08/04/2010 – How Might Gold, Silver and T-bonds Behave in a Bear Market?

This section will offer a novel viewpoint. Can you imagine a
scenario under which precious metal and Treasury bond prices would
fall together? Most people would think such an event would be
impossible. After all, as we showed in our study of March 2008,
bonds do well during deflationary recessions, and gold goes up
during inflationary booms. Shouldnt they be contra-cyclical?

Look at Figure 3 and realize that gold and T-bonds have been
going up together for an entire decade.

This is completely normal behavior according to
our liquidity theory of market movement at the end of credit bubbles
and their aftermath, as proposed in Conquer the Crash
back in 2002. If gold and T-bonds can go up together for ten years,
they certainly can go down together as well.

[Here is a scenario that] is likely to occur later, but since
it could happen now, let’s review it. …U.S. Treasuries cannot
hold up forever, particularly given the drunken-sailor approach
to fiscal management that Congress has practiced over the past
century and which has accelerated madly in the past eight years
and even more outrageously since last September. At some point,
Uncle Sam’s credit rating will begin to slip. According to the
price of credit-default swaps on U.S. Treasury debt, it is already
slipping.

When the monopoly issuing agent of dollar-denominated debt —
the Federal government — begins to lose credibility as a debtor,
the U.S.’s great experiment in fiat money will end. Read it here
first: The U.S. government is the borrower of last resort. When
it can’t borrow any more, the game will be up, because the government’s
T-bonds are the basis of our “monetary” “system.”

What will happen when creditors begin to smell default? They
will demand more interest. At first, it might not be much: 4%,
6%. But as the depression spreads, spending accelerates, deficits
climb and tax receipts fall, the rate that creditors demand might
soar to 10, 20, 40 or even 80%. In 1998, annual bond yields in
Russia reached over 200% before the government finally threw in
the towel and defaulted.

Prices of outstanding bonds, of course, collapse when yields
surge. As rates rise, many people will sell other investments
to lend at these “attractive” rates. In such a situation,
T-bonds would be the primary engine of falling prices, as they
suck value from other investments. So, this is another way that
gold and bond prices can go down at the same time. …