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Greenspan Trashes Treasuries - and Helps Gold
Chris Temple
The National Investor
Jul 22, 2003

Recent rebounds both in U.S. stocks and the exchange value of the U.S. dollar have served to take a little luster off the price of gold since it topped out at over $370 per ounce in late May. Some have seen this second swoon of 2003 after a strong run (the first after a spike to the $390 level in early February) as more "proof" that gold still has relatively few fans. To a point, that's true; as I commented in a recent article, much of the metal's gyrations this year has been due to hedge fund and other short-term trading, rather than to more serious, longer-term money coming on board.

Still, though, I see gold's recent success in holding above the $340 per ounce level as very positive. Keep in mind that much of the dollar's recent bounce came AFTER gold had already undergone most of its own very orderly consolidation. The fact that gold held its own therefore shows that at least some investors are looking past the day-to-day moves in the dollar and focusing on the longer-term environment; one that both Federal Reserve Chairman Alan Greenspan and the federal government itself have made even more bullish in recent days.

Even though other markets initially reacted with a somewhat confusing array of emotions following last week's semi-annual testimony by Greenspan to House and Senate committees, it appears as though gold traders have the best handle on things (though the reinvigorated bond market vigilantes may dispute that.) In short, Greenspan made it abundantly clear that he intends to keep the monetary spigot opened wide for as long as it takes to bring solid growth back to the economy. The resulting continuation of negative real interest rates for as far as the eye can see augurs well for gold, as does any sign that the Fed's policies will gain at least a little traction. (Keep in mind that the gold INDUSTRY is better served if the economy does NOT completely collapse, but rather regains at least some health.)

Just as important - but little discussed relative to gold - is that Greenspan has at least temporarily removed one of the impediments to investors in larger numbers looking to gold as a "safe haven" asset. Previously, investors have been happy to shift money out of the stock market and into Treasury bonds and notes whenever they felt uneasy about the world, stocks, the economy or life in general. Helping make such a trade a one-way bet for a while were Greenspan and some of his compatriots at the Fed. First, they told us that they were indeed worried about the possibility of inflation going too low, even leading to a broad price deflation. Such words favor bonds, at least in the near term. Adding more fuel to many traders' desire to invest based on the Fed's machinations have been comments of the Fed at some point taking "unconventional" policy measures to lower long-term interest rates by itself purchasing Treasuries. This added to the mad rush over the last few months to ride the bond market bandwagon; a momentum play that many (including Yours Truly) thought was beginning to resemble the tech stock bubble of 1999-2000.

Over the last few weeks, though, the air has started to come out of Treasuries; and in just the last week, they have been positively hammered. It started when the Federal Open Market Committee failed to cut short-term interest rates by 50 basis points, and settled for 25. That was compounded by an accompanying statement that simply confused everyone. Making it worse last week was Greenspan himself, as he ostensibly sought to clarify what was on the Fed's mind. Among other things, he surprised investors by offering a decidedly more upbeat assessment of the economy's prospects going forward; so much so that he added before the House Financial Services Committee on Tuesday that the Fed presently was of the opinion that buying long-dated Treasuries might not be necessary after all. Seeing the resulting carnage in the bond pits, Greenspan backtracked on Wednesday, protesting that he "never took anything off the table" and fretting that bond traders apparently misunderstood him. But the damage was done.

As I wrote to my subscribers last week, I believe that Greenspan took a calculated risk. For most of the last four months or so, he's been able to have both the stock market AND bond market advance (the latter, as already indicated, courtesy of his own schmoozing of bond traders) with long-term interest rates hitting their lowest levels in two generations. Knowing this couldn't last forever, he decided he must support one or the other; and having successfully talked down the yield on the current bellwether 10-year Treasury note to 3.1%, his remarks were thus geared toward keeping the buyers coming into stocks.

With all this added to by the government's announcement of even uglier numbers for the expected federal deficit this year and next, bond traders have rebelled. Yet again today Treasuries were trashed, even as the Dow shed a bit over 90 points (a performance that would have been considerably worse were it not for a great day for 3M.). The ferocity with which Treasuries are being sold off has been blamed on hedge funds unwinding "overbought" positions, accentuating the decline in prices and spike in yields. True enough. Some Wall Street shills are also saying that the now 110 basis point (1.1%) rise in the 10-year note's yield means that investors think the economy really will recover. This is more wishful thinking than reality.

I submit to you that perhaps the biggest reason for the sell-off is that bond traders are angry - and somewhat frightened. Worse than watching the government's rapidly deteriorating financial situation further weaken the fundamentals for bonds, traders feel they have been led down the proverbial garden path by Greenspan. Many simply feel used by the Fed chairman. After all, is he that confused himself as to so change his message to the markets in just a few weeks' time; a turnabout that has many trusting bond investors bleeding profusely right now? Is he even closer to the end of his rope than I thought, apparently reduced to an increasingly frantic exercise of tailoring his comments to whatever will help one market today, even at the expense of another?

For now, it's bond traders - the group, in the end, that Greenspan can least afford to piss off - who ended up with the short straw. They don't like it. Whatever else happens, and as the headline of a story by Rich Miller in this week's (7/28) issue of Business Week states, "The Fed Can't Afford a Bond Market Without Faith." That faith has been shaken. Maybe even deliberately betrayed for convenience's sake. One of these days, Greenspan might again need to "talk down" the bond market, and avoid (for a little longer, anyhow) those unconventional measures that in the end will do even more long-term harm than good. What if bond traders reply, "Fool me once, shame on you, fool me twice, shame on me?"

Having successfully held above $340 per ounce in its recent consolidation, gold moved back North of $350 in today's action. It will be interesting to see how much more mileage comes from this rally attempt. One thing is clear, though: while it is still too early to write the final epitaph for the U.S. government bond market, I am now convinced (I wasn't quite before) that we have seen the lowest yields of this cycle. If the big spenders and would-be world conquerors in Washington hadn't already insured that, Greenspan clinched it. Sure, he can come out tomorrow (especially if it's another day like today for Treasuries) and say that he's changed his mind yet again, and that the Fed is calling Chicago and saying "buy." But how much will it matter after all the foregoing?

Until now I have counseled against getting overly wrapped up in gold, suggesting that we all happily settle for a grinding, "two steps forward, one step back" kind of bull market, rather than work up in ourselves unrealistic hopes and fantasies for a "moon shot." In spite of all the above, that's STILL my position; and I STILL expect 2003 will close with a new trading range for gold having been carved out between $350 and $380 per ounce. Any surprise, though, appears more likely than ever to be on the up side, thanks to Greenspan. If this level is exceeded, it will be because his recent little come-on has so harmed the reliability of Treasury securities - and by extension, the U.S. dollar - that gold will be a more visible and desired safe haven in the next stock market decline, and/or as the foreign entanglements of the U.S. become ever more numerous and troublesome.

-Chris Temple
http://www.nationalinvestor.com
Jul 21, 2003