Short and Sweet

1970s redux?
“Policymakers did not see it coming.’

Sources: St. Louis Federal Reserve, Federal Reserve Board of Governors, ICE Benchmark Administration

In the days ahead, the markets will be looking to the Fed to reassert itself as the bond buyer of last resort and keep a lid on the real rate of return, as shown in the chart above. If it fails in that respect, we might end up with a full extension of late February’s bond market panic. No one is more aware of what that could mean for the economy and financial markets than the Federal Reserve’s board of governors. As for gold, the chart clearly demonstrates that it has a propensity to rise when the real rate of return is in decline and decline when real rates are on the rise. Should inflation suddenly surge, or the Fed indeed become a more aggressive buyer of Treasuries (more QE), the current uptrend in the real rate could turn abruptly.  As it is, the much-ballyhooed upward turn in real rates looks like a minor blip in a major overall downtrend.

At the moment, it does not appear that Fed liquidity operations are keeping up with an onslaught of bond selling that is pushing yields aggressively higher.  That could change overnight. We should keep in mind that the Fed moved quickly and convincingly in money markets last March at the first signs of bond market weakness. Meanwhile, the central bank’s bond portfolio continues to expand at a record pace, and we haven’t even gotten around to fully distributing the $1.9 trillion stimulus package and the $2.4 trillion infrastructure project.

In the final analysis, it rising inflation that will be the most culprit in accelerating the negative real rate of return and sustaining physical demand in the gold and silver markets. “If you look at the inflation of the 1960s and 70s,” says Paul Singer in a recent interview with Grant Williams and Bill Fleckenstein, “inflation came in the mid to late 1960s, from basically very low levels, they didn’t see it coming. They, meaning the policymakers, the central bankers, and when it came, they thought it was temporary and one-off, and one thing leads to another. So we know about the oil embargo of 1973, which took oil prices up three or four times. So wages, prices, guns and butter, the Great Society, the Vietnam War, and increases in the money supply, all combined. But once inflation lifted off, it just kept on going.”