Gold: I smell a trap

[MatthewLM]

Apparently in 2009 the federal reserve bought the equivalence to 80% of the newly issued treasuries. What do you think to this?

[cypherdoc]

Apparently in 2009 the federal reserve bought the equivalence to 80% of the newly issued treasuries. What do you think to this?

you're right; it doesn't make alot of sense that investors would pile into such a hated asset but when you know the biggest player in the room is going to be buying one week from now according to schedule you might want to front run him.  obviously this results in monetization and is why gold goes up too.  i'm just saying this is how big UST investors think.  i used to be a Bloomberg Tom Keene podcast listener via subscription and i remember this concept being discussed in detail.  sounds screwy until you realize the benefits of the moral hazard.  its free safe money for the primary dealers and they've done it for decades.  how long it continues?  i bet a lot longer than you think.  i wouldn't be shorting UST's right now.  you know what happened in Japan...

[MatthewLM]

You are contradicting yourself. Earlier you were saying that we shouldn't be surprised if the fed wanted to increase interest rates and would stop monetary stimulus.

The monetary stimulus can only go so far, especially as the debt increases constantly. Don't expect yield to go down forever. I am sure they have hit a low. I wont bet on it because the best bet is gold and silver.

And what does this create? Well inflation of-course.

[cypherdoc]

You are contradicting yourself. Earlier you were saying that we shouldn't be surprised if the fed wanted to increase interest rates and would stop monetary stimulus.

The monetary stimulus can only go so far, especially as the debt increases constantly. Don't expect yield to go down forever. I am sure they have hit a low. I wont bet on it because the best bet is gold and silver.

And what does this create? Well inflation of-course.

no, i'm just explaining some of the mechanisms for moral hazard that have been in place for years.  as for raising interest rates in the next 2 yrs i could see it happening to try and stuff gold and save the USD but who knows.  as i said, i'm agnostic on UST's which is why i do not have any position on them.

[MatthewLM]

Well, if you say the federal reserve will stop supporting them, which is nonsense, then you'd expect the yields to increase.

[Melbustus]

no, go study the UST market.  imagine this; a 0.5% drop in yield to 0.25% is a doubling in price!  this is the paradox in deflation that most ppl don't understand and why professional bond investors dive reflexively into UST's.

Where are you getting this notion that halving a bond's interest rate doubles the bond's price? I don't think you mean price... If a $100 face bond of some maturity is trading at $80, implying an interest rate of Y%, it does not mean that an interest rate of (Y/2)% implies a bond price of $160. Maybe I don't understand bond-market lingo, though... Clarify?


In any event, people are piling into USTs because the US is less worse off than other liquid sovereigns, and there are only so many places to put serious amounts of money. The other place is gold, which has clearly taken a good deal of the safe-haven flow. So, oddly enough, you get USTs and gold simultaneously being viewed as safe-haven assets....at least for a while.

[cypherdoc]

no, go study the UST market.  imagine this; a 0.5% drop in yield to 0.25% is a doubling in price!  this is the paradox in deflation that most ppl don't understand and why professional bond investors dive reflexively into UST's.

Where are you getting this notion that halving a bond's interest rate doubles the bond's price? I don't think you mean price... If a $100 face bond of some maturity is trading at $80, implying an interest rate of Y%, it does not mean that an interest rate of (Y/2)% implies a bond price of $160. Maybe I don't understand bond-market lingo, though... Clarify?


In any event, people are piling into USTs because the US is less worse off than other liquid sovereigns, and there are only so many places to put serious amounts of money. The other place is gold, which has clearly taken a good deal of the safe-haven flow. So, oddly enough, you get USTs and gold simultaneously being viewed as safe-haven assets....at least for a while.

A bond is issued for $10,000 for five years with a 5% coupon or interest rate, paid every six months. Then interest rates drop to 2.5%.

The annual payment of $500 ($10,000 x 5%) must equal a 2.5% payment. Doing the math, you discover that the face value of the bond must be increased to $20,000 so that the $500 fixed payment equals a 2.5% yield on the buyer’s investment ($20,000 x 2.5% = $500).

you can take this to infinity by halving the interest yet again, and again, and again, and again...and this is what the Fed has been doing and why bond investors keep buying.

edit:  you'd better understand this concept carefully b/c it will affect your investing health.

[kjj]

no, go study the UST market.  imagine this; a 0.5% drop in yield to 0.25% is a doubling in price!  this is the paradox in deflation that most ppl don't understand and why professional bond investors dive reflexively into UST's.

Where are you getting this notion that halving a bond's interest rate doubles the bond's price? I don't think you mean price... If a $100 face bond of some maturity is trading at $80, implying an interest rate of Y%, it does not mean that an interest rate of (Y/2)% implies a bond price of $160. Maybe I don't understand bond-market lingo, though... Clarify?


