Global Macro Notes: Winds Blow Cold For Bonds And Gold

By Jack Sparrow

On February 14th — one month ago — we pondered “Long Bonds and Yen: Big Shorts for 2012?”

Japan’s currency (which we shorted circa Feb 14) has been in freefall the past four weeks, from 77 to 83 yen to the dollar. (As the yen declines in value, USDJPY rises.)

And now, this week, we may be seeing the long bond breakdown:

Treasury bonds, as you know, have long been the “safe haven” of last resort for frightened capital in a low inflation, low opportunity environment.

While the finances of the U.S. government are terrible, treasurys have been a “least bad” option in a world of high unemployment, stagnating economies, and elevated risk.

What’s more, those who remain bullish on bonds (like Gary Shilling) foresee “more of the same” in terms of economic malaise, high unemployment, and general doldrums — not to mention slow motion crisis in Europe.

But 30-year yields around 3% have always been a temporary proposition. With any sign of genuine economic recovery, the risk to bondholders is a flight-to-safety reversal — a return to risk that sees investor capital pouring out of treasuries and back into stocks.

Tuesday’s widespread equity breakout, which came on the back of the best retail sales since September, a JP Morgan dividend hike, and a complacent Fed, have now taken the markets to pre-crisis levels.

The major indices are at their highest levels since June 2008. The Nasdaq, stretching back even further, has surpassed 3,000 for the first time since the year 2000.

Legendary investor George Soros has noted that a self-reinforcing market perception needs to pass a series of tests… and with each successful test, the perception gets stronger. Having overcome last week’s brief correction, conditions are now in place for a “melt-up” in which investors show more fear of being “out” than “in.”

Perceptions of an accelerating U.S. recovery are extremely negative for bonds, for the following reasons:

• Greater risk appetite increases the odds of capital rotation out of safe havens and into stocks.

• Perceptions of accelerating recovery against a low inflation backdrop, with rising inflation a long-term likelihood, makes low yielding treasuries finally appear toxic.

• Perceptions of accelerating recovery allow the Fed to hang back, providing less support for treasuries through its various buy programs.

The current backdrop is also an ugly one for gold. The yellow metal is performing poorly for at least a few reasons:

• Due to general economic weakness, this is still being perceived as a low inflation recovery, with accelerated inflation something to worry about far off in future.

• In an environment favorable to equities and dividend-yielding assets, gold is seen as second class for its lack of yield and lack of economic participation.

• As we wrote some time ago, gold is a kind of “credit default swap” — a form of catastrophe insurance taken out against risks of a world gone wrong. With Europe’s slow motion crisis more or less contained, the CDS aspect of gold is no longer appealing.

• The U.S. centric nature of the recovery, coupled with China slowdown fears and Europe’s troubles, mean that the dollar is slowly strengthening, even as the euro is more actively debased (think LTRO)… another headwind for precious metals.
  

Another way to look at it is like this:

Consumer retail and consumer tech have been the king of all asset classes. In spite of all the concerns over rising unemployment, a stagnating U.S. economy, and tens of millions of “left behinds,” the contingent of U.S. spenders with money have been out there spending.

This has led to dominant performance from specialty retailers, restaurant chains, department stores, and other domestic-based themes catering to the 30% of Americans who still have ample discretionary income.

This group has had the virtue of being isolated from European crisis, global slowdown threats, creeping oil prices, and other general concerns. In a sense, the purchasing power of the moneyed U.S. consumer has been “macro proof” — and an incredibly mild winter has only cemented this sense of invincibility.

Against such a backdrop — and with the weaker environs of the U.S. economy holding back wages, and thus holding back inflation — who needs to worry about gold?

Weak Europe, Decelerating China, Overbought Oil

It’s still a trader’s environment, though, because as we noted last week — in China, Brazil and Spain flip the script — global slowdown fears outside the U.S. are becoming a problem:

The global liquidity cycle has already rolled over. Assuming that no fresh action is taken, world economic growth will peak within a couple of months and then fade in the second half of the year – with grim implications for Europe’s Latin bloc.

Data collected by Simon Ward at Henderson Global Investors shows that M1 money supply growth in the big G7 economies and leading E7 emerging powers buckled over the winter.