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onds and Gold: They Can't Both Be Right (September 29, 2006) Bonds and gold are both rising, which is peculiar indeed. Why? Because they can't both be right. Bonds rise when inflation is low or declining and interest rates are declining, while gold rises when inflation rears its head. So which is it? Is inflation "under control" and bond rates set to drop? If so, why is gold rising? 
Gold is also considered a hedge against a declining dollar, and it is no coincidence that the dollar declined in the period of stagflation, rising interest rates and plummeting bond values. In the "great Bull market" of 1982 - 2000, the dollar was strong while interest rates fell and inflation remained low, pushing gold down to multi-year lows well under $300 an ounce. 
Those trumpeting a future of deflation or dropping prices anticipate the Fed cutting rates
and inflation dropping to zero or even below. If this is right, who would want to own gold?
No one. Gold is a non-productive asset, and in a deflationary environment then cash is
what is rising in value, not gold. So why is gold rising? Gold rises in the
expectation that inflation will rise and the dollar will weaken, both conditons which will
cause interest rates to rise and bonds to plummet in value.
The cycles of bonds, stocks and gold are long indeed. Bond rates tend to rise and fall in
cycles of 16 - 22 years, so why would they suddenly reverse after a mere 3 years? As this
chart reveals, gold has been in a multi-year uptrend. If inflation is about to decline to
zero and bond rates set to drop, why would gold continue rising?
Both sides can't be right. Either interest and bond rates are in a new uptrend which will last for 12-20 more years, with gold rising as the face value (coupon value) of bonds drop, or the 20-year cycles are broken and bond yields will fall back to near zero as in Japan's "lost decade" of the 90s. In such a deflationary environment, gold will drop in value as demand for an inflation and dollar hedge dries up. Which scenario is right? I'll take history's cycles over a "low-interest rates forever" optimism, but take your pick. Bonds and gold are a see-saw--when one is rising the other is declining--and unless history is overthrown, they cannot sustain parallel uptrends for long. For more on this subject and a wide array of other topics, please visit my weblog. 
copyright © 2006 Charles Hugh Smith. All rights reserved in all media. I would be honored if you linked this wEssay to your site, or printed a copy for your own use.
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