The near-term drag on gold, then the takeoff
In the short run, fear of a rate rise hurts precious metals. The market expects one more rate rise this year from the Federal Reserve and no rises next year, the central view on the CME FedWatch tool, though those views can change. The logic: someone weighing gold against a bank deposit sees gold pay no interest while a fixed deposit pays a quarter percent more, so money shifts. That is a short-term effect. Gold may fall in the coming weeks before the next rate rise is announced.
After the rise is announced, if the view holds that no further rises follow, gold should start to climb. The driver will be government bond yields, now pushing to multi-year highs on a debt load that is a far higher share of GDP than ever before. When borrowing costs keep rising while debt keeps growing, the old "gold versus yield" trade-off breaks down. A rate rise can pressure gold briefly as investors chase slightly higher returns. The bigger signal is the government's debt burden: when yields rise on a huge debt base, financing costs turn dangerous, and investors must eventually doubt whether the debt is sustainable.
Central banks and money printing
That worry makes it likely, though not certain, that central banks step in. The Treasury would invite them to support the bond market. The tool is quantitative easing, the same method used in COVID, perhaps under a new name. The Federal Reserve prints money and buys bonds; buying bonds stops prices from falling and holds yields steady or pushes them lower.
I thought 5.3% was probably the highest yield the US would find acceptable on the 30-year. It has now passed 5.3% over the last few days and stands at 5.43%, heading toward 5.5%. If the Fed steps in, which is more likely than not, it would buy bonds and flood the market with newly printed money, which would be very bullish for gold. The guessing game is whether it happens and when. It is not far away, likely not in the coming days. They will probably wait for the next rate rise; if that pushes bond prices down and yields up, the Fed will be invited, pushed, or ordered to act. You cannot officially order the Federal Reserve to do anything, yet it has been ordered in the past and obeyed. New bond buying creates fresh money exactly when confidence in government debt is weakening, which could push capital toward scarce assets like gold and silver.
Silver: accelerated moves and a shrinking buffer
Silver should do what gold does, but faster. If the economy slows, industrial demand for silver should slow too. Yet for decades industrial demand has risen, driven by electronics, and use of electronics will not fall back much. Silver demand should stay high and keep exceeding mine production, as it has for the last three or four years. The question is by how much. There is still a lot of above-ground silver, but those stocks are falling.
One piece of evidence is CME warehouse stocks. They fell substantially and are half what they were a few years ago. They stabilized around March or April and rose a bit, but the latest figures show them falling again over the last month. Every ounce of that silver is looking for a price at which to sell. Because above-ground supply is shrinking and mine supply is not enough for industrial use, even if industrial use drops in a recession there will still be a shortage. Two things matter: how much above-ground silver can be drawn out to sell, which needs a higher price to tempt sellers, and sentiment, which depends on outside factors. There are now net inflows into mining stocks, which sit a bit higher than was justified last time gold and silver were at these prices. Silver's real weakness may not be demand at all, but the vanishing inventory buffer behind the market.
Can a bond crisis pop the AI bubble?
Could a bond market crisis become the pin that pops what many call the AI bubble? Yes, it is possible. But history does not tell us that high valuations, overvaluation, or expensive shares lead to a crash. There have been many times when stocks were very high and no crash followed. What does follow from high prices, backed by evidence, is that future returns are much lower than when valuations are low. Start at high valuations like today and long-term returns over the next decade will probably be lower than starting from normal or low valuations.
The S&P 500 trades on a trailing price-to-earnings ratio near 27 times, expected to fall to about 20 times looking forward. Both are far above the historical norm of 16 or 17 times trailing. The market is distorted, because those high valuations come mostly from a small group of companies seen as the future winners. Those popular stocks are most at risk; in a decline, today's market leaders will likely lead the market down. Many stocks in the US and worldwide sit at far more reasonable valuations, so this is no call to leave stocks entirely, but exposure to the technology, semiconductor, and data center sectors should be cut. These all look overvalued. I have cut my own exposure to this sector very substantially, keeping only a little, and moved into companies on lower P/E ratios that seem to offer lower but more assured growth than the high-tech stocks, which have a lot of growth priced in that probably will not come true.
Synchronized global bond stress
Yields are rising across almost every market: European, Japanese, UK, US, Canadian, and Australian bond markets are all doing the same. Yields on the 10-year and 30-year are the highest in 20 or 30 years in some cases and highest in many years in others. The US 5-year is around 5% and the 10-year over 5.1%. National debt in the US is now over 40 trillion dollars, and there is a war America seems unable to exit.
This is a problem for all these governments. Their maturing debt was taken out when interest rates were much lower and when national debt was much smaller. Now that debt must be rolled over at higher rates than the last 15 years since the global financial crisis, though not higher than the very high yields of the 1980s and 1990s. The bond problem is no longer just American; it is hitting major economies at once. Debt-to-GDP in most countries is close to the highest ever, excluding the war period. That is a double whammy: higher rates on maturing debt, and a debt pile far larger than 10, 15, or 20 years ago. The interest part of government budgets is rising rapidly, much faster than GDP. That could cause a crisis, since interest costs are forecast to keep rising fast for years even if the Fed funds rate starts to fall. Bond yields are not coming down. A couple of years ago the Fed funds rate started to decline, yet government bond yields did not; they rose. Now the Fed funds rate is rising and bond yields are still rising.
How high yields feed through business and prices
Higher yields are bad for business in theory. Most companies borrow, and the S&P 500 now averages a bit over 100% debt-to-equity, skewed by some firms holding more and some less. As rates rise, it costs companies more to operate, invest in new factories, hire workers, and invent products. Raising rates tends to slow the economy, whether at the short-term Fed funds level or the longer 5, 10, 25, and 30-year rates. The real danger is higher rates applied to a much larger debt base, squeezing governments and heavily indebted companies at the same time and cutting room for productive investment and growth. Watch refinancing costs, not just headline Fed decisions.
Companies borrow over different periods. Some borrow from banks at short-term rates, but most carry a good part of their debt as issued bonds. When a government bond yield rises, a company's new borrowing costs that government yield plus whatever premium it must pay on top. So rising government yields raise business costs.
On inflation, the common view is that higher rates suppress inflation, but that is not proven. The idea is that higher rates slow the economy and ease price pressure, basic economics. The catch: raising rates lifts business costs, and businesses do not sell things for less than they cost, so they raise prices. Rising rates can be inflationary as much as deflationary. Firms facing higher costs may defend their profit margins with higher prices rather than absorb the hit, passing the cost straight to consumers.
