I always look forward to the 15th of each month as it is the day of the latest Treasury International Capital -- or TIC-- report. This is the report which tells us the extent to which foreign central banks are willing to finance the U.S. trade and budget deficits. A couple of months ago I penned an article on the changes happening in Southeast Asia, especially financial centers Hong Kong and Singapore, and its effects on the TIC report. In that article I made it clear that what was happening in emerging markets would yield net selling in U.S. Treasuries in future TIC reports and today's report confirms that analysis. So, what does this mean for gold going forward?
A number of things and, most importantly, this is a moment that many of us in the gold (GLD) community have been expecting for a long time, the period in which foreign central banks finally get sick of floating our deficits and defending their currencies against the U.S. dollar (UUP). I've put up this chart before and now I'll put it up again with the latest data.
Three consecutive months of net selling by foreign central banks is no longer a blip but it is now a trend. Moreover, this has not been a case of mild selling but rather more than $160 billion in net sales in 3 months with the bulk of it occurring in June. The last time we saw net selling (Red Arrow) was when China unilaterally dumped U.S. Treasuries and made a big stink about it.
This time it was simply a matter of survival on the part of countries unwilling to allow their currencies to be completely trashed in the foreign exchange markets during a period of extreme dollar strength brought on, in my opinion, by profligate and aggressive debasement by Japan of the yen (FXY).
The selling is coming from emerging markets who sell Treasuries (TLT) to obtain dollars and support their local currency. For countries like Thailand (THD) where the Baht has been under stress for months, its net holdings of US Treasuries have dropped since March from $68.4 billion to just $50.2 billion, a 26.6% reduction over just 4 months. Russia has sold $26.9 billion since February, a 16.3% reduction, to defend a ruble that has fallen 9.1% over that period. The ruble is showing no signs of stabilizing. So, we should expect selling from this corner to continue.
While Japan's and China's selling this month will grab the headlines (like this one at Zerohedge), it is the relatively heavy selling in Hong Kong that should be worrisome since the Hong Kong dollar is pegged to the US dollar and Hong Kong's bond yields have suffered the most since the USD rally began in Q1. Hong Kong dumped 9% of its holdings in June ($12.2 billion) and 16.6% or $24.4 of its total holdings since March. Hong Kong's bond yields are reflecting the risk associated with maintaining a US dollar peg in the face of massive QE from the Fed and the Bank of Japan.
The selling is broad based at this point and with the USDX now having topped - I'm watching for a weekly close below 80.64 for confirmation - we are rapidly approaching the moment where the market we've known for so long will change structurally. It will be a market where U.S. Treasuries are not the ultimate safe haven move and where gold will be.
During the last gold bull market in the late 1970s, as confidence in the dollar waned, yields rose and so did the dollar price of gold. In fact, that's when the biggest gains in gold occurred. That's normal market behavior. When confidence in a currency is lost investors require a higher yield to offset risk and the price of the currency in gold should rise. We have deluded ourselves into believing that U.S. Treasuries carry a risk-free rate of return on them and as such conventional wisdom points to that as to why rising rates should be bearish for gold.
But, if the attitude towards USTs as a means to store wealth is changing and the implied risk-free premium rises above zero, then that will be reflected by more normal market behavior for a debt instrument in relation to gold. In other words the bloom comes off the U.S. bond rose and they trade just like everyone else's bonds.
So, flash forward to today and what do we have occurring:
- A miserable TIC report which confirms the new trend of dumping or, at best, no longer accumulating of USTs by foreign central banks.
- The yield on the 10 year benchmark US Treasury Note (IEF) rising to a more than 2 year high above 2.8%
- Gold breaking through overhead resistance at $1350 per ounce and creating an outside bar on the August monthly chart - an extremely bullish event
- Silver (SLV) leading gold higher topping $23 per ounce and besting the June high of $22.98, creating a preliminary reversal signal on the monthly chart.
- GOFO rates that have been negative for a record period of time, indicating massive demand for physical gold. See this excellent article by Dave Kranzler for more details.
- India banning all imports of gold coins into the country in a vain attempt to stabilize a rupee which is weak due to inept government policy.
It doesn't hurt matters that the warehouse situation for JPMorgan (JPM) has reached an acute crisis stage and it is likely that their commodities desk is now actively buying in the futures market to secure supply to meet obligations already on their books which have been in effect for months.
All of this is winding up to the same conclusion I have had for months now. There will be no tapering of QE. The Fed cannot stop purchasing U.S. Treasuries in this environment unless it is okay with yields on U.S. debt rising significantly from here. Even if the Fed doesn't taper its bond purchases the TIC report is telling us that foreign central banks will likely continue diversifying out of them and into other asset classes which cuts them off as a long-term source of demand and will keep the U.S. dollar weak.
Now that the yen is through with its debasement program, foreign central banks have their fill of U.S. Treasuries and equity markets are looking like they have topped, where are the dollar sinks going to come from that can continue to hide the inflation being created by all of this QE? In my mind nowhere and that's why we're seeing the action we are seeing in gold and silver and why physical demand for the precious metals went through the roof this summer.
Additional disclosure: I continue to own gold, silver and a few dairy goats.