The world financial system is a closed loop with money constantly moving between countries but largely staying within the system(exception, when physical gold or other hard assets are bought). Hence, to understand the recent historical strength of the 10 yr U.S. Treasury auction one needs to identify the flows of money in Europe and which central bank is funneling the funds to the U.S..
Following the bouncing ball:(1) the Swiss National Bank(SNB) adopted a 1.20 peg to the Euro several months ago and billions each month were being placed in German bonds in case the Euro collapsed and Germany went back to the German Mark. The SNB would come out ahead in this scenario and not lose on their peg. This strategy appears sound until the returns on the German bonds move into negative territory which recently occurred.
The turmoil in Europe continues to accelerate producing an increasing monthly flood of funds into the Swiss franc at a fixed 1.20 ratio, artificially low given the panic out of the Euro. So what does the SNB do? Simple, pour money into the only remaining strong sovereign credit with a positive yield, you guessed it, U.S. Treasuries.
I find it shocking that CNBC and other financial commentators are so "stunned" by the recent historical strength of the 10 yr Treasury auction. What happened to investigative journalism? The cause and effect of Treasury strength are so simple. I cannot wait to see the stunned faces when Treasuries move to a negative yield and the tidal wave of fiat currency hits the only remaining Tier I asset in the world that has the added advantage of ZERO counter-party risk and limited physical supply. I'll give you a moment to guess the asset to which I am referring…..
Let's continue discussion. When the SNB shifts its focus to the U.S. Treasury market they have to buy U.S. dollars first. Obviously their heavy buying pushes up the Dollar. What is not so obvious, is that at the same time major hedge fund computers begin selling gold following algorithms which have long been programmed to sell gold on US$ strength and vice versa. I would submit to you this knee jerk algo trade is about to go sideways.
Said trading activity has not gone unnoticed by the PBoC(central bank of China) which becomes a major buyer of physical gold as the hedge fund algos push it down. In the first five months of 2012 alone, China has imported more gold, a total of 315 tons, than all the official gold holdings of the U.K.. Excluding China's domestic production, annualizing the 315 tons represents more than one-third of the world's yearly production. Moreover, the pattern of the PBoC's buying is accelerating.
The end game should be obvious to all. When Treasury yields become negative the flight of money will turn to gold which will catch many hedge funds short as the algorithms flip to buying mode. Relative to the huge fiat money flows, the gold mkt is quite small(with the silver mkt only a 1/10 the size of gold). It is quite possible that at some point the gold mkt will go bid only with offers several hundred dollars higher.