ShortSideofLongBlog: Bonds & Gold in Euphoria

The following is from the ShortSideofLong Blog:

I have to admit, I love the “Safety Crowd.” In case you don’t know what that means, it’s a term I coined for those who interpret every single set of news as bearish, regardless of it being inflationary or deflationary. This group of investors is also known as perma-bearish. And since we are in this perma-bearish environment, thanks to the total economic collapse in 2008, the old argument between Bonds vs Stocks is not even alive anymore. It has morphed itself into Bonds vs Gold.

You see it goes something like this: if a news report comes out showing that US ISM has declined below 50 (contracting) and that the economy is slowing, half of the Safety Crowd will tell you that this is an inflationary event because the slower the economy, the more money printing the Federal Reserve will do and the more Gold you shall buy – because Gold is a safe haven, they claim.
On the other hand, the other half of the Safety Crowd will argue that this is a deflationary event because the slower economy will tend to collapse on its own two feet and the worst thing you can have in a recession is a high amount of debt (asset deflation occurs while debts remain at the same level). Under this scenario, they claim, Treasury Bonds is the ultimate place to park your money, as they are a safe haven.
There is so much fear around since the end of 2007, that the Safety Crowd has on a consistent basis just recommended to buy Gold or Treasuries over and over and over again. They claim that these asset classes will preserve your capital and that when 2008 repeats, you are going to benefit from the risk off scenario.

Lets consider both…

In my own opinion, buying Gold right now would be extremely foolish and totally defeating the purpose of wisdom which states to “buy low, sell high”. The sentiment for this asset as measured by ETF fund flows for SPDR GLD is now at the highest ever monthly inflows. Listen to that again…. highest ever monthly inflows. That means dumb money is doing exactly that… following the Safety Crowds advice. This trade has become so obvious to the public, which are scared out of their own minds, that it is obviously wrong.Furthermore, the Gold bull market has now been in progress for over 1000 days without even touching the 200 day moving average once. I admit my warnings have been a tad early, as I have already posted about this as early as late July, but in all honesty that was only three weeks ago. I guess majority of investors today are actually traders, who only use intra day charts, so gone are the days of actually buying something and riding out the trend. Either way, previous warnings can be read here, here and here.
And while Gold remains in a secular bull market and profoundly has good fundamentals behind it for several years to come, Treasury Bonds actually do not. They are even worse out of the two, because the Safety Crowd forgot to tell you that during recessions, tax revenues decline and therefore deficits will go through the roof. I do not know how they missed that, but it is similar to the Goldilocks Crowd in 2007, which forgot to tell you that Financial Sector was actually not cheap.

So what happens to the United States budget during a recession, which the perma-deflation Safety Crowd claims will be good for Treasuries?
You see during negative economic growth, company earnings as well as profits fall and jobs are cut. That means tax revenues decline. The Treasury will therefore have to issue new bonds at a very rapid speed to finance the deficit budget, which was already at over 4 trillion dollars last year (including hidden liabilities).

The fresh issues of new Treasuries will devalue the credit quality of the actual existing bonds (not that it has any credibility with the country being bust already). Therefore, the Treasury Bond will actually be close to reassembling a Junk Bond to a certain degree. Having said all that, an investor should also consider that optimism is so high on the Treasuries right now, that the asset class is actually setting itself up for a short of the decade!

Summary:
My advice to investors with a six month to a few year time horizon looking at buying something during this turmoil is to stay away from the recommendations of the Safety Crowd perma-bears… stay away as far as possible. You must understand that these investments will not only lose you money, but also lose you sleep over the coming months. If I was to buy anything right now, it would actually be agricultural commodities or commodity related stocks that are linked to fertiliser.

Furthermore, as a side note, I would also look at buying energy commodities or commodity related stocks that are linked to Oil drilling. You see my view is that if Crude Oil declines below $75 per barrel, drilling will automatically stop and you can forget about the ability to actually find Oil at any price in the future! With the continuos increase in demand from Emerging Market economies, supply will just fail to keep pace, making Crude Oil price go much much higher. Higher than both you and I can imagine.