Readers often ask how I can be bearish on gold and my colleague Greg Canavan bullish.
It’s a good question.
But, to be honest, the answer isn’t really that complicated.
See, Greg and I share a lot of similar opinions. For example, we’re both libertarians and believe a major global financial crisis looms. We also believe that the Australian dollar and iron ore are overvalued.
Of course, our shared views go a lot further than this.
Despite arguing that gold will crash to US$931 per ounce in the short term, I believe the yellow metal will — at least — quadruple in the medium to long term. That should put a rocket under the very best gold stocks.
Greg believes that gold has already bottomed, arguing it has started a fresh long term bull market.
So, we’re on a very similar page here.
The bond bubble is ready to blow
To start, I’ll explain why I’m bullish on gold in the medium to long term. Let’s forget why I’m short term bearish today — it doesn’t matter for the moment, and if you’re interested you can check out my previous Money Morning articles.
For now, I can already hear the applause from the gold bugs at the back of the room. So, where shall we start?
Perhaps with some mainstream news.
The Australian Financial Review reported on 21 July:
‘Susan Buckley has had a long and distinguished career as a bond investor. But the head of fixed income at the $78 billion Brisbane-based fund QIC is still getting her head around the unthinkable developments in global bond markets.
‘“It does require a mind-shift change, and in my 30 year career I never thought we would get to this point,” she says before making a confession. “But yes, we have bought a negative yielding bond in expectation of greater capital gain.”
‘To say we’re in unfamiliar bond market territory is an understatement. What is going on in interest rate markets is downright bizarre, with over $US 10 trillion of government issued bonds paying rates of interest that are below zero. A recent QIC paper on the subject of negative interest rates references the Wizard of Oz, noting “We’re not in Kansas anymore”.
‘This is a world where safety comes at a cost to the point where investors are effectively paying governments to fund them as central banks in Europe and Japan drop policy rates into negative territory to spur spending.’
OK. Here’s the catch. When something is in a bubble, very few people admit it. Assuming that the times are in a ‘new normal’, most of the professionals don’t argue with the trend. It was the exact same thing, just before the subprime mortgage crisis blew up in 2008. Of course, history shows that the majority were wrong.
The majority will be proven wrong yet again. And Susan Buckley will pay dearly for it. Rather than having a punt on negative yield bonds for capital gain growth, she is better off at the casino. The 30-year bond bull market is in major bubble.
In the months ahead, the sovereign debt crisis will storm the world. The looming financial nightmare is an accumulation of 60-years of government fiscal mismanagement. As another of our colleagues, Vern Gowdie, often says, ‘borrowing more debt to pay back old debt is simply unsustainable’. To understand why in more detail, it’s useful to know how the bond market works.
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How bonds work
A bond is essentially a debt instrument the government promises to pay back in the future.
Similar to initial public offerings (IPO), bonds are originally issued by government on the primary market. Like a company, the government uses the money it receives from the primary market to help fund its promises (i.e. infrastructure and education). Once a bond is issued, it then trades on the secondary market (the bond market). That’s where it fluctuates in price — just like a stock.
When a bond price rises, its yield falls. In other words, for whatever reason, someone sees more value in the bond and is willing to buy it for fewer yields.
Of course, the exact opposite can happen.
Similar to a stock, for whatever reason, an investor may sell their bond. When that happens, the bond price falls and the yield rises.
Looking at the story, more than US$10 trillion of government bonds boast negative yields around the globe. That means prices are exceptionally high. The latest yields are shown on the chart below:
Source: Australian Financial Review
[Click to enlarge]
When a bond yields a negative return, it mean that you have to pay government to hold your money. For example, a recent 10-year German bond was sold at 100.48% of face value and should be paid back at face value (100%) in 2026. In other words, you put up 10,048 euros today to get back 10,000 euros in 10 years. And no interest.
Hello. That is madness!
It gets worse…
What happens if the bond yield jumps by, say, 1%?
That nearly happened in May 2015, when German 10-year bond yields spiked up from nearly zero to 1% in less than two months. According to RMG Wealth Management, ‘An investor who bought the benchmark 10-year German bond in mid-April [last year] lost 7% of their capital in less than 2 months, or fourteen times the total return they will earn over 10 years.’
While this doesn’t sound like a huge loss, what happens if yields jump by 2%, 3%…4%? The losses add up. And, that’s not all…
Massive default risk looms
In the history of the world, governments have never — not even once — paid back their debts. That means, if you buy a bond today, you are risking everything.
For example, Spain was once the richest country in the world. Spanish conquests in South America produced mind-boggling amounts of gold, at the expense of the brutal enslavement of the native people. But unrestrained spending, expensive foreign wars and shockingly incompetent financial management brought it all crashing down.
For a while the Spanish lived the dream — they spent all their gold, and borrowed against every ship because they couldn’t wait for the money. Eventually, like politicians today, the Spanish overspent and couldn’t pay back their debt obligations. Spain became a serial defaulter, beginning in 1557 followed by 1570, 1575, 1596, 1607, and 1647. The defaults wiped out the Italian bankers, and then the Germans.
This is just one example, of many, showcasing government mismanagement. Even England, France, and Portugal — when they were at the top of their game — defaulted on their bonds. I could go on all day…
Unfortunately, governments won’t be able to fund their bond obligations today, either. If history proves a good guide, global government will either default entirely, extend the maturity dates, or delay the interest payments on their bonds. That means, alongside another banking crisis, a major global sovereign debt crisis should blow up in the months ahead.
After this financial meltdown happens, punters won’t trust government, and gold stocks will go through the roof. Greg Canavan’s readers, over at Crisis and Opportunity, should make huge profits. In fact, if they bought Greg’s recommended gold stocks, they would have made a fortune already. He is recommending that you buy these stocks on the current pullback. You can read about his recommendations here.
If you’re interested in checking out more of my work over at Resource Speculator, click here. I wrote a free report recommending the three best mining stocks today. My readers have made huge profits from these stocks, and so could you.
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