Dark Moon Rising: Are Recently Rising Bond Yields The Beginning Of A Crisis?

by: Hebba Investments


- Bond yields across the developed world have been rising recently.

- This may have the Fed very concerned as yields are rising at a much faster pace than anticipated.

- According to Goldman Sachs, investors stand to lose the most in history because of bond duration risk if rates rise.

- Traditionally conservative bond investors will be looking for conservative assets that do not lose value in rising yield markets and gold is the premier asset for this.

- If bond yields rise quickly then that would actually be gold-positive and not negative and that creates an opportunity for gold investors to take advantage of this mispricing.
 
 
While investors are focused on the circus around US elections, something very noteworthy has been happening in the bond markets - yields are starting to rise.
 
Starting with the Eurozone, yields in France, Germany, and Italy are on the rise.
 
 

 
 
We have yet to reach the highs seen earlier in the year, but the trajectory is certainly up. But what is a bit more concerning is that even the bond yields in Sweden, where the central bank announced more QE and "lower for longer" rates, have begun to rise despite the supposed bullish (i.e. lower) view of the nation's central bank on yields.
 
 
It is not just in Europe where yields are rising, the US has seen the same thing happen to its bond yields.
 
 
 
 
There is definitely something amiss in the bond market. This is extremely important because everyone knows that central banks are consciously manipulating the bond market to drive yields down through QE - but what happens if yields no longer respond?
 
Yes, we know that Janet Yellen and the Fed are preparing the markets for a .25% rise in the Fed Funds rate in December. But it looks like US yields are rising faster than they may have anticipated especially considering they have risen by more than .25% in the past few weeks.
 
The Fed may want to raise rates, but they certainly don't want to lose control of rates - they definitely don't want a rapid rise in rates as Ms. Yellen has mentioned many times before.
 
What is going on in the bond markets? Could it be that governments have milked the low yield bond cow a little too much and we have a bit of an overhang of new issuance? Let us not forget that we just saw Austria's new 70-year bond sale go fully subscribed as well as sales from Portugal and Germany on the following day. Not only that, the investors in that aforementioned Austria 70-year bond saw 5% losses on the face value of their bonds in the first week - not exactly what a conservative investor expects from a government bond investment.
 
Not unless they plan on holding for 70 years with that juicy 1.67% yield…

Or could it be that there is a now some concern that while markets have been pricing no or negative inflation for years to come, we have signs that the global disinflationary pressures are easing. For example, we've seen massive rallies in certain commodity prices, especially metals. As China's PPI turns positive, the US and other nations' import prices stop declining.
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If inflation is truly starting to show itself, or more likely, investors are starting to take into account, then almost no developed government long-bond yield is priced anywhere near what is necessary to compensate buyers for inflation - let alone profit.
 
Why is this Important for Gold Investors
 
We have talked a lot about bond yields, but what does that have to do with gold? Why should gold investors care?
 
Well, anybody following gold knows that one of the big reasons NOT to own gold is the fear of rising interest rates. The logic is that if interest rates were higher, then gold would be a negative yielding asset (you at the very least need to pay storage and insurance) in a world of safe positive yielding assets. Thus when the Fed talks rates up, gold tends to fall. Gold investing 101.
 
But the other side of that equation is that when yields rise, bond investors also lose - at least in terms of the face value of their bonds. Just recently Goldman Sachs started ringing the alarm bell about duration risk on bonds, claiming that a 1 percent increase in interest rates could inflict a $1.1 trillion loss to the Bloomberg Barclays U.S. Aggregate Index - representing a larger loss for bondholders than at any other point in history. "We see potential for the rates market to continue to sell off, and the notional amount of duration dollars at risk is unprecedentedly large," Goldman fixed-income analysts, led by Marty Young, wrote in the report on Monday.

It should also be remembered that bond investors are supposed to be looking for the least amount of risk on their investments - do you think they would be slightly panicked if in a few weeks they were to lose 5, 10, or 15% on their supposedly "safe" bond investment? We think so. While in the past these investors bore that risk knowing that they could safely pocket bond yields despite the drop in the face-value of the bond, now most bonds wouldn't compensate their holders for inflation.
 
So the other side of the rising bond yields equation is that investors who are least willing to face risk, face significant risks of large losses on their investments. The Fed knows all of this could happen, so what they want to do is make sure yields rise VERY slowly so investors can either get out with small losses, or not be shocked into larger losses. Otherwise, the Fed knows quite well, that panic can ensue in the market in which Goldman itself said, was possibly the most overbought in history as "the notional amount of duration dollars at risk is unprecedentedly large".
 
Not a bad environment for gold - which is the only bond-like alternative that does not carry duration risk. The price of gold does fluctuate, but unlike bonds, gold can both rise or fall when interest rates rise - the face value of a bond can only drop if interest rates rise.
 
Conclusion for Investors
 
That's why the recent rise in bond yields should be very pertinent for gold investors to keep an eye on. While markets are focused on interest rate rises being bad for gold because bonds become more attractive, they are forgetting that existing bond holders can lose a lot of money when interest rates rise. In fact, we are at levels of potential losses by rising interest rates that have never before been seen - the highest in history.
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  Source: Bloomberg
 
 
Notice these are "inflation-adjusted" dollars, so we are not talking apples to oranges here.
 
What this all means is that bond investors, traditionally more conservative investors seeking to minimize risk, are going to seek investments that at the very least maintain their purchasing power and don't lose money when rates rise. Traditional bonds are not those investments, and even bond gurus like Bill Gross have been saying exactly the same thing:
At some point investors - leery and indeed weary of receiving negative or near zero returns on their money, may at the margin desert the standard financial complex, for higher returning or better yet, less risky alternatives. Bitcoin and privately agreed upon block chain technologies amongst a small set of global banks, are just a few examples of attempts to stabilize the value of their current assets in future purchasing power terms. Gold would be another example - historic relic that it is. In any case, the current system is beginning to be challenged.
While it seems the market is sold on gold being a bad investment if interest rates rise, we think that rising interest rates may be positive for gold IF they rise fast enough. No wonder the Fed wants to go extremely slowly, and play this "stop and go" game - they have to so that investors can get out of bonds in a controlled fashion and yields don't rise too fast.
 
So the recent swift rise in yields is not gold negative - it is actually gold positive. Whether its central banks starting to lose control of the bond market (see Sweden above) or investors realizing that bonds are a much more speculative investment at these yields than anticipated, there is something going on in bond markets.
 
Thus we think that gold remains a very good investment with bond yields rising in this fashion.
 
Thus we maintain our outlook that investors should take this opportunity to accumulate physical gold and the gold ETFs (SPDR Gold Shares (NYSEARCA:GLD), PHYS, CEF) - with physical gold taking precedence over the ETFs (if you do not own physical gold buy that first). For investors looking for higher leverage to the gold price, they may want to consider miners such as Goldcorp (NYSE:GG), Yamana Gold (NYSE:AUY), Agnico-Eagle (NYSE:AEM), or even some of the explorers and silver miners such as First Majestic (NYSE:AG), though miners come with significant additional risks.

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