My three favorite instruments

Submitted By Michael Krause
Gold, Japanese Yen (particularly against the dollar), and Treasuries.

I'm endlessly fascinated with this trio, and here are some latest thoughts after much belation. Today with a worse than expected jobs report, confirming a job market still in contraction after 2 years, the most notable market reaction is not in the treasury market, but the gold market. I can personally testify to the looseness of the job market here, being a somewhat discouraged job hunter right now (hint to all portfolio managers in San Diego).

Right now up about $15 off intraday lows, gold strength now reflects the general diagnosis that policy makers will resort to money printing and continuation of low Fed Funds in order to architect a meaningful and convincing recovery. I might even go out on a reach and say it is turning into a negative beta or at least low correlation asset to the S&P (S&P down, gold up), making it more desirable to portfolio managers even at these high levels. Will post updated model to confirm or deny this.

I've suspected for awhile that immediate substantial pressure on gold stocks (down 20%+ versus gold down 8%) versus outright gold bullion came from portfolio managers wanting as neutral a position as possible, going short the high beta gold stocks in combination with long lower beta gold, pricing the market out of their gold exposure. Of course, there is enormous operating leverage in gold stocks, and this neutral positioning may not do well in the case gold moves substantially. A model I've prepared shows Barrick gold price quadrupling if the price of gold rose 77%, holding input costs constant. This is just as if not more likely to explain the falloff. But it does not explain the relative longer term underperformance of the entire gold patch. More on these thoughts in another post.

Then the Japanese yen against the dollar, really my favorite position as of late. This bottomed recently around 85 yen to the dollar, and has shown continued strength ever since the Bank of Japan announced their easing program. Yesterday flying through the 93.10 mark on new Finance minister remarks attempting to talk up the dollar, it appeared this is a trend worth being a part of. My reasons for interest in being long the dollar against the yen have more to do with a belief that much like the US, the Japanese will have to increasingly resort to debt monetization to offset government deficits catalyzed by a lagging economy, correlated lower tax revenues, and most importantly a population demographic change leaving a shortage of demand for Japanese debt at absurdly low levels. Not an original idea, I envision trade against the Yen and even short the Japanese government debt will be an immense opportunity, and a giant macro game-changer as far as world trade is concerned. Imagine the changes to global trade implied by a 200 yen to the dollar exchange rate. Perhaps the best long term position idea is short yen versus gold or silver.

Onto US treasuries. Some $2T of debt will come to the market this year, and the duration of new issuance will likely increase. This means higher interest rates assuming the lending picture does not change considerably. If lending ramps up, that means more bank created money supply to finance the purchase of some of this debt. It's difficult to reconcile any dramatic movement either way, but those supply numbers are scary. Until issuance numbers start dropping off, treasuries will be under pressure unless yields move up. Today's interesting movement is the continued muted reaction (dead) in the long end, with increased inflation expectations trumping fear of outright economic collapse. Thus, gold doing better than bonds (from pre-report levels). Of notice is the strong dollar selloff today in contrast to a half a point upward movement in the 20 year future. In real terms, treasuries are stationary or even down on this news.

Did you like this article?