August 5th 2011 – It’s a form of madness – is it?

August is traditionally holiday time in Europe, but the bond markets seem to be hotting up more than the weather, with Italian and Spanish yields on the up whilst Germany basks in the glow of borrowing costs below the rate of inflation. Has the Weimar Republic finally been consigned to history’s memory vacuum? I think not.
Bunds are perceived as safer than Italian or Spanish paper; witness headlines today saying that the latest buying of Bunds is a “flight to safety”, but how do you define “safe”. A whole litany of equity research is available using sovereign debt yields as a proxy for the risk free rate of return. Risk free they ain’t; Bunds, Treasuries and Gilts included. Try valuing stock markets using Greek yields as a risk free rate! Joking aside, maybe we should…
But German, US and UK 10 year yields are all below 3%. “Why”, you may ask, when monetary easing on such an unprecedented scale should have stoked an inflationary bonfire. In the short term the flight to safety argument is the answer as no one is going to default this week and the cash from equity sales has to go somewhere.
Could the bond market be anticipating a deflationary bust a la Japan? The Bernank wouldn’t allow that so some form of QE must be on the way, mustn’t it? Or is he trying to push the onus for keeping the Treasury market afloat back onto investors who are still brain washed into thinking it is risk free? My guess is he will keep printing until he gets what he wants. But be careful what you wish for your Supreme Federal Reserveness …
So what is risk free? Gold doesn’t provide any income return so why are some treating it as a safe haven? The Bank of Korea has just bought 25 tonnes of the stuff. Are they mad? Bernank would just say that they are being traditionalists. Why not have some bullion in the vaults; after all the central banks have been doing it for centuries but why this upsurge in demand by the CBs when not so very long ago they were sellers? When the won came under the cosh in the late 90’s Asian currency meltdown, the BoK asked the population to sell their jewellery to help prop it up; some even gave their gold away for free. Now that is madness!
Today gold gets the odd brief mention in the financial press as it continues to make new highs and journals such as the Economist spout the “barbarous relic” refrain at every opportunity. They should be reminded of P.J. O’Rourke’s quote that “Economics is an entire scientific discipline of not knowing what you’re talking about.” At a recent investment seminar, I asked the delegates if they had any exposure to gold. Not a single ETF, gold mining share or sovereign amongst the lot of them. Most had no idea that you could actually buy physical bars. Does that sound like a bubble to you?
Today’s footnote concerns government bureaucracy of which we have far too much; especially here in Europe. Did you know that the Lord’s Prayer contains 66 words, the Ten Commandments 179, the Declaration of Independence 1300, the US Constitution, with all 27 amendments 7,818 and the latest EU regulations on the sale of cabbage…….26,911. For that reason alone the EU should be disbanded so we can return to tending to our own allotments in peace.