Bonds More Dangerous Than 007

It was another hard night Friday night for gold and silver, both down sharply as shares continued their Trump rally.  This of course has many scratching their heads.  This is clearly a market rallying on hope and emotion not fundamentals.  Even Stanley Druckenmiller, who said he sold his gold on the night of the election (at its peak), when queried on why he is so optimistic on shares when it is projected to blow out deficits by so much that many Republicans are hesitant to back them, responded  "I don't worry about the other stuff…”.

We discussed Friday the massive debt issue that exists already and potentially the key element in all of this is the bond market.  For Trump to spend all that money on infrastructure whilst cutting income through tax cuts, he needs to issue more bonds to the market to fund it.  The program will also be highly inflationary and put pressure on the Fed to raise rates more quickly as well.  This all comes at a time when bond prices are already falling (yields rising) and the world is as leveraged as it’s ever been.

The types and holders of bonds are wide and varied.  Apart from the aforementioned sovereign debt like US Treasuries, we have seen a proliferation of corporate bonds and just plain junk bonds (over $1.4 trillion more just since 2012).  US corporate debt now stands at 45% of GDP, the same level as the top of the last 2 credit cycles in 2002 and 2008.  Banks are tightening lending and defaults and credit downgrades are on the rise.   But critically, this is all before the now certain rising yields and rates.

This “other stuff” is very real and of a scale that is in many ways incomprehensible.  Goldman Sachs warned nearly a month ago of the repercussions of rising yields, stating a 1% rise would translate to over $1.1 trillion in losses to holders.  That happened last week.  Those rising yields also mean higher rates for mortgage holders (weighing down on property), and higher required rates of return for shareprice analysts (weighing down on shares fundamentals).

The elephant in the room is the appetite for the big bond holders/buyers to purchase more bonds to fund Mr Trump’s plans in such an environment and moreover any panicked sell off.  Druckenmiller’s stated response was to go short the bond market.  That’s not something everyday investors can easily do.  Gold on the other hand is very easy and is essentially the same play.  

This new era of high inflation and precarious bond markets is potentially very supportive of higher gold prices.  We just need to get past the current hope and emotions stage….