This week, gold briefly climbed above $2,000 per ounce. The precious metal is commonly thought of as an inflation hedge, but also serves a different function in times of financial stress. Gold can be a safety trade.

 

Gold is a highly speculative asset in the best of times. But, unlike bonds and stocks, it has one redeeming factor in times of economic slowdown, financial instability, and geopolitical tension. It does not carry the risk of an issuing entity collapsing, such as a bank or a government. There have been many examples of this throughout history.

 

The latest example was back in February 2022, during Russia's invasion of Ukraine. Gold spiked to $2,078 per ounce within the next month. Historically, gold has also functioned as an inflation hedge. In the aftermath of the Russian invasion, supply chain disruptions, especially in energy, food, and materials, pushed prices and the inflation rate higher. That aided and abetted the precious metals safety trade for a brief time.  

 

But gold's shine was diminished quickly when central banks around the world announced a tightening of monetary policy to combat rising inflation. Higher interest rates have always been kryptonite to the price of gold bullion. Gold bullion is stored for a fee, and that fee is based on the going rate of interest. Gold prices fell to $1,618 by November 2022. Higher interest rates ultimately trumped the safety trade.

 

As interest rate fears rose in 2023, gold continued to fall. It was largely dead money since the start of this year, trading at $1,832 per ounce just a month ago. The collapse of Silicon Valley Bank and Signature Bank in the U.S., and Credit Suisse's forced demise in Switzerland last week suddenly changed the calculus in gold investing.

 

As investors worried that money deposited in banks was suddenly at risk, they rushed into gold. The largest exchange-traded physical gold fund, for example, added 20 tons of gold to its ETF in a week. That was the largest single inflow of demand for gold since the Russian invasion. At the same time, yields on interest rates plummeted, as bond prices also jumped. The combination of lower rates and elevated risk provided a double boost to the gold price.

 

Investors need to realize, however, that in any safety trade, there is an implied risk premium that is embedded in the asset, in this case, the value of gold. The greater the risk, the higher the premium. Market Risk Advisory, a Japanese-based research firm, figures that based on historical interest rates, the price of gold should currently be trading around $880 per ounce in a riskless world. That would mean that the present risk premium, plus the impact of the decline in yields, is more than $1,000 per ounce of gold.

 

This week, due to the actions of the Federal Reserve Bank, the U.S. Treasury, the FDIC, as well as similar institutions in Europe, the fear of the investing public had been somewhat reduced. As a result, stocks went up and yields on most government and corporate bonds fell. As that happened, the price of gold fell more than $42 per ounce or 2.12 percent in just one day.

 

Does that mean that if the perceived risk of additional problems in the banking sector diminishes, the price of gold will fall further? It should--all else being equal — but all else is never equal.

 

Many believe that it will take some time before the banking sector returns to normal. U.S. Treasury Secretary Janet Yellen has said that she has not considered or discussed "blanket insurance" to U.S. banking deposits without approval by Congress. As such, some risk premium will likely remain in the price of gold going forward.

 

There is also the question of interest rates. The fear of financial contagion could deter further interest rises by the Fed in the months ahead. In addition, if the Fed feels they have tightened enough to slow the economy and reduce inflation, that would relieve the rate pressure on the price of gold. The direction of the U.S. dollar is also important to watch since gold has an inverse relationship with the greenback. The bottom line, there are more than enough reasons that could keep gold in play in the months ahead.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The recent calamity in the banking sector is complicated, but one issue stands out. Even the safest of investments have risk.

 

Understanding the relationship between bond prices and interest rates is extremely important. Bonds, overall, are considered safer investments than stocks and history indicates that bonds have been less volatile than stocks most of the time. However, when interest rates rise, bonds can get hurt for a variety of reasons, and credit risk is at the top of the list.

 

Credit risk refers to the possibility that a corporation (or a government entity) could default on a bond they have issued. That happens when the issuer fails to pay back the principal or cannot make interest payments. Normally, U.S. government bonds, called Treasuries, have lower credit risk. Presently, however, even Treasuries have some credit risk. If Congress refuses to increase the debt limit by this summer and allows the country to default, the consequences for our government debt could be grave.

