This is What a Bond Bubble Looks Like

This is What a Bond Bubble Looks Like

{Part of a presentation made to Seabridge shareholders at the June 29, 2016 Annual Meeting}

As 1990 began, the global bond market totalled just $10 Trillion. By 2000, it had trippled to $30 Trillion and by the end of 2014, it had more than trippled again to almost $100 Trillion.The fastest growth was in the Developed world outside the U.S., and in Emerging Markets which went from zero to more than $14 Trillion in

There are two very disturbing facts behind this bond chart. First, since 1990 the bond market has increased in size by 10 times. In the same period, the world economy, measured in current dollars, has grown from a GDP of $22.5 Trillion to just under $80 Trillion, an increase of only 3.46 times. In other words, bond market obligations grew three times faster than the economy that must service and repay that debt.

Here is the World Bank’s chart of world GDP in current dollars.

At the same time, the interest rate on this debt is at an all-time low (prices are at an all-time high). The chart below of U.S. 10-year Treasury yields since 1990 makes this point very clearly. While this trend makes the debt easier to service at the present time, the bond market is highly vulnerable to a decline in price/increase in yield.

The most fragile part of the bond market is the Emerging Market (EM) where governments and corporates have borrowed in U.S. dollars to take advantage of liquid markets and lower rates. The borrowers earn their income in weaker currencies, often from commodity-based economies. As the world becomes more risk-averse, EM debt becomes less liquid, the dollar tends to rise against the currencies of the periphery countries and commodities are typically pressured downward. Much of this EM debt is on the books of European banks who provided the funding out of the Eurodollar market. Perhaps this helps to explain the remarkably poor performance of European banks stocks in recent weeks?

Central banks are going to make every conceivable effort to prevent the bond bubble from bursting. We believe that more monetary stimulus is on the way to keep this bubble intact, including more negative yields to maturity on sovereign debt and more negative interest rates for depositors. Normalization of interest rate policy by the Fed is a fantasy, in our view. We believe gold is the indispensable defence against these developments.