bearfund

Gold Train: All Aboard

tvb, if bank deposits or Treasury bills offered a positive real return, they would be good investment candidates as they are low-risk (not zero risk, however; the dollar can and does drop abruptly in value at times, and it may not be possible to get out of these investments quickly enough to preserve capital in such an event). CDs and Treasury notes and bonds also carry duration and interest rate risk as well; that risk has to be priced into the return. But it turns out that for most of the past decade, these assets have offered large negative real returns. The only upside potential is a sudden large increase in the value of the dollar. This too can and does happen; it has happened twice this year. But these movements are to all appearances random and I do not pretend to the ability to forecast them. Therefore bank deposits, CDs, and Treasuries are not viable investments at the present time.

Long-dated Treasury securities were an excellent investment in November 1981; Volcker was beating the hell out of inflation and coupons were in the 14% range. If one bought 100 oz t worth of such bonds at auction and held them until maturity in 2011, he got about $43,000 in face value. Assuming he did not reinvest any of the coupon payments and that the dollar remains at the same value it is today for the remaining 3 years, he will end up with 490 oz t. Considering the limited downside risks in 1981, that's an excellent real return - about 5.44% annualised on a compound basis. Had he sold out within the dollar's plateau between late 1997 and the end of 2001 and chosen a time when interest rates were especially low, he might have done much better still.

So one should not mistake my hatred of Treasuries for a permanent bias; it is clearly possible to obtain a nice return from them under the right circumstances. However, today's circumstances are not the right ones; nominal yields are paltry, inflation is high, monetary policy is clueless, the public debt is very large by historical measures, and supply is exploding thanks to congressional and public indiscipline. That is why I continue to be short Treasuries. I intend to start covering when yields reach 7% and exit by 10%. If Volcker were back in charge, overnight rates were 15%, and the curve were slightly inverted with the long bond priced at 14%, I would be happy to get long. I might lose anyway, but the risk/reward calculus would be favourable. Today it is not, so gold it is.