Chart Presentation: Bond Perspective

Let's start with the bond market today.

Oct. 28 — Treasuries rose as the Federal Reserve asked bond dealers how asset purchases will influence yields, encouraging speculation policy makers remain open to large acquisitions as they try to spur the economy.
Benchmark 10-year notes advanced for the first time in seven days, ending the longest stretch of losses since 2008. Two-year yields dropped the most since the Fed said a month ago it was set to provide “additional accommodation” to help the economy.

In yesterday's issue we noted that PIMCO's Bill Gross had suggested that the Fed's QE2 program may well signal the end of the 30-year bond bull market. While that may prove to be true we are going to view the bond market in the context of the bullish trend. In other words if we can make the case that bond prices will decline within a positive trend then the argument becomes somewhat more persuasive if the trend actually turns bearish.

Below is a rather large chart comparison of... the price spread or difference between 10-year and 2-year T-Note futures and an annual percentage Rate of Change indicator for the U.S. 30-year T-Bond futures.

The 10- 2 spread is a somewhat convoluted way of showing the trend for bond prices. The spread rises when bonds are stronger in price and declines when the trend is negative.

The arguments are as follows. First, the bullish bond price trend creates a rising trend for the 10- 2 spread. Second, within the context of the rising trend each time in the past 20 years that the 10- 2 spread has risen above the channel top it has marked a peak for bond prices. Not always immediately, of course, but within the ball park. Tops were made in 1993, the end of 1995, late 1998 during the Asian crisis, 2003, and the end of 2008.

Each time the 10- 2 spread rose above the channel top the next bond price low was made when the year-over-year change for the TBonds reached -15%. This has tended to happen 12 to 15 months after the peak for the 10- 2 spread.

The point? In a world of 4% 30-year Treasury yields a price decline of 15% on a year-over-year basis suggests that there are better things to do- even in the face of QE2 than buying long-term Treasuries.

Equity/Bond Markets

So... why are we so hyped up on trying to find the top for gold prices?  A number of reasons come to mind including our rather obsessive need to catch market turns but the real driver can be seen in the chart below.

The chart compares the S&P 500 Index with the ratio between the U.S. 30-year T-Bond futures and gold futures from 1980 to the present day.

Over the past year or so we have commented on occasion about the support level for the TBond/gold ratio. In general it has held at .10 meaning that the price of gold has tended to resolve towards 10 times the price of the U.S. 30-year T-Bond futures. With the TBonds currently  trading just over 130 this puts a ‘ball park' price for gold near 1300.

Going way back in time we can see that the 1980 low for the ratio was somewhat lower than .10. From this low the ratio rose steadily for 20 years along with the U.S. equity markets. From 1980 into 2000 the SPX tracked upwards as bond prices rose relative to gold prices. Fair enough.

Over the past decade the SPX has held below the peak set in 2000 at close to 1550. With the SPX flat-lining the markets shifted gears as gold prices rose relative to bond prices. In other words the offset to no net growth in the major U.S. stock indices has been a rising gold price.

Our fascination with this chart begins with the idea that trends tend to run decade to decade. Obviously the Japanese stock market has been trending lower for 20 years so it is not a given that a correction will simply run for a decade but with the TBond/gold ratio very close to the levels that marked the beginning of the trend in 1980 our interest is definitely piqued.

Our thoughts on this chart are as follows.

First, even in a flat trend it is possible and perhaps even likely that the SPX will re-test the 1500 level over the next year or so.

Second, as long as the TBond/gold ratio remains within the downward sloping channel the markets are ‘saying' that the SPX is still in a flat trend.

Third, if a time comes when gold prices start to decline in earnest to the point where the TBond/gold ratio rises far enough to move up through the channel top then the message appears to be that the SPX should be ready to move on to new highs.

If this proves to be true then the key to a move through resistance for the SPX into a fairly lengthy bull run should come from weakness in the gold price. With gold still stronger than the TBonds this time has not yet arrived but as we push through 2010 and into 2011 it may well be time for a new trend to begin. If this trend means something north of 1550  for the SPX then look for confirmation from a weaker gold futures price.