Since Monday, there has been unusual activities in the bond pits as if a big change is imminent. This indicates that there is a distinct possibility that safe haven buyers of bonds may suddenly realize their errors and immediately flee into gold and silver. Considering the massive scale of the bond pits, this rush entrance into gold and silver may be a sight to behold.

Nice day for the DOW - VHF

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A warning from the US bond markets

By Dominic Frisby Oct 15, 2008

MoneyWeek

Amid all the turmoil in the markets this last fortnight, there was a piece of eyebrow-raising action that passed under most people's radar. That action was in the US bond market.

Normally, when stock markets decline, you get a corresponding rise in the bond markets as investors flood to this perceived safe haven. Bond yields then fall sharply.

However, last week the opposite happened: yields shot up and bonds fell. What's more, as the stock markets rallied on Monday, bonds continued to fall. This isn't the kind of thing I usually write about, but the wider implications could be very significant…

Why the recent fall in the US bond market is odd

Let's start with a daily chart. As you can see, the fall in the US bond market has been quite dramatic – so much so that the 200-day moving average (blue line) has been smashed and that most of the gains we've seen since July have been given up.

A chartist would say that this is a market that is 'rolling over after a failed retest of the highs':

This makes some sense. Given that over the past few weeks we have seen the US announce that it was nationalising Fannie and Freddie (effectively its entire mortgage industry); bailing out its biggest insurance company; injecting hundreds of billions of dollars into banks; and injecting hundreds more billions of 'liquidity' into markets (whatever that means), you'd expect some investors to think that they might not want too much money in US government bonds. But for bonds not to rally after a 1,000+ point decline on the Dow is really very odd.

So what might it all mean?

Well, we could be seeing a return of the infamous bond vigilantes, described by newsletter writer Richard Russell as "the bond people who are like bloodhounds when it comes to inflation… when the bond vigilantes smell even a hint of inflation, they head for the exits, meaning they unload their bonds."

Inflation. Could this fall in bonds indicate that, after this period of deflation that we seem to be in, during which we are seeing falling asset prices in just about every class, the massive global attempts to reflate economies using 'all the tools available' will put knock deflation concerns out of the picture and put inflation back on the map in a big way?

This is all beginning to look like one of the greatest gladiatorial contests in the history of economics. In the deflation corner, we have potentially the greatest contraction of credit ever. In the inflation corner we have the largest concerted government bail out/injection of capital ever. The audience watches with bated breath to see which will be the eventual winner, while the cross-fire wipes out just about everyone's net worth.

Why you must hang on to your gold

The only way to protect yourself is with your shield of safely-stored gold, the only really safe haven there is. The bond market is the biggest market in the world. If money floods out and heads for that other perceived safe-haven of precious metals, we should see big rises. The gold and silver markets are much smaller and such an influx of capital should send them sharply higher.

If the bond markets collapse, the wider consequences will dwarf those of the US property market. A collapse could even mean a run on the dollar, which really would be run-for-the-hills-with-canned-goods time. Then you'll really need your gold. Real inflation is frightening stuff. Anyone who thinks it isn't a big deal might want to look at Jens O. Parsson's Dying of Money: Lessons of the Great German & American Inflations , (Wellspring Press, 1974). Here's a quote to get you thinking:

"Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle.

"In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still-larger government deficits, and still-roaring money expansion, now accompanied by soaring prices and ineffectiveness of al traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation."