Thanks to Cumberland Advisors for putting this nifty graph on their website. What do we make of the recent divergence between gold and the 10-year Treasury yield? Gold has had a sustained rally since 2001, when the Fed really started cranking the monetary/credit stimulus machine. Liquidity seems to have finally spilled into gold, not just the fixed income markets, where it has been poured for the last thirty years. A "relative value"-minded trader might expect the historical relationship to snap back into place and the spread between spot gold and the Treasury yield to narrow. This would suggest a short position in gold and Treasuries. Although we might be tempted to call this spread a mispricing, we are reluctant to short gold when central banks are still pumping liquidity up (see note at the bottom of this). Rather, we think the spread will only close by Treasuries selling off and "catching up" with gold.
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