 

However, all bonds have interest rate and duration risk. Bond prices and interest rates move in opposite directions. As interest rates fall (as they have for much of the past decade), the value of fixed-income investments rise. Since last year, interest rates have risen substantially due to the Federal Reserve Bank's efforts to combat inflation.

 

This is where duration risk comes in. Let's say you have long-dated U.S. Treasury bonds that do not come to maturity for 10, 20 or even 30 years from now. If you hold them to maturity, you will receive your principal investment back plus whatever interest rate coupon was promised. However, if rates rise (as they are doing now), and for whatever reason, you sell your bonds before their maturity date, you could end up receiving less than what you paid for your bond.

 

In general, duration is expressed in terms of years and generally bonds with long maturities and low coupons have the longest duration. These bonds are more sensitive to a change in market interest rates and thus are more volatile in a changing interest rate environment. Over the last year, the Fed has increased interest rates at its fastest pace in recent history, which has caused the price of bond holdings to decline substantially.

 

Enter the Silicon Valley Bank (SVB) stage left. SVB, like most banks, relies on a mixture of short-term and long-term financing. The short-term side largely consists of customer deposits. A bank's assets typically consist of long-term loans that get paid back with interest over time as well as bonds the bank purchases that pay out over the term of the bond.

 

More than half of SVB's assets at the end of last year were "safe" bonds issued by the U.S. government or federal mortgage institutions, which they had purchased before the Fed's tightening policies began. Safe from default risk, maybe, but not from the climbing interest rates. And most, if not all, of those bonds, were low coupon, and long-term in nature — a classic case of duration risk.

 

The nightmare that all banks fear is a bank run. Think of "It's a Wonderful Life" and George Bailey's Building and Loan, a small community bank in Bedford Falls. Depression-era depositors, fearing for their financial lives, rushed to take their money out of Bailey's bank. Few depositors understood how credit and loans work. They thought their money was simply sitting in the safe. George tried to explain the concept but ended up making good for his customers by giving them his honeymoon money.

 

In the case of SVB, the same thing occurred, although, unlike George Bailey, the management of the bank could not make their depositors whole. For most depositors, there was no need to stand in line. A simple electronic transfer via computer transferred millions out of the bank in seconds. As a result, SVB was forced to sell bonds at a loss to satisfy depositor demands until it couldn't. The rest is history.

 

What may some readers have in common with SVB? In today's market, there has been a mad rush to capture higher interest returns after years of an interest rate famine. The U.S. Treasury markets, especially on the short end, have seen yields of 5 percent or above for six-month, one-year, and two-year notes and bills.

 

Putting excess cash into these high-yielding instruments and intending to hold them to maturity is a reasonable financial strategy. However, if you need to sell them to raise cash for an emergency may leave you open to losses. Remember that a bond's yield is not the same as the interest rate coupon promised at maturity on that instrument.

 

A six-month note may have been issued with a fixed 1.75 percent coupon, however, because of the Fed's recent interest rate hikes, the price of the note has declined. As it does the yield has climbed. 

 

You are in effect, buying that note at a discount to the original purchase price. If you hold the instrument to maturity, you will receive the full-face value of the note when it was issued, plus the coupon. That is ideal. But remember, yields will go up and down over time in an inverse relationship with the instrument's price depending on market conditions. If things change and you need to sell early, you may face the same issues as SVB. That is the risk you are taking when you buy Treasuries.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Coats to protect your pets from severe weather, or orange safety vests during hunting season are fairly common but today, the fashion industry has embraced the concept and taken pet clothing to new heights.

 

Canine couture is a big business. The pet clothing business market is growing by 4.5-5 percent per year, and by 2030 should exceed $9.15 billion annually, according to Brainy Insights, a research firm that tracks sales in the pet industry. The U.S. accounts for 30 percent of global sales and hit almost $2 billion in 2022.

 

I divide the pet clothing market into two segments: clothes that are practical, and clothes that are indulgent. Practical items have a surprisingly long history. Ancient Greek armies, for example, would fasten leather boots on their horses to protect them from the snow. Greyhound and whippet owners have long-used coats to keep their pets warm in cold weather. Police horses and dogs are often dressed in fluorescent coverings.

