In my August 9 E-Letter, I warned that investors who have herded into gold and Treasury bonds in recent weeks were taking on a lot more risk than most believed. I warned that gold prices could experience a very nasty plunge at most any time, and I’m not talking about the brief dip last week. Gold could easily plunge to $1,600 or even $1,500 before finding support.
I also warned that recent purchasers of Treasury bonds and related mutual funds or ETFs may be taking much more risk than they imagine as well. US T-bonds are widely regarded as one of the safest investments on the planet, even with the latest downgrade to AA+. It is true that IF you hold T-bonds to maturity, you get all your money back.
Yet I wonder how many investors who stampeded into T-bonds and/or bond funds over the last month or so realized that they were buying those bonds at some of the highest prices in history. The current yield on the 30-year US Treasury bond is around 3.6%. That’s the lowest it’s been since 2008 at the height of the financial crisis.
A little explanation of the chart above may be helpful. First, when interest rates fall, the price of bonds goes up; conversely, when interest rates rise, bonds fall in value. Interest rates on bonds have been falling for the last few months, thus the move up in bond prices on the far right side of the chart. The other point of note in the chart above is that bond prices have failed in the 140 area on the last two rallies. That means there is “overhead resistance” (ie – more selling) in this area. It remains to be seen if bonds will break out decisively above 140 on this move. If another failure occurs, that will be seen as a bearish development.
As I discussed in my August 16 E-Letter, the Fed may be planning more quantitative easing (QE3) just ahead with the goal of lowering medium and long-term interest rates, in which case T-bond prices might move even higher. But with prices already in nosebleed territory, any negative news could send yields into free-fall on a moment’s notice – as happened the last two times rates were this low.
I hope investors who dumped stocks recently and bought gold and/or T-bonds in an effort to reduce risk realize that they may have jumped from the frying pan into the fire.
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