I had started working on a small editorial about this sector rotation from Bonds into Gold over the next few years, and this editorial with Craig today, is inspiring me to get it wrapped up, and I’ll post it when completed.

The Great Sector Rotation Out Of Bonds And Into Gold

By: Shad @ ExecelsiorProsperity – (02/05/2021)

It is easy for investors to get swept up into the daily fluctuations for any asset class or stock, and to be on the edge of one’s seat trying to determine what will happen right around the corner. We all wonder what will happen tomorrow, next week, next month… Sometimes it is helpful to zoom out from all the daily noise, and look at the larger macro forces at work.

With regards to what the drivers for the Precious Metals will be, there are always short-term events (black swans, Fed statements, Brexit, trouble in EU, stimulus bills, news on repo market swaps, etc…) that come and go, but the longer term thesis (boring as it is for so many now) is still quite relevant.

There really IS way too much national debt on that backs of countries all over the globe. Central bank meddling and increasing the money supply through easing measures, combined with super low – to zero – to even negative rates that also translate to negative real rates, is a great environment for the Precious Metals. Gold is increasingly being remembered as the “uncurrency” and uncorrelated store of value that it is, and this will become even more apparent as the Humpty Dumpty general markets fall off the wall, and all the Feds horses, and all the King’s financial advisors can’t put Humpty Dumpty back together again.

It is interesting to note that when most market pundit “experts” discuss the demand divers for gold, it is often focused on as jewelry demand out of the East, industrial fabrication, and then the debate around the edges is where the investment demand will come from. These are all real fundamental factors that absorb the physical markets, but ultimately they are not the source of what is driving the gold prices.

The Gold prices are driven by the futures markets, and they are massive and forward looking. This is almost entirely investment related, and has little to do with what the little guy on the street is buying from his local coin shop, and much more to do with larger money flows in the paper markets of futures contracts, or at a minimum the ETF inflows on “paper gold.” It would be nice if the actual physical markets were what drove price for real supply and demand fundamentals, but that isn’t what we’ve seen for many many years. One can fight that reality, and get upset about it philosophically, or just embrace the price action as it comes, and follow the macro trends.

The ebbs and flows of the larger paper markets in the futures contracts or GLD pricing, has little to do with jewelry and industrial fabrication, and more to do with larger big money reactions to national and international monetary policies and as tool to store value without national or individual company counter-party risk.

For a long time, as the haters and bears came out to bash Gold as a pet rock, their basic attack was that it was a boring, lifeless asset, that didn’t do anything, didn’t pay dividends or interest, and was an archaic relic of the past that no longer was money.

> The simple question to ask then is: Well if Gold isn’t Money, then why the hell are Central Banks continuing to buy Gold and store it in their vaults then?

This point, while very obvious, it getting stale in investors constant need for even more reasons why the Precious Metals will continue to see more demand. For the time being, let’s take the jewelry demand, industrial fabrication demand, smaller retail demand, and even central bank demand out of the equation for just a moment, and look at the crest of an investment wave that is just now coming into shore.

>> There is actually a huge 800 Pound Gorilla in the room that very few of the macro “experts” are discussing or have even considered.

The new money flows into gold won’t necessarily need to be physical buyers of jewelry in the East, small retail investors in the West, or even a large increase in purchases from central bankers, because it will actually be a huge “rotation trade” out of Bonds and into Gold. This may sound like a shocking claim, but follow the yellow brick road.

On a larger institutional level, the real rotation into Gold (and Silver) hasn’t even really begun yet, and most funds have zero allocation or possibly a 1-2% allocation. As that allocation grows in Gold, it will represent massive demand and soak up far more precious metals than Reddit rally or enthusiastic retail buyers. This thought should be a very encouraging thought to all precious metals investors.

The Bond Bubble will pop, and the everything rally in the general markets, already at nosebleed valuations, will be coming to an end, sooner rather than later. Yes, even though it has been a market boogey man for the last 12 years, a more significant correction really will hit the general markets in the next year or two.

Yes, nations around the globe will introduce more and more stimulus (as austerity measures in many countries were a trainwreck and failed experiment. ) and they’ll pour on MMT (Modern Monetary Theory = More Money Today) policies to reflate their way out of the mess. As anyone that has studies economics realizes, this will eventually end in currency debasement and true inflation, as stimulus funds, are actually getting to consumers and small businesses and this will finally increase money velocity of supply and circulation. Off in the distance I hear the central banks and national fiscal handlers chanting, “To infinity and beyond!”

When the music stops, and larger funds start scrambling for the remaining chairs, a large sector rotation will shift into to high gear looking for a place to shelter their assets from the coming storm. It will happen gradually at first, and then as things devolve in the general markets, all of the sudden.

