Bonds: Is it Time to Redefine the Concept of Safety?

Many investors are often tantalized by the concept of getting safety and regular income from bonds. Whether from the sacrosanct U.S. Treasuries, or the bonds from large corporations, there is a traditional expectation of minimizing risk while “maximizing” returns. In fact, many advisors often list high-grade bonds among “safe-haven” investments. However, the current market is changing some of those perspectives.

Time to Understand the Current Environment

The truth is that bonds are so varied and complex today that it is important to understand the type of bond being discussed to gauge their relative safety. Bonds are used by every government (national and local) and all types of institutions and businesses. They are a form of loan provided by investors of all types. Bonds are supposedly secured by some form of asset or form of income owned by those entities.

However, the ongoing and growing concerns over the global financial environment are creating an artificial pricing in even those bonds considered the safest, such as U.S. Treasuries. Particularly since the shock of the Brexit referendum, investors of all stripes are running to bonds as they seek some form of security for their assets.

The State of Bonds Today

Of course, the laws of supply and demand also play in the bond market, and this massive rush to bonds is upsetting traditional values in the market. For example, a recent analysis by Business Insider notes: ¹

• There is more than $13 trillion in bonds that are producing negative yields. ²
• U.S. Treasuries are being priced at the lowest levels ever recorded, and setting new lows with each auction.
• Corporate bonds are at the lowest levels since the Kennedy Administration.

Bill Larkin, manager of the fixed-income portfolio at Cabot Money Management notes, “When I see a good bond now, I have about four seconds to hit the buy ticket or it’s gone. That means the retail investor is going to be buying the issues that nobody wants to buy.” ³

Understand the Long-Term Picture of Bonds

One of the most difficult things for many investors to understand is that bonds are often affected disproportionately by near-term financial factors. Longer-term bonds are commanding prices that are not supported by their intrinsic value, making them a very expensive option for those seeking “safety.”

Summarizing a very extensive analysis of the current market, Francesco Garzarelli, one of the heads of the market and macroeconomic research teams at Goldman Sachs notes, “…bonds are expensive across the board, but especially so in the U.S.”

The fact that bonds are now considered “pricey” is made even more concerning when the real rate of return or yield on many of these “safe” instruments is now zero or negative. That essentially locks in a loss on the bond the moment it is purchased.

Finding Opportunity in Gold

While there is always a debate among experts about the relative merits of different asset classes, today’s economic environment sets some of those arguments on their head. When bonds no longer generate a real rate of return, the potential of gold shines anew, as recent activity indicates.

Additionally, many new buyers of gold are awakening to a reality that has supported the rationale for investing in gold for decades. The bottom line of all investing is to increase the net value of your portfolio. If the purchasing power of currency-denominated assets continues to fall, the real value of gold becomes readily apparent to even the most jaded skeptic.

Additional Sources