"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Wednesday, August 15, 2012

Are we Witnessing a Shift in Investor Sentiment?

As many of you who listen in to my regular weekly radio interview on the KWN Markets and Metals Wrap are aware, in my mind, the most important financial market is the bond or interest rate market. Everything revolves around interest rates and as such, those levels are the key in understanding where traders/investors are in their thinking at any given moment in time.

Take a look at the following chart denoting the interest rate being paid or the yield on the US Ten Year Note. Within the span of a mere 3 weeks or so, this yield has shot up from down near 1.4% all the way to 1.8%. That is a very rapid shift. It is now sitting at levels that we have not seen since the middle of May of this year.

From a technical analysis perspective, it has reached an inflection point. ON the way down, this 1.8% level, held the market in check back late last year and early this year. Once it was broken to the downside in May, it subsequently tried to rally back above that level but failed. From that point on, it was straight downhill.

Now it has regained this level. Where it closes this week is going to be critical to our understanding of where things are headed in the following weeks. Apparently, investors have moved past the European debt crisis in their thinking (at least for the present). Something has gotten their attention to the point that they are pushing up interest rates.

Now, whether the Fed is particularly happy with this remains unclear but one has to suspect that the last thing the Federal Reserve wants to see is these longer dated rates getting too far out of hand. Also, keep in mind that the higher these yields move, the higher the cost of servicing the gargantuan, humungous, mind-boggling, stupendously large (how's that for superlatives?) US federal debt burden will become.

Given the mediocre condition of the US economic recovery, it is difficult for me to envision yields breaching this overhead resistance level. Still with a great deal of speculative short positions in the US bond and note futures markets, their short covering might be enough to take them higher for a while longer. A lot of those positions were put on as a result of anticipating the "slowing global growth" scenario; in other words, deflationary forces.

If this market however does not reverse course soon, chances are we might have seen a long term low point in interest rates. Stay tuned on this one folks as it will have implications for gold.

Also, I am wondering if the following chart might have something to do with bond and note traders shifting away somewhat from the "falling prices" scenario. I doubt that this in itself would be sufficient to take the bloom off of the deflation rose but when combined with the soaring price of grains, it certainly has to regarded at the very least as a contributing factor.

Note that the gasoline market has retraced 61.8% of its entire decline from the peak made earlier this year. That is a key Fibonacci retracement level. If it powers up and through this level, particularly if it closes the week above this level, odds will favor a push towards $3.20 initially followed by a test of the high near $3.40 if the former level does not hold. Generally speaking, if a market fails at the 61.8% level, it will drop back towards the 50% level and retest that to see if the bulls are still eager to buy.

By the way, if the shift towards inflation fears has gained ascendancy over the fear of deflation, you silver guys will be very happy indeed. Again, let's watch what develops. It is still too early too tell and we are not out of the wood yet on the European debt mess but things are indeed getting interesting.


  1. sorry to be a knucklehead but

    are rising rates good for Gold and silver or bad?


  2. @Lisa:

    Quickly, depends on the rate of inflation (and how you calculate that). The Real Rate of Interest (RRI) is the important thing. The RRI is approximately the nominal interest rate minus the inflation rate.

    Negative real rates are good for gold, because holding your money in cash is actually losing you value. Better to hold gold then.

    So a rise in interest rate could mean something, little, or nothing at all for gold, depending on other factors (inflation).

    1. what do you think Dan means in his writings above...
      with respect to silver it sounds like a good thing but I was not sure with respect to Gold.

      thanks for your time.

    2. This comment has been removed by the author.

  3. This post was way over my head. I'll take Dan's word for it.

  4. > the cost of servicing the gargantuan US federal debt

    Actually, this cost is still not too big... remember, that the FRS repays the interest received on the treasuries and other securities back to the Treasury (as an income to the government! ;)

    In fact, the ratio of the servicing cost to the government income even did decline since Sept 2011. Here is a nice graph showing servicing cost/income ratio (yellow) vs. federal debt (red) since Sept 2001.
    Note that the cost/income ratio never get higher than 10% (even in 1980s when 10-year note yield jumped up to 14%):


  5. People forget that the yield on the 10-year reached nearly 4% in the spring of 2010, and I hardly recall hearing about the federal government having difficulties servicing its debt at the time. While the debt has also gotten bigger since then, so has the economy.

    If markets push the yield on the 10-year back up to 4% again any time soon, it will be because they're seeing much stronger economic growth (and likely inflation too). If the economy is growing more rapidly, tax receipts will also go up. We could even see the deficit go down due to stronger growth. High interest rates don't necessarily mean difficulties for the federal government. They might even regard it as a good sign (I sure do).

    BTW, don't be surprised if the 10-year yield reaches 1.9% tomorrow, or Friday at the latest. Maybe even 2%. If I'm right, it should shoot up, oh, just after 8:30am eastern time.

    1. BTW, speaking of rising yields (not to mention 8:30am ET tomorrow), recall my comments almost a month ago on complacency in the markets:

      "The market is right, VIX included. You will be finding out why in the near future, possibly starting tomorrow."

      Dan's pickup of rising yields in this article today is related to his observation on market complacency a month ago. The markets are slowly beginning to sense doomsday isn't going to arrive any time soon.

  6. Dan,

    Interesting thoughts as usual. Thank you for emphasizing the importance of interest rates.

    The problem is, the market for US Treasuries essentially sets the stage for the entire bond market, and the market for US debt happens to be the most manipulated market probably in world history--thanks to the Fed. I like thinking about markets because they give me some glimpse of reality. I just don't know how well the bond market reflects reality with the NY Fed's traders in there every day.

    At any rate, I've been long GDX since Monday on the expectation that the dollar will trend lower until Jackson Hole:



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