How bad are the bond market returns?

 

Bonds are a bad bet, or have been a bad bet. In fact, the current period has been the worst in the longest history available. It is worse than the period of high inflation in the 1970's, worse than the Civil War. 

However, there is hope. As rates move higher, current yields rise, which offsets some of the capital loss. Coupons provide a cushion for further yield increases. Total returns can improve quickly if overall yields are higher.

Where are we going to get the needed copper?

Copper has hit new highs as investors focus on rising demand from the tech sector, yet a fundamental supply problem remains. Not enough new fields are being discovered and developed to meet demand. 

There is talk about commodity cycles, yet understanding long-term demand requires looking at how supply is created. Mining is expensive. It requires capital investment, but that only happens after a discovery, and discoveries have different ore qualities. If prices are low for an extended time, then there is no development, which creates a shortage. The shortage then raises prices, which, if sustained, creates the incentive to develop new mines. This is the basis for a commodity cycle. 

 

The gold real rate change in sensitivity

There are supposed to be certain “rules” between market drivers and gold. Gold is supposed to hedge inflation. This relationship has proven mixed. A second relationship is linked to real rates. Since gold does not earn a return, investors should prefer an asset with a positive real return over gold. The longer-term relationship is negative, yet the last four years show a relationship in transition. Right now, there is a a much stronger link with real rates. 

Gold can be viewed as a meme asset that reflects investors’ fears. There may be an economic relationship, but the link is often unstable.

Who is the marginal. bond buyer?

 

To price assets, you ned to know who will be the marginal buyer who will clear the market. How sensitive is the buyer to value or economic shocks? For the longest period in the US, the Fed was the marginal buyer through QE. QT was tried, but there always seems to be a hesitancy that selling would stop or slow down if rates rose too quickly. Now, the world has changed. The marginal buyers are private investors. Those private investors may either be domestic or foreign. Again, the issue is whether the marginal buyer needs to hold safe assets regardless of valuation or whether these buyers focus on valuation. I place less emphasis on Treasury arbitrage and basis traders, which is a different problem. If the perception is that bonds are expensive, or, more importantly, that rates are trending higher, yields will clearly be higher. 

Nominal yield will fall only if inflation expectations fall, term premiums fall because risk is perceived as lower, and real rates move lower because growth slows. Pension funds and insurance accounts will drive the US bond market. These buyers do not have to be vigilantes; they can just price-sensitive investors.