Gold and silver hit by massive dollar rally

The return of the carry trade is creating a dollar illusion. But rising US Treasury yields are threatening to destabilise the entire global credit system, ultimately for the benefit of physical gold.

Against a background of a soaring dollar, gold and silver suffered a predictable shakeout. Yesterday (Thursday), gold closed at $2567 after dipping below $2540, for a net fall from last Friday’s close of $121, down $222 from 30 October’s high. Silver closed yesterday at $30.46 after an intraday low at $29.76, down a net 116 cents and off $4.40 from its 22 October high.

The sharpness and rapidity of these falls suggests that a decent technical bounce on bear closing in both gold and silver is in prospect for today. But it would be too early to say with conviction that Thursday’s lows represent the end of their correction.

Driving gold and silver’s decline has been the remarkable rally in the dollar. The next chart shows its trade-weighted index:

Far from reflecting a sudden appetite for dollars from foreign investors, US hedge funds and others have returned to the carry trade, which involves borrowing yen cheaply (and perhaps to a lesser extent euros), selling them to buy dollars and investing in T-bills for the yield pick-up. Other than the profits to be made from the interest rate arbitrage, the logic can be summed up as Trump and his tariffs will do less harm for America than to everyone else. And the domestic inflationary implications will keep short-term US bond yields high while Japan and the Eurozone resist the trend for fear of the consequences on their own economies.

However, there appears to be some confusion over the US inflation outlook, with the probability of a cut in the Fed funds rate of 0.25% next month currently assessed at 79%. But with the impact of the new president’s intended tariffs leading to higher consumer price inflation, it makes more sense for the Fed to put rate cuts on hold until the tariff position is clarified. And yields on the Treasury 10-year note are rising strongly, confirming there is too much optimism for lower interest rates:

The reality is that the marginal buyers, being foreign holders of US Treasuries in aggregate, are unlikely to buy more for economic or political reasons. Instead, foreign central banks and governments outside the western alliance are selling down dollars and dollar debt for gold. And foreign private sector institutions are suffering greater losses on term debt as yields rise. In the absence of this foreign support, the yield on the 10-year UST-note is set to rise above 5%, not only tripping debt traps for the US Government, but for Japan, the Eurozone, the UK, and all the zombie corporations in these jurisdictions who less than two or three years ago thought that interest rates would never rise again.

In short, while US hedge funds party on the proceeds of the carry trade, already we can see how the markets’ reactions to Trump’s landslide are creating potential chaos elsewhere. As an example, look at the problems for Japan: 

The yen is declining and undoubtedly will hit new lows, while bond yields are on the rise. Time is being called on the Bank of Japan’s monetary stance. On Wednesday, the BOJ revealed that the producer price index for October rose 3.4% compared with a year ago: compare that with the yen’s close to zero short-term interest rates. Trump’s election has since made things considerably worse for Japan’s monetary policy, and possibly threatens the very survival of the BOJ, which desperately needs a massive recapitalisation to retain its ebbing credibility.

Japan is only one example. Having come to rely on an outlook for lower dollar interest rates, the Eurozone and UK face their own crises. Far from improving the dollar’s prospects as a fiat currency, current events are destabilising the entire fiat currency world. They confirm the thesis that the entire gold-less period since the end of Bretton Woods is running out of road — and rapidly at that. I shall end this report with gold’s technical chart:

Clearly, the correction from $2790 has taken much of the short-term froth out of gold, and it is in a stronger technical position for it. It has been an opportunity for foreign central banks frightened for the dollar’s future, and even more so following the presidential election, to redouble their efforts to acquire physical bullion, for which there is no counterparty risk.

And if they are rejecting fiat for bullion, then surely tells us all we need to know.