 

Certain kinds of animals benefit from wearing coats, boots, and rain gear. Dogs that are old, thin, tiny, elderly, have thin coats, or are ill often need protection from severe temperatures, rain, and snow. Therapy jackets and those that are used for medical conditions such as hip dysplasia, and canine arthritis or to protect an incision from the aftermath of surgery are useful protective clothing. 

 

Our dog, Atreyu (a poodle), has an insulated coat, which came in handy this winter in sub-zero temperatures. He also wears an orange vest during hunting seasons. Boots, on the other hand, while useful, (due to the heavy use of salt in our area during snow season), are a no-go. As it is, this dog is such a drama queen that he balks and runs when he sees his coat come out of the closet.

 

Canine couture, however, is an entirely different world. It is here that I believe that our tendency to anthropomorphize our pets has run rampant. Anthropomorphism is the tendency to map human traits and emotions onto animals. For many, assigning human characteristics to our pets helps them to make sense of the world around them.

 

For others seeing our pets as human-like fulfills a social need. They believe that dressing dogs, cats, and other animals in trendy, high-fashion clothing allows the pet and the owner to stand out and gain social status among certain groups. In short, you are dressing your pet for success. Doing so today, however, may cost you more than dressing yourself.

 

A deluge of high-end fashion houses has jumped into the pet clothing business with specially designed pet collections. Dior, Prada, Versace, and Fendi, among many others, offer everything from designer purses to matching people/pet outfits for all occasions.

 

Their success has spawned all sorts of marketing efforts. Tika, an Italian greyhound model, has over a million Instagram followers and has been a big celebrity at New York City's Fashion Week. Boobie Billie, an Italian sighthound/Chihuahua, another Instagram favorite, has launched a luxury clothing line. Dozens of lesser-known pet celebrities are modeling for various brands and establishing followings on social media. Dog agencies are springing up and signing these four-legged stars to contracts. The rates vary per dog, but these new influencers have millions of followers.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

It may not be the 1970s when interest rates offered investors double-digit returns, but 5 percent on a six-month U.S. Treasury bill isn't bad.

 

We last saw that kind of return in 2007. To be sure, the rate still comes up short when compared to the 6.4 percent annual rate of inflation right now. Yet inflation is declining and has fallen for seven months in a row.

 

The dilemma investors faced last year was that there simply was no haven to park their cash. The stock market was treacherous and falling. The Federal Reserve Bank was hiking interest rates on an almost monthly basis to combat inflation, and most bond prices were falling almost as much as equities.

 

This year the stock market rallied for the first month and a half, but many investors have now turned less bullish. Over the last week or so, the bond market has begun to price in at least three more interest rate hikes in the first half of the year. The strength of the economy and a slight uptick in some of the most recent inflation readings has been behind the increase in bond yields across the spectrum. The rush for cash and cash alternatives has suddenly taken a front seat in preferred investments.  

 

At this point, investors can earn 5 percent or more on the six-month Treasury Bill, which is one of the safest debt securities in the world. Certificates of Deposits (CDs) are yielding 4.8 percent for the same three-month maturity. Buyers need to go out to one-year CDs and beyond to capture an equivalent 5 percent yield or above.

 

At this point, the three-month Treasury bill at 5.07 percent has a yield that is now competitive with far riskier assets like stocks as measured by the S&P 500 Index. Readers need to be aware that these "riskless" securities are not quite what they seem. Treasuries, while backed by the full faith and credit of the U.S. government, do have interest rate risk. If interest rates climb higher, the price of all notes, bills, and bonds declines. The longer dated the bonds are, the deeper the decline when rates rise.

 

However, there may be another, upcoming glitch in the risk profile of the six-month bill's perceived safety. Last week I wrote a column on the present political debate on raising the debt ceiling. The Congressional Budget Office is now projecting that the U.S. government will run out of cash to pay its bills sometime between July and September. The six-month U.S. note will mature sometime in that time, which puts it squarely in the crosshairs of this partisan battle. It is conceivable that some investors, wary that there may be a government default, are steering clear of the note, while others are willing to take the risk.

 

However, I noticed that both the one-year (5.08 percent) and 18-month (5.01) U.S. Treasury notes are now trading above 5 percent. That indicates to me that the present rise in yields is more about higher interest rates tethered to the Fed's intent to keep interest rates higher for longer than it is about fears of a debt crisis.

