Gold and silver to outperform US bonds and equities!

Over the last three months, both the US bond and stock markets have rallied strongly. The bond market rally is driven by investors' expectations of a weaker economy and interest rate cuts by the US Federal Reserve Board later in the year or in early 2007.

As a result, investors have pushed the yield on 30-year US Treasury bonds down from 5.20% in June to currently a tad over 4.70%. At the same time, investors have driven up the US stock market to a more than five year-high. Investors clearly expect continuous corporate profit growth and declining inflation rates.

I have to say that an investor buying 30-Year US Treasury bonds as a long term investment (say, for holding his position to maturity) must have a lot of faith that, for the next thirty years, the US rate of inflation will never exceed more than 3%. This is an assumption which, given the history of the Fed and its money printing bias, is most unlikely to materialize.

Sell US equities and bonds

In fact, I am leaning increasingly towards the view that both buyers of bonds and equities could get it badly wrong. The bond buyers because inflation will continue to increase despite a weaker economy and the stock buyers because corporate profits will begin to disappoint!

Therefore, given the over-bought condition of both the US stock and bond markets and a rather poor technical picture (the new high list is not expanding sufficiently), I would certainly not rule out a more meaningful downside correction starting soon, or even a nice little crash. In addition, the US dollar has begun to weaken significantly against the Chinese RMB, which could add to inflationary pressures.

So I am far less optimistic after the recent strong US stock and bond market performance than the complacent buyers of bonds and stocks. There are many factors affecting US financial assets that could in future have a negative impact on their pricing.

Crash coming?

And, while I am not ruling out some further strength over the next few months, we also need to recognize that both equities and bonds are very overbought right now. Therefore, I would either postpone any new buying or implement some selling. A better buying opportunity is likely to present itself at the end of October or in November.

Since emerging markets have a close correlation with commodity prices, and since the correction of industrial commodity prices, which began in May, is likely to last longer, we would also postpone any buying in emerging markets.

In fact, for the intermediate term US equities could out-perform emerging markets. Also, Asian stock markets are likely to out-perform the markets of Russia and Latin America.