Miraculous Credit Spreads - Precious Metals Supply And Demand

|
Includes: AAAU, AGQ, BAR, BIL, CLTL, DBS, DFVL, DFVS, DGL, DGLD, DGP, DGZ, DLBL-OLD, DLBS, DSLV, DTUL, DTUS, DTYL, DTYS, DULL, DZZ, EDV, EGF, FIBR, FTT, GBIL, GEUR, GHE, GHS, GLD, GLDI, GLDM, GLDW, GLL, GOVT, GSY, GTU, GYEN, HYDD, IAU, IAUF, IEF, IEI, ITE, OPER, OUNZ, PHYS, PLW, PSLV, PST, QGLDX, RISE, SCHO, SCHR, SGOL, SHNY, SHV, SHY, SIVR, SLV, SLVO, SPTL, SPTS, TAPR, TBF, TBT, TBX, TLH, TLT, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBG, UBT, UGL, UGLD, USLV, UST, USTB, USV, VGIT, VGLT, VGSH, VUSTX, ZROZ, ZSL
by: Keith Weiner

Running From "Risk-Free" to Not So Risk-Free Debt

The price of gold blipped $13 last week, while the price of silver was unchanged. Speaking of interest rates and central planning by central banks, we note that in mid-2016, a correction (counter-trend move to the main trend) began in 10-year bond yields.

10-year treasury note yield vs. 10-year German Bund yield over the past decade [PT]

It occurred at the same time in the Swiss government bond and the US treasury bond. Also the German Bund, the British gilt, and the Japan government bond.

Americans, living in a bubble of our own making, think the Fed is printing dollars to infinity, therefore inflation, therefore higher rates. The proof that this view is wrong is that the same move occurs all over the world at the same time.

At the same time, an extraordinary thing is occurring in less-watched spread. Corporations with a credit rating that's below investment grade should pay more to borrow than the risk-free bond. How much more? This is a spread, and the St. Louis Fed provides a convenient graph of it.

Option-adjusted US junk bond spread (option-adjusted = adjusted for first call dates). These bonds remain in demand by yield-seeking investors on the slightly adventurous idea that the US economy is so strong that defaults are highly unlikely regardless of how high the pile in corporate debt becomes. In fact, the trend in credit spreads is diverging to an unprecedented degree from the surge in net corporate debt (and the associated surge in debt/EBITDA ratios). Investors are probably overestimating the ability of low-rated corporate debtors to continue to refinance their debt without a hitch. Sooner or later, a negative surprise or two will upset the current happy state of affairs. [PT]

This spread has just broken down to a new post-global financial crisis low. So, we are going to have inflation, and you better trade your risk-free bonds for junk bonds issued by zombie corporations? Do it quick before inflation and rates really rise!

Fretting about the government's ability to pay the interest in rising rates, they buy the debt of corporation who already couldn't pay the interest prior to rates going up? Clearly, here is a rotation out of government bonds, based on whatever story. Which does not need to be a true story, or even consistent.

And the gold community wonders why the gold price action doesn't seem to make sense...

Fundamental Developments

We will look at the supply and demand fundamentals of both metals. But first, here is the chart of the prices of gold and silver.

Gold and silver, priced in USD

Next, this is a graph of the gold price measured in silver, otherwise known as the gold-to-silver ratio (see here for an explanation of bid and offer prices for the ratio). It rose this week.

Gold-silver ratio - moving back up a tad

Here is the gold graph showing the gold basis, co-basis and the price of the dollar in terms of gold.

Gold basis, co-basis and the USD priced in milligrams of gold

The price of the dollar dropped slightly from 26.1 mg gold to 25.9 mg (i.e., the price of gold rose when measured in rubber band dollars). However, along with this, we see a reduction in scarcity, with the co-basis moving from -1.25% to -1.4%. Including on Friday, when the price of gold dropped. Which means the price move was caused by selling of metal rather than futures.

The Monetary Metals Gold Fundamental Price fell hard, from $1,352 to $1,272, especially on Friday. We shall see if this drop is durable.

So let's look at silver.

Silver basis, co-basis and the USD prices in grams of silver

In silver, the same action occurred Thursday and Friday - the price of metal falling (dollar measured in silver, green line, rising), with the co-basis falling concurrently. Someone was selling metal.

The Monetary Metals Silver Fundamental Price also fell hard, from $15.83 to $15.27.

Charts by: StockCharts, St. Louis Fed, Monetary Metals

Chart and image captions by PT