What is the bond market telling us?
March 10, 2005

Twelve months ago the yield on three month Treasury Bills was 0.96%. Today the yield is 2.76%. That's a 188% increase in short-term interest rates in just one year. By contrast, the yield on ten year Treasury Notes has increased by only 7%, from 4.04% a year ago to 4.32% today.

Given the rapid increase in short-term interest rates, which are being driven up by the increase in the federal funds rate set by the Federal Reserve, one would have expected longer-term interest rates to move up as well -- certainly more than what they did.

One possible explanation for the fact that longer-term interest rates in the US have not increased in response to the rapid increase in short-term interest rates is that (mainly institutional) investors could be concerned the rise in short-term interest rates is going to negatively affect the US economy, and by extension, corporate profitability. When investors are nervous about the equity markets they often invest in bonds because bonds are perceived to be safer than stocks and they have a pre-determined yield, which stocks do not have.

Recall that bond prices and interest rates are flip sides of the same coin. When bond prices rise interest rates fall and when bond prices fall interest rates rise. The economic recovery currently underway in the US is openly mocked as a jobless recovery since very few jobs are apparently being created. In my opinion, the recovery itself is a joke, and I don't, for a minute, believe that we are out of the woods. If, indeed, institutional investors are nervous about the equity markets and have been moving funds into bonds then we could have an interesting year ahead of us.

A decline in US equity prices concurrent with low medium to long-term interest rates should not bolster the dollar. Under this scenario the dollar should fall and the gold price (in US dollars) should rise. But, as long-time readers of my commentaries might recall, I have stated many times that the US dollar will not collapse until we see it decline in conjunction with rising interest rates.

The dollar is currently softening up in conjunction with falling interest rates as money is moving into the bond market. That means I don't think the current rise in the gold price (as a result of the falling dollar) is the beginning of the "big one". If medium to long-term interest rates in the US should start rising we could very well see a rally in the dollar, and a concomitant fall in the gold price. That would be the time to back up the truck, as my friend Doug Casey is fond of saying.

Since I am not a trader, I don't intend to sell into the current gold price strength -- the markets can change too rapidly. Even though my focus is small exploration companies, I still remain an investor at heart, and I look for stocks that I can own for the longer term. And since I cannot (and do not) give anyone specific investment advice, my best response to emails asking about specific companies is a reminder that my weekly newsletter discusses the stocks that I am buying and selling myself. I tell my subscribers what I'm buying, and why. I also tell them when I sell and why I sold. You can get information about my newsletter on my website, www.paulvaneeden.com, under the "Newsletter" heading.

Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com) or contact his publisher at (800) 528-0559 or (602) 252-4477.

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