May 25, 2024

A World Of Zero Interest Rates

We have arrived at 0 interest rates and the reasons we are at this point are all negative indicators for where we are and where we are heading.

Theodore Ake, head of U.S. Treasury trading at Mizuho Securities USA Inc. in New York, one of the 17 primary dealers of U.S. government debt, said some investors bought three-month Treasury bills from his firm with negative yields of 0.01% to 0.02% Tuesday. By the end of active trade, the yield had inched back up to positive 0.02%.

In round numbers, the investors were willing to pay $100, knowing they would get $99.99 in return, in the belief that a small but guaranteed loss was preferable to investing in stocks, corporate bonds or other securities. Treasurys have been flirting with 0% yields since the Lehman Brothers bankruptcy nearly three months ago.

“The bond market is doing a much better job than stocks right now of telling you about the risks that are out there,” said Thomas H. Attenberry, a partner at First Pacific Advisors, an investment-management firm in Los Angeles. The high yield investors are demanding on anything other than Treasurys is particularly worrisome because companies need to refinance more than $800 billion worth of debt next year, according to analyst estimates.

The notes the extraordinary amount of risk aversion taking place as investors loss their confidence in the ability of anyone other than a central bank to repay their debts.

The investor search for a safe places to store wealth as the financial crisis shakes faith in the system has caused extraordinary moves in global markets over recent days, driving the yield on 3-month US Treasuries below zero and causing a rush for physical holdings of gold.

“It is sheer unmitigated fear: even institutions are looking for mattresses to put their money until the end of the year,” said Marc Ostwald, a bond expert at Insinger de Beaufort.

The rush for the safety of US Treasury debt is playing havoc with America’s $7 trillion “repo” market used to manage liquidity. Fund managers are hoovering up any safe asset they can find because they do not know what the world will look like in January when normal business picks up again. Three-month bills fell to minus 0.01pc on Tuesday, implying that funds are paying the US government for protection.

“You know the US Treasury will give you your money back, but your bank might not be there,” said Paul Ashworth, US economist for Capital Economics.

The gold markets have also been in turmoil. Traders say it has become extremely hard to buy the physical metal in the form of bars or coins. The market has moved into “backwardation” for the first time, meaning that futures contracts are now priced more cheaply than actual bullion prices.

The latest data from the World Gold Council shows that demand for coins, bars, and exchange traded funds (ETFs) doubled in the third quarter to 382 tonnes compared to a year earlier. This matches the entire set of gold auctions by the Bank of England between 1999 and 2002.

Credit markets may have thawed somewhat but after suffering horrendous losses on virtually every asset class, investors seem determined to put whatever cash they have left in the most risk free category possible – even if that means paying for the privilege via negative interest rates.

A desire for a return of capital rather than a return on capital, as the old saying goes, is what we are looking at here.  Of course, at some point, the disgust of receiving a zero return on your money is bound to drive at least a portion of the capital now in treasuries into another asset class.  Investors will be willing to risk some of their capital in another asset class which might be riskier but which also promises some good chance of obtaining a return on capital.

My guess is that one such asset class will be gold, as I previously discussed in  Gold, Cheap at $5000?
I view gold as the ultimate insurance hedge against a government’s propensity to spend itself into insolvency and, accordingly, I believe that gold should constitute 10 to 20% of one’s core investment assets.   Historically, governments  have regularly and repeatedly defaulted on their sovereign debts.  In every such case of default, the citizens of those nations would have been far better off holding gold rather than government paper.