As the global financial system’s widening cloud of doubt spread to the United States on Monday, investors stepped up their rush to safety – and found it in a trusted shelter that now finds itself in the path of the storm.
Stocks, commodities and many currencies suffered another day of heavy selling, as the apparent failure of the U.S. Congressional “supercommittee” to agree on a government deficit-reduction plan rekindled fears that the United States could face its own debt crisis. That prospect, coupled with Europe’s relentless debt woes, triggered selling as investors sought to raise their cash cushion and find less risky homes for their money.
The safe harbour of choice was the U.S. bond market. Investors piled into U.S. government bonds, pushing the 10-year yield below 2 per cent for the third time this month and fuelling a rise in the U.S. dollar, which hit a six-week high against a basket of major global currencies. The U.S. bond and currency gains overwhelmed another traditional investor haven – gold – which slumped $42.30 (U.S.) to $1,682.80 an ounce in New York, its lowest level in almost a month.
The day’s trading highlighted a trend in recent weeks that, on the surface, defies logic. Investors are piling into U.S. bonds and the greenback even as the risks in the U.S. debt situation appear to be mounting, and are increasingly doing so at the expense of gold, which suddenly seems to be investors’ forgotten friend in the quest for safety.
The key to understanding this seemingly irrational pattern, market experts say, is the huge size of the U.S. bond market. U.S.-issued bonds account for roughly 40 per cent of the entire global bond market; the next-largest market, Japan, is about half as big. Europe's troubled bond market is not only exposed to risks from the debt troubles of Greece, Italy and others, but is fragmented into the many smaller markets of its issuer countries – giving investors far less ease of movement than the U.S. market in the event of a serious credit crunch.
That makes the U.S. bond market a de facto round-the-clock savings bank for nervous investors who want to know they can get to their money quickly in the event of a sudden financial crisis.
“In times of trouble, the one market that trades through hell and high water is the U.S. bond market and U.S. dollar,” said Stewart Hall, senior fixed income and currency strategist at RBC Dominion Securities. He said investors learned in the 2008 financial crisis that their only protection in times of panic is to be able to quickly liquidate their holdings and get access to cash – and that’s why they are turning to U.S. bonds as pressures mount again.
“It’s the last line of liquidity,” Mr. Hall said. “It’s the only market you can easily get in and out of, in size. These other markets just don’t have the depth.”
The much smaller gold market, on the other hand, has been the subject of selling precisely because nervous investors are seeking more liquid positions. Gold’s big gains this year make it a target for selling when fund managers want to scale back their holdings in less-liquid markets and keep more cash on hand for a rainy day.
“If a hedge fund faces redemptions, they’ve got to sell stuff,” said long-time gold expert Martin Murenbeeld, chief economist at DundeeWealth Inc. in Victoria.
But Mr. Murenbeeld said the bigger issue for gold investors has been the growing view that the European and U.S. debt problems will be a crippling weight on the global economy – one that triggers another recession, and perhaps even a “mini-depression” for Europe. That would be deflationary –which is distinctly bearish for gold, a traditional hedge against inflationary pressures.
“In times when people think the economy is headed toward recession, gold tends to go down,” Mr. Murenbeeld said.
Meanwhile, Mr. Hall said the failure of the U.S. supercommittee doesn’t seem to have the power to spook the bond market the way that uncertainty over U.S. debt did last summer, as investors are now more comfortable with impasses in Washington.
“The fact that [the Congressional panel] wasn’t able to come to terms was pretty much expected,” he said. “We already saw this in August. I don’t think it has the same impact any more.”
The Globe and Mail
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