 

The question is whether yields on other government debt will follow suit.  Recently, weekly bill auctions have drawn strong demand. However, auctions this week indicated that bond investors, fearing future rate increases, were demanding higher yields. The U.S. Treasury sold $60 billion of three-month bills, $48 billion of six-month bills, and $34 billion of one-year paper as well as auctions of two-, five-, and seven-year notes.

 

For those who are waiting out the volatility in the stock market in cash, short-term U.S. Treasuries could be an interesting purchase right now.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

In a few months, be prepared for politicians of both parties to turn up the heat as the June debt ceiling deadline approaches. Normally, the stock market responds with increased volatility. The question is should investors pay attention at all?

 

That may sound like heresy given that we are talking about the full faith and credit of the United States of America. If the government defaults on its debt, the global repercussions of such an event would be momentous. Currencies would plummet, stocks would crash, and interest rates would soar. Armageddon would reign, or at least that's what is predicted to happen, but no one knows for sure because the U.S. has never defaulted on its fiscal responsibilities.

 

"But there could always be a first time," you might say. And that is exactly why politicians can hold the nation hostage to advance their political careers while making outlandish demands that they know will never become law.

 

Legislation establishing a debt ceiling was passed in 1939. Since then, Congress has revamped the limit 100 times since World War II. Back then, Congress was more heavily involved in federal borrowing, as opposed to today, where the focus is solely on spending. For those who are unaware, the debt limit is not in the Constitution, nor in any of its 27 amendments. It is at best, a statute (law) that gives politicians a chance to disrupt, lie, evade, and create headaches for the country whenever they please.

 

The biggest joke of all is that the debt limit reflects money that has already been spent and is now owed to others. Has it ever stopped Congress from spending more money? No, at most it just redistributes spending into different areas such as more in defense, less in social programs, or vice versa for a short time. Given that serves no policy purpose whatsoever, why have one?

 

Because it is an immense bargaining chip for some.

 

Fear of default gives leverage to those who have none. All that is necessary is to threaten while stretching out any compromise agreement to the last possible moment. By doing so, they are counting on the financial markets to become unwilling negotiators on their behalf. Those leading the opposition to raise the debt limit receive enormous coverage by the media.

 

Demands for programs and legislation, no matter how outlandish, that have nothing to do with the debt limit give politicians a national forum and unearned legitimacy. Debt limits become the saving grace for the economy and the nation for a few short months. However, when they finally do vote to raise the limit, few hear about it.

 

Unfortunately, all this rhetoric seeps into the national consciousness. In a recent poll by the Economist, only 38 percent of U.S. adult citizens (and only 20 percent of Republicans) think Congress should raise the debt ceiling.  Given those numbers, it is no wonder that agreeing to pay the debts we already owe has become an extremely partisan affair.

 

As for those on the other side of the debate, in this case, the Biden administration, there are a variety of avenues available to them if they choose to take them. The U.S. Treasury, for example, could stop making some payments (Social Security and Congressional salaries for example), while coupon and principal payments continue to be paid in full out of tax revenues.

 

A more drastic direction would be to keep the debt ceiling in place, but the Treasury borrows more money anyway arguing that failing to do so would be unconstitutional under the 14th Amendment. They could also mint a trillion-dollar platinum coin that could be used to fund new spending, including debt service on the national debt. The problem with pursuing any of the above would be that it would almost guarantee that the Republicans in Congress would have no incentive to vote to raise the debt ceiling.

 

Democrats have learned some hard lessons by giving in to debt limit demands in the past. Back in 2011, during a clash between former President Obama and the Republican Tea Party, the administration spent months negotiating without success.

 

At the eleventh hour, an agreement was fashioned by Mitch McConnell and some Democrats to avoid a debt default. But the credit markets, spooked by the close call and partisan behavior, downgraded the country's credit ranking for the first time, which resulted in raising the costs of our future borrowings.

 

The facts are that those who threaten default are part of the partisan political process, but some person, group, or party that causes a debt default will go down in flames along with the economy and nation. Politicians know this, or if they don't there are still enough level heads in Washington to get the deal done.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.