In recent months, we have seen stocks go down, Treasury bonds go up (meaning interest rates are falling) and gold prices reach new highs. For any believer in efficient-market theory, this begs a question. What scenario explains all three price movements?
The most puzzling aspect of the recent trend is seeing both gold and bonds rising at the same time. Gold is historically seen as an inflation hedge, so record gold prices suggest higher inflation, which would in turn suggest higher interest rates, which means lower bond prices. So what are gold and bonds doing moving up together?
Several possibilities suggest themselves:
1) The market is rational, and market participants are pursuing their interests in a sensible manner. The U. S. is going into a double-dip recession followed by a few decades of low growth (the Japan scenario), while gold is going up because the Chinese are getting rich and buying lots of jewelry.
2) The market is rational, and market participants are pursuing their interests in a sensible manner. The U. S. is Japan. Gold is rising because the Israelis are about to take out Iran’s nuclear program, or a similar geopolitical calamity is in store.
3) The market is irrational, and market participants are frequently both uniformed and foolish. Bonds are going up simply because the average investor is scared, of inflation along with everything else, and does not understand the inverse relationship between bonds and inflation. Gold is going up because Glenn Beck still has followers who expect hyperinflation and Armageddon.
4) Something else. I’d love to know what you think. The best (most amusing) scenario that explains the facts wins a bottle of wine of my choice. Call it Occam’s Corkscrew.