If Bond Prices Collapse, Will Gold Takeoff?

Includes: GLD, IAU
by: Patrick MontesDeOca

On Monday, Citigroup analysts cut their gold forecasts for 2013 by 4.2% to $1,675 a troy ounce and for 2014 by 0.2% to $1,653 a troy ounce. Their silver price forecasts remained unchanged. I find this morning's news headline-- indicating central banks' expectations of lower prices for gold-- very telling about what is happening to the transformation gold from a speculative investment into its original role as a currency.

For thousands of years gold was a currency and it is becoming one again. Gold was once the basis of all wealth and was regarded as the only currency with reliable, long-term value. It was the standard by which all wealth was measured. This changed in the 1970's when the United States government, plagued by debt from the Vietnam War, ended convertibility between the U.S. dollar and gold. The fascinating chart below shows the purchasing power of the U.S. dollar, from 1792-2004. The dotted line represents periods when the dollar was not backed by hard currency.

After gold lost its position as the standard measurement of wealth, beliefs about what formed the basis of wealth changed. As the economic rules of the world changed, everyone developed their own methods of measuring wealth. People were able to create currencies without foundations. Paper money was printed whenever governments needed it and new wealth, based on uncertain value, became dominant.

Given where the United States stands economically, its record debt to GDP ratio and record low interest rates, it is extremely difficult to believe what the media is saying. New York Times columnist Paul Krugman says the problem is already "pretty much" solved. While the federal budget deficit has increased, admits Krugman, don't worry-- it's supposed to happen that way. The deficit is supposed to increase in a depressed economy to support demand.

According to Eric Sprott of Sprott Asset Management, "I have always believed that one of the world's fundamental flaws is the leverage in the bank system. As you might be aware, the typical leverage of a European bank is something like 30 to 1. This means you have roughly 3 cents of capital supporting $1 dollar of assets, and as these economies have run into a bit of a roadblock (the best examples are Greece and Spain), you find out that values were too high."

In a recent interview I asked Eric the following question:

In an interview we did last year, we touched upon Venezuela's President Hugo Chavez's request to repatriate Venezuela's gold on deposit from British banks. You commented in King World News recently that we're beginning to see the same requests coming from the more advanced economies such as Germany, Austria and the Netherlands; and now, according to The Financial Times, Latin American central banks are buying gold. They are estimating they will buy 500 tonnes, if not more. For the benefit of our audience, can you expand on what it could mean in terms of supply and where the price could be headed, if we see more countries making the same requests.

And he said, "But to answer your question, I've written articles answering your question; do the Western central banks have any gold left, because as you've pointed out, we have seen that non Western central banks have been the most aggressive people in terms of buying gold, and I'm referring to Russia, China, Mexico, S Korea, Latin American banks. If they are doing it, one of the countries, was it Peru that bought gold recently? I always try to put myself, if I was looking in on what the Western central banks are doing, and I'm referring to the Bank of Japan, the Bank of England, The European Central Bank [ECB] and the Fed, and you're looking at what is happening and presuming that you are not a money printer, I think you would be thinking there is only one result that can happen from this money printing, and that is the value of the currency will go down."

The problem is we're getting different signals from the bond market. As I have examined previously, I explore the consequences of interest rates moving higher as the U.S. bond market gets closer to having to deal with the inevitable; the exponential tail cost of the national debt.

"It seems the market will have to adjust rates for that risk with much lower bond prices (higher yields), to compensate for the risk and prevent flight of capital out of U.S. Treasuries. This translates to a higher yield for investors but carries a much greater risk of principal loss if prices continue to decline. As bond investors become aware of the serious risk consequences they carry by owning U.S. securities and the impact on the U.S. and global economy, they will begin to look for alternative investments and specially precious metals."

If we take a look at the 30 year U.S. Treasury Yield chart, we can see that the yield (lower prices) on July 25, 2012 was 2.46% or the equivalent of 153 in terms of price. This was a historical high for bond prices and a historic low in yield. Since then the price of bonds has come down to around 143.75 levels (January 20, 2013) or an equivalent yield of 3.4%.


Buy gold and silver at current prices as they are the best way to preserve whatever integrity is left in the purchasing power and value of the dollar as a fiat currency.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.

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