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US Treasury Bonds Fast Becoming Certificates of Confiscation

Interest-Rates / Inflation May 22, 2008 - 08:09 AM GMT

By: Adrian_Ash

Interest-Rates THE PRICE OF GOLD BULLION slipped $10 from a new five-week high in London early Thursday, pulling back to $925 per ounce as crude oil broke new record highs and the US Dollar fell yet again on the forex market.

" Gold has rallied over 8% in the last five days and is now trading over $80 higher than May's low," notes Mitsui, the precious metals dealer, in London today.

"Record oil prices and a resurgent Euro are playing a significant part in this precious metals rally. But there are also fresh concerns today about the credit crisis."

US credit spreads – a measure of investor anxiety over the risk of non-payment – turned higher on Wednesday after ailing Swiss banking giant UBS sold $15.5 billion worth of mortgage-backed assets to the Blackrock hedge fund at a 30% discount.

UBS also lent Blackrock the funds needed to complete the purchase, mimicking the "vendor financing" tactics employed by home builders and auto-dealers before the bubble in consumer credit burst in spring 2007.

Shares in Moody's – the credit ratings agency – fell a record 16% meantime after the Financial Times reported how a computer glitch in early 2007 led the company to award "triple A" ratings to high-risk debt derivatives.

Moody's is now reviewing the ratings on $4 billion in so-called constant proportion debt obligations (CPDOs) – likened by Bloomberg columnist Mark Gilbert to a " Nigerian banking scam ".

( What's the link between Gold & Credit Defaults ? Read more here... )

Today the price of government bonds – the main "safe haven" bought by large funds and financial institutions after the global banking crisis first broke – also fell as crude oil rose above $135 per barrel.

"For bond market players the focus is now on accelerating inflation," said one senior analyst in Tokyo to Bloomberg this morning.

Fixed-income investments destroy wealth when the cost of living rises. That's why US Treasuries became known as "certificates of confiscation" during the double-digit inflation of the late 1970s.

Ten-year US government bond yields rose to 3.86% on Thursday as prices fell. Karsten Linowsky, fixed-income strategist at Credit Suisse in Zurich , believes the 10-year yield is heading for 4.00% and above – meaning a capital loss of $3.50 on every $100 invested.

"The inflation outlook is weighing more on the market as it implies the Fed could hike interest rates," says Linowsky. But Wednesday's release of minutes from the Federal Reserve's latest policy meeting showed the central bank most likely frozen for the rest of 2008.

After slashing the cost of Dollars from 5.25% to 2.0% in just nine months, the US Fed no sees cost pressures staying "elevated" while unemployment rises "significantly".

The Fed also cut its 2008 growth forecast down from a ceiling of 2.0% as low as a mere 0.3%.

US interest rates at 2.0% are barely half the rate of consumer price inflation meanwhile. That negative return to cash savers is likely to boost commodity and Gold Prices as investors seek to defend their wealth.

"Renewed credit market strain could put further pressure on global bond and equity markets," adds Manqoba Madinane for Standard Bank in Johannesburg today.

"This could lift precious metal investment demand amid rising global inflation expectations.

"Continued Dollar weakness should also support precious metal investment appeal. Under these conditions, we see upside potential."

The US Dollar continued to slide vs. the Euro this morning, dropping to a new five-week low despite a sharp fall in European industrial orders reported for March.

The UK data agency in Cardiff added that business investment in the United Kingdom shrank by 1.4% during the first three months of this year. But the Pound also rose against the US currency, reaching its best level so far this month above $1.9800.

That pulled the Gold Price in Sterling down almost £10 per ounce from a five-week high of £474.50.

For French, German and Italian investor wanting to Buy Gold today, the price moved back to €587 per ounce after touching its highest level since April 18th.

By Adrian Ash

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2008

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

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