The bond market is shouting at you. It began when the 10-year Treasury note traded below a 2% yield in late summer. If you were alive the last time that happened, you qualify for Medicare.

Throughout the liquidity crisis of 2008, rates on that benchmark bond didn't get that low. Not when Lehman collapsed, not when the U.S. economy was losing 600,000 jobs a month, not when the Treasury was "forced" to guarantee even commercial paper issued by corporations for money market fund holders.

If you heard the bond market's cry, did you know what it was trying to tell you? As every major government bond market around the world rallies, and stock markets reflect uncertainty, the message is clear to bond mavens: Global deflation is that shadowy shape dead ahead of the world economy, and it threatens to tear a hole below the waterline.

I know some of you are thinking, "Wait. The gold market is saying inflation, not deflation."

That's not how I see it. I see the negative real rate on cash parked in T-bills as a clear indication that prices are going down, not up. As more market participants equate gold to another currency, they are simply diversifying their cash into that currency along with dollars, pounds, Swiss francs, yen and euros. If you consider the total bullion supply, the allocation into gold is less than $10 trillion worldwide, a small fraction of the total debt held as investment.

The key to understanding the mixed signals of gold and the bond markets is to realize it makes no sense to look at one market such as gold and conclude there is inflation ahead, while ignoring other larger markets telling the opposite story. It also bears stating that markets are complex, but prices are simple. Even with deflation lowering prices and wages in general, prices will rise in some markets. With gold, the deflationary forces that are moving the bond markets are being overshadowed by a strong trend that has nothing to do with the push-pull of inflation.

I believe the rising price of gold is telling us that its relative value as a currency is perceived to be strong enough to overcome the general decline in prices for big-ticket goods and wages in the real world. But bond investors believe those wages and goods will continue to decline in price. Otherwise, those investors would buy the goods - houses, real estate, oil, etc. - instead of bonds. There is downward pressure on the price of gold due to deflation, but it's more than offset by the metal's non-sovereign currency nature.


Howard Hill recently worked as a portfolio manager at Babson Capital. Previously, he was vice president of mortgage finance at UBS Securities and later founded Deutsche Bank Securities' securitized products department.

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