-- Posted Sunday, 19 March 2006 | Digg This Article

I’m scratching my head...

What should we make of the action in bonds?

The long end of the curve has baffled so many for so long. There’s a solid fundamental case for higher interest rates and yet yields have remained stubbornly low.

Perhaps the latest breakout has everyone paralyzed.
Is this really it?
Nah, better wait and see.

Here’s what I’m thinking:

The latest breakout in bonds is not attracting much commentary which creates the potential for a MAJOR surprise!

The market is cunning and emotionless. Regardless of what we do (or don’t) say, long-term interest rates are indeed moving upward albeit ever so slowly.

Our job as investors and speculators is not so much to question as it is to react. So without further adieu, lets take a look...


Chart 1 - 30 Yr Bonds (red) versus US Dollar (green)

Please cast your eye on the insert in the above chart. This is a snapshot of the 30-year US Bond yield (daily chart). A breakout was clearly signalled when the yield moved above the blue line. The target - around 5.25%

With so much debt fixed to long term rates I wonder what the knock on effect will be?

Chart 1 provides the clue:

The US Dollar (Green line) has a long-term correlation with Bond Yields.
There are time lags, in some instances up to 2 years - Bonds peaked in 2000 and the US Dollar in 2002. The current strength in the Dollar may be in response to rising rates in mid 2003 OR because of the current rise in rates.

Regardless, the message is that the Dollar has more upside than currently expected!

Now it’s well known that there is an inverse correlation between the Dollar and Gold.
Could this mean that Gold has a lot more downside than the current consenus?

Hold on folks...lets take a deeper look.

Rising Long Term rates are (I believe) only half the story.
The full story lies in the yield curve.
EXPECTATIONS in the spread between short and long term rates have more bearing on the price of Gold.

Why?

If the expectation is that money will become easier (the yield curve will steepen), people will borrow more to invest at higher rates and the money supply will expand. An expanding money supply IS the definition of Inflation. And Gold responds positively to rising inflation.

So what’s the current expectation around the yield curve?


Chart 2 - Yield Curve Daily

The daily chart is showing every indication of a double bottom.
The second bottom at 1.007 was not confirmed by either the MACD or RSI (green lines).
In addition the yield curve reversal has been accelerating as evidenced by the MACD crossovers (red circles).


Chart 3 - Weekly Yield Curve (red) vs HUI (black)

Divergences are even more pronounced on the weekly chart (green lines).

THE EXPECTATION IS THAT THE YIELD CURVE HAS BOTTOMED AND MONETARY CONDITIONS WILL BECOME EASIER (the yield curve will steepen). Based on the above chart that’s great news for Gold Stocks!

But what about the nagging strength in the Greenback?

The answer to that lies in Chart 4:


Chart 4 - Goldfields (red) vs Yield Curve (Green) vs Newmont (Orange)

This chart needs some explanation but also provides some valuable insight.

In 2001, when this Secular Gold Bull market began, conditions were eerily similar to what they are today.

In 2001, the yield curve began to steepen and gold stocks began to rise (refer to chart 3).
Also, from 2001 to 2002 the US Dollar continued to strengthen (Chart 1).

A stronger Gold Price and a stronger Dollar created the PERFECT conditions for Non-US Gold Miners to ROCKET higher. Which is exactly what we see with South African Miner Goldfields!
US based miners like Newmont (orange line) were slower to join the party and only saw their massive gains when chronic weakness emerged in the Dollar (2003).

We are now standing at the precipice of the next METEORIC rise in this historical Gold Bull market. As before, the first Train to leave the station will be Gold miners who count their costs in non-US Dollar currencies.

More commentary and stock picks follow for subscribers...
-- Posted Sunday, 19 March 2006 | Digg This Article

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