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Safe Havens Coming Back In Style

Two big things happened on Tuesday. The first big thing: US markets fell significantly. The Dow Jones Industrial Average fell 700 points or 3%, the NASDAQ lost almost 4%, the S&P somewhere near 3%. The sharp downturn followed a strong rally on Monday fueled by optimism that Trump and Xi had agreed to a 90-day stand down in the two nations escalating trade dispute.

But the devil, as always, is in the details. And while everything about this trade war has been short on details, the two countries issued very different statements following the meeting – so the details we did get didn’t match up.

As the scale of the differences set in, Monday’s market optimism turned to skepticism on Tuesday that Beijing would yield to US demands any time soon. And fair enough. There are major issues that cannot be resolved, whether over a leaders’ dinner or within 90 days, including but not limited to intellectual property rights, Beijing’s subsidies to strategic industries, and Taiwan.

The lack of agreement was a stark reminder of how complicated and uncertain this trade war really is, and that got investors anxious. And so the markets skittered and slid down while investors moved to safer areas – liked bonds and gold.

Let’s tackle those one at a time. Investors bought bonds, but preferred shorter duration notes to longdated ones. And that matters, as it created the other ‘thing’ that happened on Tuesday.

The second big thing: yields on 3- and 5-year Treasuries fell below those on 2-year notes. That means the bond market is collectively saying that rate hikes need to end, and soon.

In general, longer-dated bonds only yield less than shorter ones when investors see recession ahead. The reason is that investors pile into long-dated bonds when they are worried; since bond yields move opposite their price, all that buying drives yields down. When investors are confident they move out of long-dated bonds in favor of stocks; the selling pushes 10-year prices down and yields up.

That’s the basics of bonds: long-dated notes are the ones that matter in terms of investor confidence and they rise in price when confidence falls. Since bond yields move opposite their prices, 10-year yields fall when confidence falls.

Trends are great, but to compare periods we have to iron out the differences in interest rates, as they underlie bond yields. Enter the yield curve, which subtracts the yield on the 2-year Treasury (which is always just a bit above interest rates) from the yield on the 10-year Treasury.

Whenever times are at all good – and investors expect times to remain good for a while – the yield curve is positive: the 10-year Treasury yields more than the 2-year. When things turn shaky, investors pile into 10-year notes, boosting the price and driving the 10-year yield down. If things get shaky 3 enough, the 10-year yield goes below the 2-year yield --> the yield curve goes negative or inverted.

Right now the difference is still positive, but only barely. In fact, the difference is the smallest it has been since January 2008, just before the financial crisis.

As this yield curve chart shows, the yield curve has turned negative a year or two before every US recession. That’s a strong correlation. Also very strong is the inverse correlation between the 10-year yield…and gold.

Yup: when 10-year yields decline, gold rises and vice versa. It makes sense. Yields on longduration bonds slide when investors lack confidence in the economy. That’s what turns the yield curve negative. And it’s what drives investors to safe havens like gold.

In the first half of 2016 gold gained 28%. In the same timeframe, the 10-year yield dropped almost 40%. Near the end of that year, following the presidential election, investor confidence jumped; so too did 10-year yields. Gold did the opposite.

OK, so what has transpired in 2018? Yields on 10-year Treasuries have risen all year, from 2.4% to as high as 3.23% in September. As per the correlation, gold eased in response.

But those trends seem to be changing now. Look at the right edge of each chart and you’ll see that 10-year yields are falling and gold is rising.

This trend will continue – 10-year yields will keep falling and gold will keep rising – as long as investors remain uncertain. The fact the Trump and Xi, in the midst of waging the biggest fight the global economy has seen for a long time, not only couldn’t agree on ending the trade war but couldn’t even walk away from a meeting with the same idea of what they’d discussed showcases why markets are so uncertain.

Then add in the shine coming off FAANG stocks, declines in US housing, the Italian budget crisis, the endless Brexit drama, and – in breaking news today – the arrest of Huawei CFO Meng Wanzhou in Canada for extradition to the US and you have lots of reason, as an investor, to be uncertain.

Meng was arrested on suspicion of having violated US trade sanctions on Iran, but little else is known about the situation.

Meng was granted a publication ban preventing the US Department of Justice from releasing further details about her arrest. Meng is not only the CFO of

Huawei; she is the daughter of Huawei founder Ren Wanzhou. Ren is a business icon in China. The arrest of his daughter is shocking to most Chinese. Huawei is one of the world’s largest makers of telecommunications network equipment. The US has previously accused Huawei of shipping US-derived tech products to Iran in violation of US sanctions.

Meng’s arrest comes amid a two-year-long campaign by the US government against Huawei, which it views as a national security threat. Washington has restricted Huawei’s business in the US and recently launched a major international effort to persuade its allies to follow suit. New Zealand and Australia have since stopped telecom operators from using Huawei equipment in new 5G networks out of concern about possible Chinese government access to the infrastructure. Several US Senators are lobbying Canada to make a similar decision.

Meng’s arrest matters. The Chinese government is torn whether to make a deal with Trump or not and Meng’s arrest will push sentiment to the Not side. It will be very interesting to see how Beijing responds, but no matter what the official response Meng’s arrest can only escalate tensions between the two countries.

I remain optimistic that Xi and Trump will figure out a way to avoid a full scale trade war, for the sake of their respective economies, but moves like this are concerning. The silver lining, however, is gold, which will rocket if things start (continue?) to deteriorate.

I have said many times of late that gold never ‘lost’ its safe haven appeal; rather investors just haven’t needed in recent years to shelter from anything. That is now changing – and gold’s safe haven appeal is once again becoming apparent.

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I think Peter Krauth's analysis articles are second to none. It would be impossible to conduct a fuller report than those which I have read.

-RP (September 2022)

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