In any event, people are piling into USTs because the US is less worse off than other liquid sovereigns, and there are only so many places to put serious amounts of money. The other place is gold, which has clearly taken a good deal of the safe-haven flow. So, oddly enough, you get USTs and gold simultaneously being viewed as safe-haven assets....at least for a while.

A bond is issued for $10,000 for five years with a 5% coupon or interest rate, paid every six months. Then interest rates drop to 2.5%.

The annual payment of $500 ($10,000 x 5%) must equal a 2.5% payment. Doing the math, you discover that the face value of the bond must be increased to $20,000 so that the $500 fixed payment equals a 2.5% yield on the buyer’s investment ($20,000 x 2.5% = $500).

you can take this to infinity by halving the interest yet again, and again, and again, and again...and this is what the Fed has been doing and why bond investors keep buying.

edit:  you'd better understand this concept carefully b/c it will affect your investing health.

Except that bonds repay the principle when they mature.  In your example, and ignoring the discount function, the original bond has only appreciated by 20%.  The next halving of the interest rate will only give 11%.  A few more and you are down to 1%.  Zeno noticed a couple thousand years ago that the sum of this series is not infinite.

Two other factors make this system less than practical.  The first is that people will accept negative interest only when all the other places they could possibly park their money look really shitty, like back in 2008 when the commercial paper market broke the buck.  The second is that bonds mature, plus new issues have been for shorter and shorter average durations since the 90s, so the possible influence of older issues is shrinking steadily.

But yes, people do actually do what you describe.  Prior to the auctions, the primary dealers get their analysts to announce that the new issue will clear for a lower rate, which drives up the values of the bonds they are holding and also becomes a self fulfilling prophecy as the upcoming issue clears for less than it would have if the institutional investors that are required to buy bonds hadn't picked them up early.  Hey, free money for the primary dealers.  Who here can guess who they are?

The problem is that it is on a collision course with the two factors I mentioned earlier, plus all of the usual problems, plus the demographic timebomb (pensions will start paying out, reducing the size of the pools that are required by law to buy bonds), plus some other stuff.

The questions, as always, are how long the game can keep on, and what will replace it?  Armageddon is scheduled for "next week", or at least "real soon now", but it has been for 20, 30, 40, or 80 years (pick one).

P.S.  If you are under 60, this should probably be a matter of great concern to you.

[cypherdoc]

Except that bonds repay the principle when they mature. 

Except that investors trade these in on the secondary market way before they mature.

In your example, and ignoring the discount function, the original bond has only appreciated by 20%.  The next halving of the interest rate will only give 11%.  A few more and you are down to 1%.  Zeno noticed a couple thousand years ago that the sum of this series is not infinite.

Two other factors make this system less than practical.  The first is that people will accept negative interest only when all the other places they could possibly park their money look really shitty, like back in 2008 when the commercial paper market broke the buck.  The second is that bonds mature, plus new issues have been for shorter and shorter average durations since the 90s, so the possible influence of older issues is shrinking steadily.

to me, today looks even shittier.  the imbalance are even greater than 2008 and commercial paper is even worse off.  i would argue scared investors are moving out even further on the yield curve predicting that we will have an even longer and more protracted depression than we originally thought.  especially if the Fed ever implements Operation Twist.

But yes, people do actually do what you describe.  Prior to the auctions, the primary dealers get their analysts to announce that the new issue will clear for a lower rate, which drives up the values of the bonds they are holding and also becomes a self fulfilling prophecy as the upcoming issue clears for less than it would have if the institutional investors that are required to buy bonds hadn't picked them up early.  Hey, free money for the primary dealers.  Who here can guess who they are?

The problem is that it is on a collision course with the two factors I mentioned earlier, plus all of the usual problems, plus the demographic timebomb (pensions will start paying out, reducing the size of the pools that are required by law to buy bonds), plus some other stuff.

The questions, as always, are how long the game can keep on, and what will replace it?  Armageddon Hyperinflation is scheduled for "next week", or at least "real soon now", but it has been for 20, 30, 40, or 80 years (pick one).

P.S.  If you are under 60, this should probably be a matter of great concern to you.

fixed that for you.

[MatthewLM]

If you buy a $100 (principal) treasury bond for $98 (discounted) with a yield of 2% for example, then the return is $4 over the lifetime which is a 4.08% return. If you received no interest on the bond and sold it for twice the value, $196, then the return would then become -46.87% unless you could sell it for higher in which case it becomes a bissare game of pass the financial bomb.

Doubling price does not half the actual return in repayments inc. interest.

The yields shown on US treasuries aren't negative so they couldn't have shot up majorly in price unless fraud is involved?

[cypherdoc]

gold looks to have failed at the 61.8% retrace from the top to bottom.

as i said, stocks should rally from here while pm's get hit.  its their turn.

[MatthewLM]

Everyone is going to be saying "head and shoulders pattern" now.

[kjj]

Except that bonds repay the principle when they mature. 

Except that investors trade these in on the secondary market way before they mature.

