had its woes, namely a brisk selloff after the Fed embarked on its "second" round of quantitative easing last year (QE2). [By highlighting "second" I mean to dispel the idea that this was really a "second" round — the Fed engages in quantitative easing continuously through its permanent open market operations (POMO).] When inflation expectations heat up, the prospect of negative real yields prompts a selloff of lower yielding Treasuries into commodities and higher yielding equities and bonds, as evidenced by market action between September 2010-April 2011. Markets were also expecting real economic growth, but an alternate reality has since crept into market psyche.

As the European debt crisis flared again alongside US debt concerns in April-June 2011, investors chose both Treasuries and gold as "safe havens," and they have been remarkably correlated ever since. The acceleration of the trend throughout the US debt ceiling blowoff, S&P US credit downgrade and the Fed's declaration of a 2-year moratorium on zero target interest rates (ZIRP) should give observers pause. Is this a rational market or an irrational search for economic sanity?

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