The Long Bond Is A Signal For Gold

Summary

  • Bonds are for safety.
  • China has been supportive of the U.S. bond market.
  • Risk-off on the back of Coronavirus.
  • The action in bonds continues to support gold - rates will stay low for most of 2020, CBs will keep buying.
  • Grind profits with JNUG and invest the gains in GDXJ.
  • Looking for more stock ideas like this one? Get them exclusively at Hecht Commodity Report. Get started today »

It is hard to believe that back in the early 1980s, a US 30-Year Treasury Bond offered an almost 20% yield. In the days when inflationary pressures were roaring, a $100,000 investment in a US Treasury bond paid the holder a coupon of $20,000 each year over the 30-year life of the fixed income instrument.

Rates came down steadily, starting in the 1980s. In the aftermath of the global financial crisis in 2008, the accommodative policy of central banks around the world pushed short-term rates to an all-time low. The Fed and others around the globe dug deep into their monetary policy toolboxes to develop programs of quantitative easing that forced rates lower further out along the yield curve. In the US, the short-term Fed Funds rate dropped to an incredible zero percent.

Since the US has the world's leading GDP and a long history of political stability, the US 30-Year Treasury Bond has long been a bastion of safety. When markets around the globe become volatile these days, capital flows to the long bond and another safe haven, the gold market. The correlation between US Treasury securities and gold has been tight over recent years. In early 2020, the bonds have exhibited strength along with the yellow metal. Gold mining stocks tend to outperform gold on a percentage basis when the price of the precious metal moves higher. Junior gold mining stocks often do even better because of their leverage to the price of the metal. The Direxion Daily Junior Gold Miners Index Bull 3X Shares (NYSEARCA:JNUG) magnifies the price action in a portfolio of junior mining shares.

During periods of heightened fear and uncertainty, US bonds and gold have moved higher, and that trend is likely to continue.

Bonds are for safety

The US 30-Year bond has been in a bull market for decades.

Source: CQG

The quarterly chart of the US 30-Year Treasury Bond futures contract highlights the rise of the long bond since the early 1990s. The bond futures took off on the upside following the 2008 global financial crisis as central banks slashed short-term rates and put pressure on rates further out along the yield curve.

Over the years, US government debt securities have been a bastion of safety during periods of market turbulence. Holders of the bonds have experienced a decline in yields, but significant capital growth as the bond market has been in a one-way trend higher.

China has been supportive of the U.S. bond market

As the second wealthiest nation in the world, China has been one of the leading buyers and holders of US government debt. The long bond corrected lower in 2018 because the Fed became more aggressive, increasing the Fed Funds rate. Four rate hikes for a total of one full percentage point weighed on the value of the bonds as did the balance sheet normalization program where the US central bank allowed the legacy of QE to roll off its balance sheet.

Source: CQG

The weekly chart illustrates the decline in the long bond throughout most of 2018. However, rising rates caused a correction in the stock market in the final quarter of 2018, and market participants flocked to the safety of the long bond. After reaching a low of 136-16 in October, selling in stocks triggered buying in bonds. As the Fed reserved course in 2019 and began cutting short-term rates and ending its balance sheet normalization program, bonds rallied to a high of 167-18 in late August.

As the trade war between the US and China escalated in 2018 and 2019, the fears of a global recession began to drive buying into the bond market. On August 1, 2019, US President Trump suddenly slapped new tariffs on the Chinese, and the Asian nation retaliated. The bonds moved from 154-14 during the final week of July to a high of 167-18 in late August as the trade war reached a boiling point.

Risk-off on the back of Coronavirus

The long bond corrected after the US and China reached a "phase one" trade deal in late 2019. The two nations signed the agreement on January 15 in Washington, DC. The long bond declined to a low of 155-05 as the fear and uncertainty over trade dissipated. However, the outbreak of Coronavirus turned the bond market higher once again.

Source: CQG

The daily chart shows that as risk-off conditions gripped the market as the number of cases of Coronavirus grew, the long bond rallied to a high of 164-05 on February 3. The bond has a long history as a safe haven during periods of market turbulence.

The action in bonds continues to support gold - rates will stay low for most of 2020, CBs will keep buying

Lower interest rates are typically bullish for the price of gold as they lower the cost of carrying the yellow metal. Moreover, gold competes with other assets for capital flows. As the yield on bonds drops, gold tends to shine. The gold market broke out to the upside in June 2019 when the US Federal Reserve told markets to expect lower interest rates by the end of the year. The Fed followed through on its guidance, cutting the Fed Funds rate three times for a total of 75 basis points and ending the program of quantitative tightening that reduced the central bank's balance sheet.

Source: CQG

As the monthly chart highlights, the gold futures market broke out of a $331.30 trading range to the upside in June 2019. The price continued to rise as interest rates declined. The timing of the Fed's decision to cut interest rates and gold's rise was more than a coincidence. The Fed is an apolitical body. The US central bank is more than likely to leave rates unchanged until after the November 2020 election as it does not want to make any changes in monetary policy that could influence voters.

