As Treasury Yields Fall, Gold and Silver Stocks Could Shine
New York (June 2) Following a miserable fourth-quarter swoon, the stock market shone brightly in the first quarter. The broad-based S&P 500 wound up advancing by just over 13%, marking its best start to a new year since 1998. Better-than-expected corporate earnings, strong U.S. economic growth, and a temporary cessation of trade-war tariffs between the U.S. and China all provided the spark that eventually lifted the market to record highs.
But, if there's something you learn as a longtime investor, it's that there's always some event or statistical figure that can rain on the stock market's parade at a moment's notice. Right now, that worrisome figure is the precipitous decline in U.S. Treasury yields.
A small fanned pile of $100 bills lying atop a larger fanned pile of U.S. Treasury bonds.
Image source: Getty Images.
U.S. Treasury yields are plunging, which is an ominous sign for stocks
As of this past Wednesday, the closely watched 10-year Treasury yield, which plays a big role in helping to dictate where mortgage rates will head, hit a 20-month low of 2.21%, which is down 32 basis points from this time last month, and 57 basis points from the year-ago period. Since bond prices and bond yields move inversely to each other, it simply means that investors have been actively buying bonds since November, pushing the yield on the 10-year Treasury note down just over 100 basis points from an intraday high of 3.24% on Nov. 8, 2018.
What's the big deal if bond yields drop, you ask? The problem ties into risk.
Ideally, if the U.S. economy were viewed as strong, and corporate earnings were motoring along, we'd like to see investors selling bonds and putting their money to work in equities (i.e., the stock market). Although stocks offer considerably greater risk than Treasury bonds, the aggregate return over the long run is much higher with equities. The fact that we've witnessed a precipitous decline in bond yields since November, and therefore pretty significant bond-buying, suggests that Wall Street and big-money investors are very concerned about the stock market and aren't willing to risk their capital, despite the historically superior return of stocks relative to bonds.
Gold and silver stocks could soar if Treasury yields continue to sink
Interestingly enough, though, declining Treasury yields aren't all bad news for equity investors. In fact, these falling yields could light a spark under precious metals, setting the stage for a gold and silver stock rally.
To be clear, there are no shortage of factors that influence the spot price of gold. Everything from physical demand to intangible fear can influence the price of the yellow metal, and in turn pull silver along for the ride.
But what can arguably be described as the biggest factor in the ascent or decline of gold is U.S. Treasury yields -- the reason being that gold is a physical asset that doesn't have a yield. If you buy a gold ingot or bar, you're not going to receive a dividend, and you're certainly going to be exposed to downside risk if the spot price of gold declines. Meanwhile, Treasury bonds are backed by the full faith and credit of the U.S. government, meaning a bondholder is practically guaranteed to be paid the stated yield at purchase.
When bond yields are high or rising, more investors will choose to buy bonds over gold for their safety and certainty. But when Treasury yields fall, the return potential of gold becomes more attractive. This is especially true when T-bonds approach, or fall below, the 2% yield level. At this point, inflation tends to cancel out most (or all) of the nominal gains that bond buyers would generate in a given year from interest. That's pretty much where we're at right now. Investors could purchase a T-bond with the expectation of making virtually no real money, or take a possible, but nowhere near-guaranteed, cue from the bond market that turbulence could await the stock market and buy gold or silver stocks instead.
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