London, England

The significant spike in global bond yields this week has punctured gold and other metals as investors react to the rapid rise in interest rates. Despite the Fed’s planned $900 billion dollar purchases of government securities from now until next June, investors are dumping Treasury bonds. European and Japanese bond prices are also falling sharply.

Gold prices also took it on the chin yesterday. Since hitting an intraday high of $1,429 earlier this week, gold is down about $41 an ounce. That’s not a meaningful correction in the grand scale of this bull market. And gold mining stocks, which typically fall hard in such an environment, have barely declined since hitting an all-time high on December 6 as measured by the XAU Gold Index.

The major ratcheting of the entire yield curve this month is posing a threat to gold-bugs because it implies dollar strength, therefore making gold less attractive. But I disagree. Global growth expectations don’t suggest a boom is underway anytime soon.

The major economies are still struggling with a protracted cycle of debt de-leveraging, subpar domestic consumption and slack industrial capacity. U.S. employment growth is stuck in no-man’s land. None of these statistics imply an extended period of rising long-term interest rates. But investors have turned bearish on bonds following another wave of U.S. government stimulus after the extension of the Bush tax cuts for another two years, which must be ratified by the upper house.

On the contrary, I think interest rates in the West will remain low for the foreseeable future. There is too much economic uncertainty plaguing the major industrialized economies and we’re still living in a dangerous economic climate. The sovereign debt crisis in Europe is not over and threatens to unravel confidence in the eurozone as some sort of debt restructuring (aka a default) seems imminent. No major central bank will hike interest rates now or in 2011.

This suggests that perhaps bonds might be a good speculation at these levels. Bond yields have rapidly increased since November and any bear on the economy is probably accumulating long-term Treasury’s now. I’m not, however.

Though I’m not bullish on the long-term growth outlook, I still prefer dividend-paying global stocks, agricultural commodities, gold and silver, crude oil and high quality investment-grade corporate bonds. I also like cash.

Sovereign debt is laced with all sorts of potential dislocations amid frighteningly high deficits that will be increasingly harder to finance as government tax revenues remain sluggish and tax rates in most countries rise. That spells trouble for longer dated bonds and will require more central bank support or quantitative easing.

Back in 1980, it took almost 20% interest rates to finally suffocate the gold bull market that kicked-off after Nixon broke the gold standard in 1971. Long rates are at 4.45% now.
I suspect this period of yield ratcheting will barely dent the post-2000 bull market for precious metals because interest rates are still extraordinarily low and will remain at current levels for a long time – at least those set by central banks.

The global economy can’t handle rapidly rising rates. The patient might be out of the hospital since Q1 2009 but remains weak and in constant need of care or, in this case, all sorts of stimulus (fiscal and central bank injected).

It’s only a matter of time until the Fed, the ECB, the Bank of Japan and their cronies start accumulating government securities again to keep the recovery afloat. This should support the next leg of the gold bull market as we take-out $1,750 twelve months from now coupled by another attack on one or more eurozone countries or, possibly, the Chinese balking at financing U.S. Treasury paper in the absence of some sort of deficit reduction plan in Congress.

I’ll be in-transit early tomorrow morning from Vienna back to Montreal. Dugald will give you the big picture on U.S. Treasury bonds and where we stand now on the technical picture.