These are not your grandfather’s markets; asset repricing is quicker due to electronic trading, and the bandwagon mentality is more prominent due to instant information dissemination. Further, unprecedented and unfathomable government stimulus via pandemic checks and aggressive monetary and fiscal policy has turned the financial markets into slush funds. 

In the 1990s, only the well-funded traders had access to live quotes and news feeds. Today, such information is free or affordable (depending on the asset), and FinTwit (the financial side of X posts) levels the informational playing field. Yet, we’ve found ourselves in a toxic soup of momentum trading. One in which retail traders weaponize worthless assets such as GameStop to stick it to the institutional traders, and mathematical valuation models are obsolete. Love it or hate it, this is the new reality. 

Are the Masses Getting It Wrong?

I attempted to answer this question yesterday while talking to Scott Shellady on RFD-TV’s Cow Guy Close, but as usual, I am a better writer than a speaker. Here is the clip if you are interested in watching - https://decarleytrading.com/learn-to-trade-commodities/1077-history-suggests-the-gold-and-treasury-trends-are-unsustainable

Moody's weekend credit downgrade of US debt doesn’t change the fact that the US dollar and US debt are the most tolerable porta-potties at a hot and humid seaside music festival (I spent last weekend at Sand in My Boots in Gulf Shores, so I am an expert in this field). There is nowhere else to go to get the same type of yield per unit of risk, liquidity, and price stability. Yet, many sellers are doing so because they must, not because they want to. For instance, the credit downgrade probably forced the hands of some fund managers and even foreign governments. For example, the Bank of Japan is said to be limited to the percentage of its sub-AAA portfolio, which requires some indiscriminate trimming.

Only time will tell the story of how the bond and precious metals markets play out. However, despite widespread consensus calling for lower bonds, higher yields, and higher metals prices, the math and history suggest a different outcome. Of course, this has been our take for some time, and we have yet to see the aggressive gold buying and Treasury selling reverse course. Nevertheless, it will; it always does. The key is not to hold the bag when it does. If you have pressed the trend and made money, be sure you are playing defense, not offense. Everyone is on the same side of the boat; that is unsustainable. 

We have shared this chart before, but it is worth noting again. There are two primary safe havens, or risk-off, assets: Treasuries and gold. However, one of these pays interest and the other doesn’t. Furthermore, one has a 99.99999% or higher probability of investors receiving their principal plus interest back if held to expiration. The other offers no guarantee. Buy and hold investments in gold that span decades have provided returns regardless of when and where you bought, but those holding for less than a decade might experience something quite different. With gold near all-time highs and Treasuries paying the highest yield in decades (trading at historical lows), the math strongly favors buying Treasuries, not gold, with safe-haven allocations. In other words, if you are dead inside and have the pain tolerance of a NAVY SEAL, buying gold above $3,000 might work out. But if you are the average human prone to panic during a deep and long drawdown of an asset that doesn’t provide any cash flow, Treasuries are a better bet. Yet, the world is doing the opposite with their safe-haven-seeking dollars!

One final word on gold: this is an element on the periodic table that can be created in a lab via nuclear reaction. Thus far, technology has not advanced enough to make it worthwhile from a cost and resource standpoint, but there was a time in history when we believed extracting crude oil from fissures in shale rock formations was impractical. High prices tend to bring about innovation; if such innovation occurs in gold, the human value we have assigned to a pretty rock disappears. I am not predicting this will happen, but the truth is the value of gold is arguably arbitrary, and like fine art or baseball cards, that value is not assured. 

Seasonality is Bullish for Treasuries and Bearish for Gold

The Treasury futures market tends to find a significant low in the early summer months and rally into fall. Although seasonality isn’t certain, it is likely. The accompanying chart depicts the path traveled most often by the September 10-year note future over the previous 30 years. Betting against historical norms will work occasionally, but it is a low-probability trade.

On the contrary, the gold market often peaks in April and suffers from summer doldrums through August. In fact, many of the most notable collapses of precious metals have taken place in the heat of summer.

Speculators are Short Treasuries and Long Gold

When everyone in the room is thinking the same thing, nobody in the room is thinking at all. This is what comes to mind when I look at the Commitments of Traders Report (COT) released weekly by the CFTC (Commodity Futures Trading Commission). It has become unpopular to have different market opinions publicly; I’ve been harassed on X for questioning the sustainability of the gold rally. Even worse than herd mentality, we are exploring new extremes regarding overcrowded trades. I might be proven wrong, but it has been my experience that when groupthink takes hold and emotions run hot, the contrarian view eventually establishes itself as the correct take. 

Large speculators have been holding historically significant bearish bets against US Treasuries. These bets against America are being placed in anticipation of a repricing of the bond market to account for increased default risk and a lower credit rating by Moody’s. However, the bulk of the selling took place a few years ago; since then, the shorts have maintained their position because they have yet to be proven wrong. However, if that time ever comes, there will be substantially more buyers in the market than sellers, and the rally will rip faces off without regard to humanity. Did we expect it to take this long to play out? No. Do we think the multi-year consolidation changes the outcome? No. The Treasury market, and its participants, are working through years of manipulation in the form of Quantitative Easing and later Quantitative Tightening, an explosion in money supply, inflation, and government spending, and now a reorganization of global trade and a credit rating downgrade. It is conceivable to assume that anyone who wanted to sell Treasuries probably already has done so. The current net short position held by speculators dwarfs anything we have seen in the past; eventually, it will have to be unwound.

Gold futures speculators, on the other hand, are holding sizable net long positions. This should come as no surprise. 

The gold COT report is a bit misleading; the net long position generally peaks well before the market tops. But, once speculators amass historically long positions, the eventual outcome tends to be several years of lost gains, or worse, in 2011, the market experienced a 45% haircut. In either scenario, buying gold at these prices would statistically be a misallocation of capital (lack of appreciation and/or income) or a painful drawdown. 

The Sloppy Math

The price of gold would have to appreciate by roughly 5% annually to keep up with the coupon being offered by duration Treasuries. At current valuation, this equates to $150 to $175 per ounce per year, depending on the day. Gold is moving that much in a week, so it seems doable, but if gold behaves in the manner it has historically, some of this rally will eventually be clawed back, leaving buyers of gold without an income stream to parachute the downside risk. On the other hand, even if Treasuries continue to dwell near multi-decade lows or a bit lower, coupon payments will continue to flow, and compound interest will act as a tailwind to the allocation. 

Summary

The masses are liquidating their long-dated Treasuries and buying gold, but this isn’t a good life choice unless we enter a financial apocalypse. Compound interest at 4% to 5% with very little risk if held to maturity is a gift we have spent almost two decades hoping for. Conversely, gold is the type of market that should only be bought when nobody wants it; instead, we are in the Costco gold bar era. If bandwagon investing always worked, there would be no risk; it doesn’t. It is never that easy. I can’t rule out short-term extensions of the current trends, but we are likely in the last inning of these moves. 

*There is a substantial risk of loss in trading futures and options. There are no guarantees in speculation; most people lose money trading commodities. Past performance is not indicative of future results. Seasonality is already factored into current prices, any references to such does not infer certainty in future price action. 

These recommendations are a solicitation for entering into derivatives transactions. All known news and events have already been factored into the price of the underlying derivatives discussed. From time to time persons affiliated with Zaner, or its associated companies, may have positions in recommended and other derivatives.