Resource World Magazine

D E C E M B E R / J A N U A R Y 2 0 1 7 www.resourceworld.com 25 Bond Yields vs gold price bOnd hOlders fleeinG lOW Yields fOr preCiOUs MeTals COUld driVe GOld priCe hiGher. by Daniel Maarsman T he bond market has had a fantastic run over the last 30 years as interest rates continued to drop to levels we see today. Interest rates at these levels were unthinkable years ago. How and why governments and central banks manipulate and use creative statistical data to keep interest rates artificially low is a whole other story. For the most part, just remember that whenever governments get involved in manipulating the financial markets it generally doesn't turn out the way they planned. Many times they end up accomplishing the exact opposite of what was intended. Thirty-five years ago the situation was the total reverse of what it is today. Interest rates were setting record highs and bond prices cratered to all-time lows. In 1980, our federal government cited the Canadian dollar in defending its decision to hike interest rates to 20%. Afterward, they discovered a high dollar wasn't so good for an economy entering a recession. Strangely enough, while interest rates were hitting new highs in 1980, the gold price was also hitting record highs. The general consensus among many experts in the financial industry is that interest rates and gold trade on an inverse basis. It wasn't so dur- ing that period, and even during periods since then. To really get a grasp of the potential effect bond market yields could have on the gold price you need to understand the size of the two markets and understand the effect an interest rate rise would have on bonds. Real estate and equities would also be greatly affected but for this example the bond market is large enough on its own. How do bond values react when yields increase or decrease? It's a complicated formula to get the exact figure but as a rough guide, a 1% increase in the interest rate on a bond portfolio with an average term to maturity of seven years will drop the value of the portfolio by approximately 7%. A 20-year bond would drop by ~20% on a 1% rate rise. That's a lot for a bond that has a yield of, say, 2%. The reason interest rates and the bond market will have such a huge effect on the gold price is due to the size difference of these two asset classes. The global bond market is approximately $157 trillion while the gold market (all equities and bullion) is esti- mated to be close to $8 trillion. If just 0.05% of the bond market headed for the exits in fear of upcoming rate increases, and looked to gold as a short-term safe haven, it would likely double the price of gold quite quickly. Imagine if the real estate and equity mar- kets also had a small percentage of capital gravitate toward gold as a safe haven. A large percentage of bond investors are long-term, expecting to hold for the full term of the bond. Holders to term will not experience any capital loss. The pain will be felt by traders who need or want to sell during rising rates. The consolidation of wealth into fewer hands these days is also an important factor. This creates more volatile moves in the mar- kets as much larger amounts of capital shift from one asset class to another. Estimates are that the top 1% owns more than 50% of the world's wealth. The top 1% does not move capital around the economy the same way the middle and lower income earners do. They usually just park most of their capital into the four main asset classes: bonds, real estate, equities and precious metals. While there are always many variables to consider when trying to predict any future moves in the financial markets, the extreme size difference between the bond market and the gold market pro- vides plenty of leverage to really move the needle up on the gold price. Many analysts claim that gold trades at an inverse relation- ship to interest rate yields. Some have even claimed that the gold price will drop when yields start to rise as investors will sell their gold to buy the higher yield bonds. What they're not taking into account is that bond values drop as yields rise. They missed the possibility of bond investors looking for somewhere to hide until the rates stop rising. Interest rates can't rise, you say, because governments just won't allow it? Well, governments have been doing everything in their power to keep rates artificially low for many years and they will soon run out of their magic manipulation tactics. History has taught us that whenever governments try to influ- ence and/or manipulate markets their interference often makes matters worse. We shall see. n Gold & 10-Year treasury Yield Comparative (1977-1984). Source: StockCharts.com iNvES TmENT

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