Sunday, February 21, 2010

US Bonds Versus Gold In The Past Year

Although the current size of the US government's debt is so large that it is extremely hard to conceptualize, it is nevertheless likely to have significant effects on the value of the US dollar moving forward. Over the past year, as the government's debt has grown, there has been a relative decline in the value of long-term bonds and an increase in the value of gold, which indicates falling confidence in the dollar. See the following post from Daily Wealth.

To most people, any talk of the U.S. government debt simply doesn't mean anything.

For instance, I could tell you the annual funding costs of our national debt are approaching $4 trillion per year – that's $1.5 trillion in new annual deficits, plus $2 trillion-$3 trillion a year in short-term obligations coming due that need to be refinanced. Foreigners hold roughly half of this debt. Thus, we have about $2 trillion in foreign debt that must be repaid or refinanced each year.

But this obligation is so large that it's meaningless to most people. I could also tell you $2 trillion is 20% of our GDP, but even then, most people won't understand just how much money this is. So think of it this way...

If you spent $1 million per day from the time of the founding of Rome – roughly 2,700 years ago – until today, you would have accumulated about $1 trillion in debt. Now, double that amount. And that's the size of our annual foreign borrowing obligation.

(Thanks to Eric Margolis for the trillion-dollar metaphor. See his essay "Spending America Into Ruin" here.)

But more important than understanding the size of this debt, it's vital that you understand its effects. In this essay, I'll show you the easiest way to track those effects... and the actions you must take to protect yourself from them.

The Barclays iShares 20+ Year Treasury ETF (TLT) tracks the value of the U.S. government long-bond market. This is the primary market the Fed was trying to support over the last year. Gold, on the other hand, is the best market-based judge of the soundness of the U.S. dollar and our creditors. The SPDR Gold Shares ETF (GLD) is an accurate proxy for the price of gold.

Look what happened to U.S. bonds (TLT) and gold (GLD) over the past year. This occurred even as the Fed was massively intervening in the credit markets.



Note the value of the U.S. long-bond market fell by more than 10% despite the government support. And the value of gold increased by more than 10% as investors fled the dollar.

It's interesting the relative moves were nearly identical. There's no free lunch. For every penny the government prints or borrows and uses to manipulate long-term interest rates, that same penny is being taken out of the value of the U.S. dollar, as is revealed in the price of gold.

You will see lots of debates about what the coming currency crisis means. But if you can simply understand this chart, you will grasp what's happening and how to protect yourself. It's simple: The value of the dollar is collapsing as the un-creditworthiness of the United States becomes evident. That means the price of hard assets – like gold – will keep rising and the value our government's long-term obligations will fall.

The safest thing to do right now is split your savings between short-term Treasuries and gold. That's the equivalent of a "cash" position, as the gold will hedge your dollar exposure and the short-term Treasuries will mitigate the volatility of gold. You can do this through ETFs. The Barclay's iShares 1-3 Year Treasury ETF is an easy way to own short-term Treasuries. The symbol is SHY. And GLD is the most liquid gold ETF.

I personally hold my gold in bullion coins and recommend you do the same. It's better and safer than the ETF. But for lots of people, the ETF is simply more convenient.

However you decide to take a position in gold, do it soon. I expect the divergence you see above – of U.S. debt decreasing in value, while gold increases in value – to get much bigger in the coming years.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

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