Gold or Bonds?

"We will never return to the old boom and bust." - Gordon Brown (2007)

Well obviously Mr. Brown timed his statement to perfection as right behind that came the housing bust!  True to form the political leadership of the day while talking a good talk has absolutely no clue about the future or the economic perils that face our society. If they did there would have been no way that Mr. Brown would have said such an absurd comment right at the peak of the housing bubble.

There is a lot of talk regarding the gold bubble and the bond bubble.  Both have appreciated significantly over the last few years.  Gold is up more than 150 percent since 2007 and bonds are near historic low yields (bond prices move inversely to their yields).  An argument is that one of these markets must be right and the other market must be wrong.

Typically gold appreciates when there is a high level of concern about inflation rates (so the argument goes), while bonds with such low yields point to a lack of concern for any inflation in our immediate future.  As one is sky high pointing to inflation (gold) and the other is at historic low yields pointing to no prospect of any inflation in our future (bonds) one must crater.

I believe that this argument has one fatal flaw.  Gold while a decent proxy for investor concern regarding inflation is also a hedge against fear as are bonds.  I believe that both are being held at their respective highs due to this fear.  If you remove the fear gauge I believe that the gold market would fall precipitously while the bond market would move lower (higher yields) but not to such an extent as the fall in gold.  Why?  At present inflation indications are mute.

Given the fact that fear is rife in the market and given that there is no chance that this fear will dissipate any time soon (unless you magically repair all the mess in Europe with one wave of the wand) I would imagine that this spread will remain intact for a while at least.  Some fund managers I know are playing the spread game by selling gold and bonds short.  To be honest if I were to play that as an investment I would go short gold and long the bond but I think the trade is a mugs bet given the uncertainty and fear that remains in the market.

There is nothing to suggest that the bond market will not climb higher in the next twelve months just like it did in 2011, and that gold will not rise as we progress through the year due to heightened fear levels .  If I am correct in my prediction this will result in a terrible market for stocks and for the savers out there as yields will continue to fall.  Just as with everything to do with the market, if consensus points one way you can almost bet that the opposite will happen!  Keep the powder dry and good luck in 2012.