One of the big fears within the precious metals community is the worry over U.S. Treasury bonds. With more than $5.6 trillion held by foreign central bank, the worry is that relentless quantitative easing (QE) to fund both the trade and budget deficits will lead to a loss of confidence in the U.S. being able to pay the interest on the debt. In such a case, the argument goes, selling would ensue and bond rates will rise. I believe that we have seen some of that behavior at various times in the past few years, notably by China but others as well. Whenever that happens, however, someone else is always there to step up to the plate and buy the supply and keep the pyramiding of debt going.
Last month I noted that the Treasury International Capital (TIC) Report of foreign-held securities finally revealed the truth that China, who had not been a net buyer of U.S. Treasuries for more than a year, began buying in earnest again starting last September, conveniently coinciding with the announcement of QE3 and the cessation of Operation Twist. Moreover, the irony of the situation was that without China's actions in December, there would have been a net dishoarding of U.S. Treasury bonds.
The latest report shows that not only has the trend continued but it began back in November.
Change in UST Balance
Looking more closely at this month's report, a number of things popped out at me that are noteworthy.
- China bought $44.1 billion in US Treasuries. That is more than the Fed is supposed to be buying under QE4 -- $40 billion.
- The Caribbean Banking Centers - Cayman, Bahamas, etc. - disposed of $29.3 billion
- Thailand bought $8.4 billion.
Thailand buying is significant simply because it shows they are willing to intervene if the Baht rises too quickly. The ASEAN countries have been, on balance, not buyers for nearly a year. It hasn't done much good as the Baht has been one of the few currencies in 2013 to rise versus the Dollar since the Euro peaked in mid-February. It put in an all-time weekly close of 29.277, and is up 1.8% in the past month.
If we look at the monthly chart of the 30-year bond, we can see that absent this support buying by China and others, the yield would have broken through that September 2012 high at 3.28% and would have caused a lot more worry in the market. The Fed along with the People's Bank of China (PBoC) averted a potential catastrophic move out of bonds as we approached the end of 2012 where significant profits were booked in front of the fiscal cliff uncertainty.
And now, with the situation in Europe deteriorating again we are seeing more safe-haven buying in the long bond, but unlike last year prices refuse to rise. So, as capital flows out of Europe into the U.S., all it is doing now is offsetting the flight out of the U.S. and this is with a net ~$80-100 billion per month of buying by just the Fed and the PBoC.
The Fed will not allow a run on the bond market and it will raise its level of buying, regardless of what it says, to ensure that there is no panic in the markets. If you don't believe me let's do a little math. Since Christmas the adjusted monetary base has risen $343.54 billion or $114.5 billion per month, 37% faster than the stated rate of buying under QE3/4. And because of this, rates continue to hang around 3.2%.
This is where things get really interesting. Here's my updated chart of the TIC report with a 3rd order polynomial fit that I presented in my last article (linked above). The data pushes the peak out a couple of months but it still yields a maximum before the end of 2013. With the rejection of the so-called bail-in of Cyprus by the Cypriot parliament and the IMF pretty much getting schooled by Russia, this paves the way for one of two outcomes regardless of whether Cyprus stays in the Euro and gets crushed or not:
- The massive acceleration of QE in the coming months by both the Fed and the ECB as capital flight out of the West intensifies precipitating a need to stuff more reserves into the banking system. This will be coupled with a slowdown in foreign buying.
- The beginnings of write-downs of some of the impaired sovereign debt of the European periphery.
Why? Because the cat is out of the bag and a run on the European banks is inevitable, even if it occurs in slow-motion. The current trend will continue with situations like Cyprus springing up over and over again around Europe and the U.S. until it's finally over. In either case, both the Dollar (UUP) and the Euro (FXE) will fall in relation to Gold (GLD). U.S. Treasury bonds will leak higher in yield, supported by China, but with the Yuan steadily rising versus the Dollar. Cyprus was a trial-balloon for this type of solution to the problem of deteriorating sovereign debt and the balloon popped. Would the people be willing to be directly fleeced of their life's savings after having most of its value stolen via inflation? It seems the answer is no, at least in Cyprus.
But this turn of events confirms that gold will return as the savings vehicle of choice until it is finally brought officially back into the world's monetary system. Long dated bond prices have not been able to stage a follow through rally on the most serious threat to the stability of the Euro-zone since it formed. This tells me that there are sellers ready and waiting to come out and liquidate into central bank maneuvering. I would watch for a close in March below 3.09% on the 30 year bond, that would signal the return of real safe-haven buying.
Additional disclosure: I own physical gold, silver and a few dairy goats