Sell-Off in Bonds Could Be the Catalyst for Higher Gold Prices
If you are trying to figure out where gold prices could be headed, it’s important to look at the bond market. As it stands, the bond market is facing rigorous headwinds.
Why? The Federal Reserve has made it very clear that it wants to raise interest rates. Basic economics suggests that when interest rates increase, bond prices go down and their yields go higher.
We are starting to see a sell-off in short-term bonds. We see the yields skyrocketing. Just look at the chart below, which shows the yields on two-year U.S. Treasuries.
Since July 2016, the yields on two-year U.S. Treasuries have soared from below 0.6% to 1.74%. If you do the simple math, yields on these U.S. bonds have increased 190%! Mind you, the yields on these bonds currently stand at their highest level since 2008.
Chart courtesy of StockCharts.com
But don’t get too fixated on two-year U.S. Treasuries. The Federal Reserve expects the federal funds rate (FFR) to be around three percent by 2020. Currently, these rates stand at 1.25%. So, the most basic rates are expected to double in the matter of a few years.
With this, also understand that the bond market is massive. Don’t just think U.S. government bonds; think corporate and municipal bonds as well. They could be highly impacted by rising interest rates.
At the end of the second quarter of 2017, the outstanding U.S. bonds amounted to $39.9 trillion. (Source: “US Bond Market Issuance and Outstanding,” Securities Industry and Financial Markets Association, November 6, 2017.)
Gold Prices Outlook: Major Upside Could Be Ahead
Now, bringing in everything together…
Let’s assume for one second that bond investors start to question the interest rates and decide to sell their bonds.
They could, all of a sudden, be sitting with a lot of cash at hand. Know this: funds are not liked by their investors if they are not invested at all times.
Where do you think investors could be headed next to park their money? Will they go buy stocks? Keep in mind, stocks are significantly overvalued relative to their historical average. Chances are, investors might think twice before buying stocks.
Dear reader, to me, it would not be shocking if some of the money from the bond market flows into the gold market. It shouldn’t be forgotten, gold is an uncertainty hedge. Here’s the even better part: it doesn’t really have to be a lot of money going into the market to send gold prices soaring.
This is pure assumption here: if $1.0 trillion leaves the bond market in the next two years, and just $100.0 billion goes to the gold market (just 10% of the total amount), it could make a massive impact. The yellow precious metal market is not as big as the stock market or the bond market.
Keeping all this in mind, I continue to keep a close eye on gold mining companies. As I see it, they are trading for pennies on the dollar. If gold prices rise as a result of a sell-off in the gold market, mining stocks could be worth significantly much more than they are now.
Over the past few years, thanks to suppressed precious metal prices, they have been forced to become leaner and meaner. As I see it, you don’t really need gold prices to go up much for some gold miners’ stocks to double or more.