Unimportant.  They still pay off eventually, so the income stream is not their only value.  Of course, if you only ever hold them for a few days or months hoping the interest rate will go down, and you consider the face value to be as good as cash (because you can easily use it for a loan), then it gets really easy to see the coupon as the fundamental item and ignore the actual purpose and reality of the bond.

I had previously typed up a post about how speculators learn to see the tiny wart that they operate on as the fundamental thing and ignore the face behind it.  I kinda wish now that I had posted it.  No offense meant to you, but I bet that if we were talking about futures markets, your comments would reveal an internal view of them as cash machines that grudgingly tolerate producers and consumers only because they are easy marks for fleecing.

In your example, and ignoring the discount function, the original bond has only appreciated by 20%.  The next halving of the interest rate will only give 11%.  A few more and you are down to 1%.  Zeno noticed a couple thousand years ago that the sum of this series is not infinite.

Two other factors make this system less than practical.  The first is that people will accept negative interest only when all the other places they could possibly park their money look really shitty, like back in 2008 when the commercial paper market broke the buck.  The second is that bonds mature, plus new issues have been for shorter and shorter average durations since the 90s, so the possible influence of older issues is shrinking steadily.

to me, today looks even shittier.  the imbalance are even greater than 2008 and commercial paper is even worse off.  i would argue scared investors are moving out even further on the yield curve predicting that we will have an even longer and more protracted depression than we originally thought.  especially if the Fed ever implements Operation Twist.

Did I miss something?  The first time that the money markets fell below parity, it was huge news.  I haven't heard peep since then, so I don't think they could possibly be worse off now.

[cypherdoc]

this move the last few minutes has all the smell of the trap i've been talking about.  be nimble.

SLW has tripled tested the 61.8% Fib and appears to be failing to penetrate.  PAAS is also peetering out.  i still think the $DXY rises from here.

Euro's in trouble again which should also drive USD up.  we may be getting ready for the all one market effect; everything down with USD up.

[cypherdoc]

[Melbustus]

Euro's in trouble again which should also drive USD up.  we may be getting ready for the all one market effect; everything down with USD up.

Euro being in trouble again is bullish for gold. I see the point you're making about the USD, but the reality lately has been that BOTH the dollar and gold are currently seen as the best safe-haven plays. Hence they can both go up simultaneously. Odd, but, for the moment, true. If sentiment shifts to gold being a dollar-inflation hedge, that can't happen, but it's all safe-haven right now...

[cypherdoc]

Euro's in trouble again which should also drive USD up.  we may be getting ready for the all one market effect; everything down with USD up.

Euro being in trouble again is bullish for gold. I see the point you're making about the USD, but the reality lately has been that BOTH the dollar and gold are currently seen as the best safe-haven plays. Hence they can both go up simultaneously. Odd, but, for the moment, true. If sentiment shifts to gold being a dollar-inflation hedge, that can't happen, but it's all safe-haven right now...

i find it interesting how diff mkts can diverge in their relationships at transition pts.  i think we're at one right now where gold and USD appear to move together but eventually gravity will take hold of gold and drag it down abruptly. i think this consolidation after a parabolic move will have a diff result this time.  the $DXY has formed a small descending wedge for the last 3 wks or so.  at the very least this early USD move UP should make you sit up...

[MatthewLM]

I'm sure next week gold will push past $1900 again with Obama talking about increasing deficit spending on stupid job plans.

[miscreanity]

I'm well aware how dependent modern society is on electrical power, yet it's still amazing how lack of it is so inconveniencing, to put it mildly.

GLD is trading at $177.  How do you buy in the money puts for "pennies?"

Not in-the-money. Wait until they're out of the money. As GLD rises above 240, puts around 200 should be under $1. Puts around the current range of 160-180 will definitely be pennies by then. At that point, buy puts at those ranges for about 6 months out and simply hold until the shorts make their next grand effort. Theta has a negligible effect here since we're looking at enormous volatility.

Making prediction is difficult, but if I had been consistently wrong on gold for the last 10 years, I'd feel guilty about my followers' financial loss, apologize, or at least keep my mouth shut. 

I used to keep a spreadsheet. In it were names, predictions/projections and several fields to examine whether the individual was right or wrong on a claim at a certain time frame.

After about two years of that, it was very easy to narrow down who knew what was going on in the world. Even within six months, the greats were becoming obvious.

Prechter was at the bottom, along with Jon Nadler. I no longer need to use spreadsheets; that experiment honed my bullshit-detection skills.

Head and shoulder reversal?

There have been many H&S patterns during the gold bull, often far more convincing than this latest. A lot of technical patterns based primarily on price charts are giving false signals due to markets entering transition phases.

I'm sure next week gold will push past $1900 again with Obama talking about increasing deficit spending on stupid job plans.

Politicians generally look backward, not forward. Their words simply provide reinforcement for existing trends, not the other way around. You don't change the world; the world changes you.

[cypherdoc]

Congratulations miscreanity.  Good to see you back.  Awesome few days for gold and silver.