Gold Among Negative-Yielding Bonds

The amount of global debt with negative yields soared to $16 trillion, or more than 25 percent of the market. This number has nearly tripled since October 2018. In July, even the 30-year German government bonds went negative for the first time ever, while Nordea Bank, a leading Danish bank, said it will begin offering 20-year fixed-rate mortgages with zero interest, as well as 30-year mortgages at minus 0.5 percent. Isn't this economic madness? And what does it imply for the gold market?

Normally, instead of spending it themselves, lenders offer the borrowers money, in return receiving the promise of being paid back, and interest. Negative bond yields seem to turn the credit relations upside down. But after closer examination, it turns out that the negative yields do not necessarily deny the laws of economics. The key to understanding it is grasping that negative yield to maturity does not mean negative coupon payments. Negative yields imply losses for investors who purchase these bonds and hold them until maturity, not for all bond investors.

More specifically, the negative yields may result from specific government regulations that, for example, require pension funds to invest a certain amount of funds in government bonds, no matter the yield. Investors may also desperately need to purchase a given bond in order to close a certain transaction. And inflation-indexed securities may turn negative when investors fear high inflation and expect not even these instruments to keep abreast with inflation.

However, the main reason behind negative bond yields is the flight to safety. Investors that have large sums of money and who do not trust the banking system would prefer buying government bonds as a safe place to store their wealth. After all, the odds of Germany defaulting on its debt obligations are quite low.

Another reason is speculation on exchange rates and bond prices. If investors anticipate the appreciation of the given currency, they may accept small negative yields. If one fears, for example, the abrupt depreciation of the Argentinian peso, or the breakup of the euro area, paying a small fee to hold Swiss franc does not seem to be irrational. Similarly, investors can purchase bonds with negative yields if they expect they could sell them at higher prices to other investors. Given that the central banks has been buying enormous amounts of debt since the Great Recession, the strategy of purchasing bonds at prices that seem "foolishly" high and reselling them later to "a greater fool" makes actually perfect sense.

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