U.S. bonds could be entering dangerous territory!

According to Bank of America Merrill Lynch indices, 30-year U.S. bonds have declined more than five percent so far in 2013. Their decline in January 2013 was 4.3%—the biggest monthly decline since March 2012. (Source: Bank of America Merrill Lynch, February 6, 2013.)

The following is a price chart of the 30-year U.S. bonds—almost looks like a free-fall:

Chart courtesy of www.StockCharts.com

Why are the U.S. bonds prices falling? After all, wasn’t the Fed buying the majority of new U.S. bonds issued, thus pushing down yields? There is no rocket science behind this. The fact of the matter is that U.S. debt has increased significantly over the past four years. Just like you wouldn’t lend money to a person who has lots of debt already and poor job prospects, neither do U.S. bonds holders.

According to the Congressional Budget Office (CBO), the U.S. budget deficit will decrease to $854 billion in the fiscal year of 2013, after it was over $1.0 trillion for the past four years in a row. As the saying goes, “I’ll believe it when I see it.” (The CBO’s numbers do not include any extraordinary events, like interest rates rising, the government having to take a write-down on student loans, natural catastrophes—they left no room for these kinds of events.)

Even if you believe the CBO forecast, this means the “official” U.S. debt will move from its current $16.5 trillion to $17.4 trillion. Looking at U.S. debt in relation to gross domestic product (GDP) paints a worse picture. The $17.4-trillion current U.S. debt would equate to more than 109.3 % of GDP if we assume GDP of $15.8 trillion. (Source: Federal Reserve Bank of St. Louis web site, last accessed February 6, 2013.)

Here is what the director of the CBO, Douglas Elmendorf, recently said: “…at this level of debt relative to GDP, our country would be incurring costs and bearing risks of a sort that we have not [had] in our history except for a few years around the end of the second World War.” (Source: Paletta, D., “Debt Rise Colors Budget Talks,” Wall Street Journal, February 5, 2013.)

Dear reader, the reality is that the government is still spending way too much and increasing U.S. debt far too much. Let’s call a spade a spade; U.S. debt is simply being bought by the Federal Reserve. Where does the Fed get the money to buy U.S. bonds? Well, it creates it out of thin air—a form of fiat money “madness” with far too few critics! How can this end well? It won’t. And maybe that’s what rising bond yields are telling us.

Michael’s Personal Notes:

Basic rules of economics are at play with gold bullion prices; when demand rises, prices increase. We currently have a significant amount of demand for gold bullion by both investors and central banks, but the supply for the yellow metal is very limited.

The importation of gold bullion into Mainland China from Hong Kong increased 94% in 2012 to a new all-time high. According to Bloomberg, 834.4 metric tons of gold bullion was imported into Mainland China in 2012, compared to only 432.2 metric tons in 2011. (Source: Bloomberg, February 5, 2013.)

In the first half of its fiscal year 2013, demand for gold bullion increased 29.15% in Pakistan. On a month-to-month basis, the appetite for gold bullion increased 121.96% from November to December 2012. (Source: Bullion Street, February 5, 2013.)

Standard Bank Plc notes that the demand for gold bullion in January 2013 was higher than usual. The Standard Bank Gold Physical Flow Index indicates that gold bullion demand in January increased to the highest it’s been since November 2012 due to “good” buying in South East Asia. (Source: Standard Bank Plc, January 22, 2013.)

In addition to this, the central banks, which I believe will become the biggest driver of gold bullion prices, have been buying more of the metal. In the last six out of seven quarters, central banks around the world have been purchasing about 100 metric tons of gold bullion. (Source: International Business Times, December 28, 2012.)

Let’s remember, central banks used to be the net sellers of gold bullion; now they are buyers. Let me give you some idea about the amount of their buying: the central bank of Ukraine increased its holdings of gold bullion to 7.72% in 2012, compared to 4.36% in 2011. Similarly, the central bank of Brazil doubled its holdings of gold bullion (which it keeps in reserves) from October 2012 to November 2012.

Gold bullion is becoming the “go-to” source for safety once again. It looks to be the only option to store wealth in a world where central banks are in a rush to devalue their paper currencies. Don’t listen to the “noise” about gold bullion; just look at the supply and demand situation, and you’ll see the fundamentals for gold bullion are quite strong.

Where the Market Stands; Where It’s Headed:

Stock market optimism is far too high. Investors are getting back into stocks, and stock advisors are turning very bullish—both bearish indicators. On the other hand, corporate insiders are net sellers of stock, corporate earnings growth has slowed to a snail’s pace, and we had negative GDP in the U.S. in the last quarter of 2012—more bearish indicators. How anyone can be bullish on stocks; I just don’t understand.

What He Said:

“The Real Threat to the Economy: U.S. retail sales are falling, the producer price index is crashing, house prices, car prices are all falling—and no one is talking about deflation but me. Fed governors are still talking about inflation—they’ve got it wrong. There’s no need for me to get into the dangers of deflation as I’ve written about them (many times) before. Let’s just put it this way: Deflation is about the worst economic state a country will experience. The risks to the U.S. economy in 2007 are greater than I’ve seen in years.” Michael Lombardi in Profit Confidential, November 15, 2006. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in their worst state of deflation since the Great Depression.