Skewed Interest Rates
Based on some of the comments that have been coming in from the readers, I thought it might be best to post a general story which might help explain the reasons behind my confusion regarding the movements in the platinum, copper and silver markets.
As noted in the previous post about the Silver COT, I am a lifelong fan of using the Yield Curve to try to get a sense of the sentiment in the interest rate markets in regards to either growth or no growth. It has been the most reliable indicator that I have used throughout my entire trading career. I still remember well the time when I was first introduced to it and how learning to decipher its message helped turn around my trading career.
Right now, the yield curve remains extremely flat with the spread between the Ten Year Treasury and the Two Year Treasury separated by a mere 79 basis points.
Here is a longer term chart, courtesy of the St. Louis Fed’s research site, showing the ten year history of the spread.
Notice that the spread is near a nine year low.
By the way, do you see how the yield curve INVERTED in 2006? That was a clue that something was wrong as long term interest rates actually fell below short term rates. Generally speaking, an inverted yield curve is an early warning sign that things are not well and that trouble is coming.
You can see the periods during which the spread widened out or STEEPENED (remember this curve is forward looking) only to then have it flatten once more. Since 2010, the yield curve ( as illustrated by this spread) has tended to have a lower trajectory. That is a vote for slowing growth, or at least growth accompanied by no inflationary fears.
Here is a closer look at this data from my own file.
Clearly the current spread continues to have a predominant trajectory lower (flattening). Yet, in spite of this warning that growth is stalling, we see hedge funds buying industrial metals such as copper and platinum and silver (the quasi industrial/precious metal ).
Here’s my concern – never before in history, at least that I am aware of, have we had such a phenomenon as NEGATIVE INTEREST RATES. Think about that? What would you tell an unlearned observer from a different time period those things are? How would you describe them? Large banks being forced to pay for the “privilege” of keeping reserves on the books of the Central Bank… How does that work? What is the theory behind this concept? For that matter, who even came up this idea in the first place?
Perhaps, the distortions in asset prices being caused by this Central Bank foolishness have rendered the yield curve movement obsolete. I am posing an honest observation and am really trying to grasp the implications of this monetary environment across a host of various markets.
Maybe the fact that the Yield curve continues to flatten no longer has any predictive capacity like it once did. Again, I am just asking the question.
If you are a citizen in any of these nations/regions, etc. where negative interest rates are official policy, where can you go to obtain yield? Do you chase high priced stocks and take your chances in the equity markets? Do you go further and further out along the yield curve buying longer-dated after longer-dated maturities so as to eke out some sort of pathetic return on money in this Central Bank created interest world wasteland? Do you buy some sort of tangible asset such as gold for a vote of no confidence in these Bankers? How about even an industrial metal such as copper or platinum? or Silver? Why not crude oil, perhaps one of the most effective inflation hedges of all time?
Again, I think that these Central Banks, who are using us all as guinea pigs in some sort of perverse grand experiment in monetary policy theory, have produced a financial environment in which no one knows what do to any more. People are desperate for yield and will look at anything that they feel might give them a chance at generating some sort of return on their money.
That in itself produces yet another set of price distortions in the interest rate markets. If you think about it – how much money from overseas is flooding into the US Treasury markets from investors who view a pathetic yield of 1.46% for a government IOU of TEN YEARs as a pearl of opportunity? Compared to what they can obtain from bonds in their own nations, it looks downright obscene for its liberality!
The problem is that this overseas flow produces yet further price distortions in our own bond markets as it has the effect of pushing those prices higher and thus yields even lower especially if these same flows concentrate themselves further and further on out the yield curve as well. Such a thing would work to push bond prices at the long end of the curve higher than they might normally be at the expense of the shorter end. That would help to further flatten the Yield curve. Maybe this is skewing the yield curve so that it is not reflecting an accurate sentiment? Again, just posing the question….
All of these distortions being created as a fallout from Central Bank machinations are preventing me from being dogmatic on just about any of these major markets. The resultant money flows are determining asset prices for all the wrong reasons. The question then becomes – what are their prices actually reflecting? Is it real or not? By “real” I do not mean what is on the tape – that is obvious and of course it is “real” in that sense. Traders have no choice but to work with that. What I do mean is whether or not it actually reflects something based on the fundamentals of supply/demand or if the demand side of that equation has been so distorted by speculative activity looking for yield that no one really knows what the price would be if this speculative demand were to evaporate.
I fear this is the state we have reached and quite frankly, knowing the nature of how fickle this demand can be, I have great concerns that a lot of investors/traders are going to be seriously hurt in the months and years ahead. You would think that people would learn about the dangers of excessively leveraged, one-sided bets but apparently not. If the credit crisis of 2008 and the subsequent Japanese Yen carry trade unwind did not teach them, nothing will.
The interest rate environment created by Central Banks has if anything, made matters even worse this time. Only heaven knows how all of this is going to end especially at the speed which these bets are now able to be unwound.
Disclosure: None.
So, Trader Dan, interesting article. All bonds are gaining in demand, based on Basel rules and clearinghouse demand for collateral. Negative will actually allow banks and counterparties to continue to have good collateral, without margin calls, etc. And then the governments get funded by negative bonds.
So, when Greenspan rebels, know it is his idea of pushing risk off banks that started this structured finance debacle. It is just going to the end of what was inevitable. Maybe you will find this interesting: www.talkmarkets.com/.../hoarding-the-new-gold-early-history-about-structured-finance
Certainly there has to be a weakness in this seemingly foolproof system. Could be lack of bonds as collateral, or maybe austerity of all things.