At the same time, central banks around the world have been buying gold and adding to reserves over the past years. Even as the price rose last year, they continued to purchase the yellow metal. Gold is a reserve asset that monetary authorities and governments hold as an integral part of their foreign exchange reserves. By their actions, central banks have been telling the world that gold is the ultimate form of money. The odds favor a continuation of net buying of the yellow metal in 2020 by the official sector. The breakout to the upside combined with low yields on US bonds and other debt securities around the globe is bullish for the price of gold. While the precious metal did not make a new all-time high in US dollar terms during the recent move higher, the dollar and Swiss francs were almost the only currencies that did not experience new record levels for gold.

Grind profits with JNUG and invest the gains in GDXJ

Markets rarely move in a straight line, even during the most aggressive bull markets. After breaking out above the July 2016 high and level of critical technical resistance at $1377.50 last June, gold has continued to make higher lows and higher highs. With interest rates going nowhere fast over the next ten months, the odds of a continuation of the bullish price action in the gold market are high.

Source: CQG

The weekly chart shows that gold rose to a high of $1559.80 in early September and then moved to a peak of $1613.30 in early January. The bull market in gold began in the early 2000s when the price of the yellow metal was below $300 per ounce. After rising to a high of $1920.70 in 2011, gold entered a corrective period that took the price to a low of just under $1050 in late 2015. The move above the technical resistance level last June ignited the next leg in a bull market that began almost two decades ago. At around the $1565 level on Wednesday, February 12, gold was above the September 2019 high. The current trend suggests that it will be only a matter of time before the precious metal rises to a new high above the January peak at the $1613.30 level.

Buying gold on price weakness has been the optimal approach to the market. Gold mining shares tend to outperform the gold futures market on a percentage basis on the upside, and junior miners do even better. If gold is heading higher, buying dips using a leveraged instrument, taking profits on recoveries, and investing the gains in physical gold or unleveraged ETF products could be an excellent way to build a position in gold. Lots of sings, including the action in the US bond market, are telling us that gold is working its way towards the 2011 high and the $2000 per ounce level.

The Direxion Daily Junior Gold Miners Index Bull 3X Shares is a short-term trading instrument that holds a leveraged diversified portfolio of junior gold mining shares. JNUG could be a useful tool when it comes to buying dips in the gold market to magnify returns when the price of the yellow metal recovers. However, any instrument that magnifies upside results can do the same on the downside if a significant correction in the price of gold occurs. Therefore, JNUG is only appropriate for short-term trading positions. The fund summary and most recent top holdings of JNUG include:

Source: Yahoo Finance

The top holding of VanEck Vectors Junior Gold Miners ETF (GDXJ) include:

Source: Yahoo Finance

JNUG has net assets of $1.03 billion, trades an average of around 2.7 million shares each day, and charges a 1.17% expense ratio.

The price of gold rallied from a low of $1266 in late April 2019 to a high of $1613.30 at the most recent high, a move of 27.4%. As gold rallied, GDXJ appreciated from $27.80 to $43.23 per share or 55.5% as the junior gold miners rose twice as much as gold on a percentage basis.

Source: Yahoo Finance

Meanwhile, JNUG rallied from $31.55 to $104.00 per share or 3.3 times higher. While gold and GDXJ reached highs in January, JNUG peaked in August as time decay ate away at the gains when gold reached a higher high in early January. JNUG only traded to a peak of $89 per share earlier this year.

JNUG can turbocharge results, but timing is everything when it comes to the triple leveraged product. Buying JNUG on dips, taking profits on rallies, and investing the gains in gold metal or unleveraged ETF products like GDXJ is one way to build a long-term position in the precious metal to take advantage of higher lows and higher highs.

Bonds are telling us that the current interest rate environment continues to support the price of gold. Sustained buying by central banks is another reason why the yellow metal is heading for a new record level in US dollars.

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This article was written by

Andrew Hecht profile picture
27.9K Followers
Weekly commodities commentary and calls, from a Wall Street veteran
Andy Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is the #2 ranked author on Seeking Alpha in both the commodities and precious metals categories. He is also the author of the weekly Hecht Commodity Report on Marketplace - the most comprehensive, deep-dive commodities report available on Seeking Alpha.

Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.

Over the past two decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities.

Andy understands the market in a way many traders can’t imagine. He’s booked vessels, armored cars, and trains to transport and store a broad range of commodities. And he’s worked directly with The United Nations and the legendary trading group Phibro.

Today, Andy remains in close contact with sources around the world and his network of traders.

“I have a vast Rolodex of information in my head… so many bull and bear markets. When something happens, I don’t have to think. I just react. History does tend to repeat itself over and over.”

His friends and mentors include highly regarded energy and precious metals traders, supply line specialists and international shipping companies that give him vast insight into the market.

Andy’s writing and analysis are on many market-based websites including CQG. Andy lectures at colleges and Universities. He also contributes to Traders Magazine. He consults for companies involved in producing and consuming commodities. Andy’s first book How to Make Money with Commodities, published by McGraw-Hill was released in 2013 and has received excellent reviews. Andy held a Series 3 and Series 30 license from the National Futures Association and a collaborator and strategist with hedge funds. Andy is the commodity expert for the website about.com and blogs on his own site dynamiccommodities.com. He is a frequent contributor on Stock News- https://stocknews.com/authors/?author=andrew-hecht

Disclosure: I/we 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 author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

The author is long gold

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