The bond market is broken, time for gold to shine

As more and more central banks continue to expand their balance sheets at unprecedented rates, this artificial demand for debt has caused yields to be suppressed. 

 In fact, 25% of all bonds in the world trade at negative interest rates.

This has caused a major discrepancy in how capital is deployed in money markets around the world, which is leading to astounding malinvestment.

Risk-free assets now have negative yields that are forcing pension funds, sovereign wealth funds, institutions, and retail investors to take on more risk in the search for yield.

Welcome to the era of central banks, where money printers can endlessly inject liquidity in financial markets while the fundamentals are thrown out the window. Most companies in the S&P 500 stock index have reported their first-quarter earnings, which on a per-share basis, has fallen by 13%, which signals the worst collapse since 2009.

Meanwhile, regardless of fundamentals, the market seems to stay propped up, as investors are relentlessly in the hunt for yield. It is important to note; this is all happening when there is a record amount of USD cash on the sidelines.

JP Morgan’s implied cash allocation level has spiked, but it remains at its historical average of 37%. Currently, there is more than $4 trillion in cash on the sidelines:

With it being a fairly safe bet that interest rates will stay at zero in the United States for the foreseeable future, investors must ask themselves when this capital is redeployed, where will it go?

I certainly don’t believe it will be in bonds due to negative yields but also because, from a historical perspective, investors are already overweight.

Since the beginning of the coronavirus pandemic, investors have rushed into bonds. In fact, the allocation is at 24%, which is well above its historical average of 19%. But what do you think these bondholders will do when they realize their fixed income holdings are yielding nearly zero or potentially negative? They will begin shifting focus to stocks, but the smart money will also rotate to gold, as we are in the early innings of a paradigm shift in monetary systems.

Gold continues to perform as it should in a time of unprecedented economic uncertainty with countries on a global basis resorting to historic budget deficits, collapsing GDP, and skyrocketing unemployment. Meanwhile, gold is at all-time highs in pretty much all fiat currencies except for the USD. It has still performed exceptionally well, as it is up nearly 19% against the USD over the past six months.

We have now reached a point where the bubble in bonds could soon be popped. We have seen historic selling in US treasuries, which has caused the Federal Reserve to really step in and support the treasury market.

Interest rates peaked back in 1981 and have been falling ever since. The average historical yield on a 60% equity / 40% bond portfolio has averaged 4.36% and is now at an all-time low of just 2.0%. To show how absurd things have gotten, research suggests 30-year bond rates going back before the Civil War (1790) displays that the United States has never been able to borrow long-term capital more cheaply than it can right now.

This showcases the reason why countries around the world have been net buyers of gold since the financial crisis of 2008. With this debt binge globally, what will happen if countries have a hard time deleveraging? Well, historically, inflation, taxation or outright defaults happen. 

This loops us back to one of gold’s most important principles, which is, of course, that it has no counterparty risk once you have it in your possession. It won’t be restructured, defaulted on, or inflated away like the risks associated when we hit the point in an economic cycle where deleveraging is needed.

With trillions now yielding negative worldwide, it is only a matter of time before mainstream investors come to understand that gold has been the world’s best-performing money throughout history with regards to preserving wealth. On top of the importance of owning physical gold, unlike companies in the S&P 500, gold mining companies are booming in this environment.

Many gold producers, alongside royalty companies, are reporting improved top and bottom-line growth alongside many companies increasing their dividend after Q1.

This sets up for a lot of value to be unlocked for investors as many mining companies over the past 5-8 years have had to be extremely diligent by reducing debt loads while advancing profitable projects. In many respects, all-in sustaining costs (AISC) have declined for gold companies, while financial flexibility has improved.

As gold continues on its upward path, leveraged mining companies to gold and silver should certainly be on your radars. As companies in the S&P alongside the Dow report horrible earnings, these miners are going to showcase their earning power due to monetary chaos and geopolitical uncertainty.