Sure in the short term, interest rates have been rising, and while it seems like a lot on a percentage basis to go from 0.55% to 1.15%, these higher yields are dismal in comparison to past returns. Those celebrating the uptick in rates recently are not going to get the last hoorah though, as the central banks are definitely leaning towards controlling the curve and can’t let rates go that much higher. The Ten Year has been at 1.15% recently, (which is nothing that zesty), and maybe they let it get to 2%, but there is no way they are going to let rates normalize up to 4%-7% again, as it would implode their whole system.

As for stimulating the economy by lower rates, there isn’t much bandwidth to work with, and last summer rates were already down at bare bones minimums near zero, or even negative in Europe and Japan. That is the other bookend of the narrow range that rates are going to be stuck in for the foreseeable future. Real rates are still negative in any scenario, as inflation will outstrip the nominal rates, and so Precious Metals and maybe the Cryptos will be recipients of money flows trying to get outside of the financial tomfoolery we’ve seen on display since the 2008-2009 Great Financial Crisis.

In her recent article on Seeking Alpha called “The Hindsight Depression,” macro investor, Lyn Alden Schwartzer recently quipped:

“By 2020, private debt had gone flat for a while as a percentage of GDP (household debt was down while corporate debt was up), but federal debt began skyrocketing from an already high 106% of GDP baseline due to the pandemic and subsequent economic shutdown. Federal deficits reaching 15-20% of GDP in 2020 approached World War II levels for the first time in modern history, resulting in federal debt levels rapidly moving to 125-130% of GDP and likely higher in the years ahead. The Federal Reserve began discussing yield curve control as an option, and bought a massive amount of Treasuries in mid-March when foreigners and hedge funds sold hundreds of billion in Treasuries, and the Fed continues to buy a significant percentage of Treasury issuance out of necessity. Unlike the 2010s, the broad money supply went up extremely quickly in 2020, because banks were already well-capitalized in this environment, so the combination of fiscal spending and QE (“pandemic MMT”) injected those funds directly into the economy, much like the 1940s.”

When large generalist institutional investment funds, pension funds, and family offices look for an alternative to the “safety” that Bonds have offered in their portfolios over the next 3-5 years, (realizing that the cheese has moved), then there really aren’t that many safe havens to pick from. Gold is a far larger and more liquid market, that can actually absorb outflows from the Bond market, compared to Bitcoin & cryptos, or REITs, etc… To be sure, some funds or family offices may start allocating to something like Bitcoin, but for the old-guard bond investors, many of them will finally start rolling funds over into Gold.

This IS the major investment DEMAND that is coming for Gold, and it will play out over the next 3-5 years. It will only take a relatively small percentage of the “Safe Haven” funds currently in the Bond sector, to finally get allocated to Gold to make a massive difference in pricing. They won’t likely be storing bullion in a vault, so most of those investor funds, pension funds, and family offices will purchase exposure to the yellow metal through ETFs like the GLD. This will increase the ETF demand for much more physical inflows, and this massive institutional buying will be the market force that sets the pricing, more so than the retail guy or gal on the streets.

This is the prime mover in demand that is coming in the medium to longer term, and worth considering, far more than the daily gyrations or latest black swan event or Fed statement.

Most of the generalist investors working on the front lines in Wall St. or Bay St. have never really experienced a true recession or depression. Yes, there was the Great Financial Crisis of 2008-2009, but it was bailed out by what seemed radical at the time – Quantitative Easing by central banks, and government policies like home credits, cash for clunkers, appliance credits, and interventionist policies. This trend has only perpetuated all over the globe, with more and more QE, more direct purchasing of corporate bonds and securities in the open markets, and has been paired with more government stimulus. All of this ongoing easing, with near zero rates to borrow more and more money by banks and large corporations has just further spiked the punchbowl, and pushed more and more buying into the nosebleed levels the general markets have reached. A point is coming, where the jig will be up, the music will come to a screeching halt, and that game of “pump it up” will no longer work.

When the stocks top and start gradually turning down, some will buy the dip like they always have, but the markets will keep dropping, Then the selling will beget more selling, and the market function that usually provided a floor (short sellers covering as they clean up shop on a correction) won’t be there. Short sellers are nearly extinct at this point after 11 years of getting decimated. What this means is that when the selling really picks up steam, there won’t be the kind of support floor that normally is there, so it will be market circuit breakers instead, and a surging VIX.

When the generalist investors go through this, as their phone lines light up, and redemptions keep coming in, they’ll look for safety, and few older participants may remember the strange yellow relic from the past, that doesn’t do anything, and just sits there as a store of value – Gold.