We might as well clear away a bit of smoke and get right to the point. The thesis that we are currently working on argues in favor of a very strong recovery in the financials and an equally significant decline in gold prices. It includes ongoing dollar strength, at least some amount of weakness in the BRIC themes, downward pressure on commodity prices from lower metals prices, a continuation of the movement of money away from the major oil stocks, strength in the tech sectors, and at least an improvement in the relative strength of grains prices. There are a few holes in the thesis and most definitely a number of issues that may turn out to be contradictory but that is how it looks at the moment.

Below we return to the chart that we showed yesterday of the yield spread or difference between 30-year and 10-year U.S. Treasuries. We are using this particular yield spread instead of the more standard 10-years minus 3-months simply because it avoids the inclusion of almost 0% short-term interest rates.

Further below we feature a chart of the ratio between the share price of Japan’s Mitsubishi UFJ (MTU) and the gold etf (GLD).

The charts have been offset or shifted by 3 years. We have lined up the peak for the banks vs. gold ratio (MTU/GLD) in 2006 with the high point for the yield spread in 2003. The argument is that when the yield curve reaches its most positive it pushes growth into the economy which leads to a peak in cyclical asset prices about three years later. Conversely when the yield spread gets to its lowest point it is acting as an economic brake. Inverted yield curves in 2000 and 2006 preceded equity markets bottoms by three years as well.

The charts suggest at the least the possibility that the crises that we waded through in 2007 and 2008 were the result of the sharp decline in the yield spread through 2004 and 2005. On the other hand the sharp rebound in the spread coming out of 2006 and into 2009 argues for a reversal of the previous pressures.

The point is that the end result of the falling yield spread from 2003 into 2006 was downward pressure on the banks and upward pressure on gold prices. Our thesis is that the trend will reverse over the next few years leading to surprising strength in the major banks and equally surprising weakness in gold prices.

Equity/Bond Markets

The argument that we are making has to do with ‘offsets’. An offset is when one market goes down because another one is going up. Or vice versa.

Below is a chart of the ratio between the Bank of Montreal (BMO) and the Nasdaq Composite Index from 1998 into 2003.

While there is no direct link between Canadian banks and U.S. tech stocks the trend from 1998 into March of 2000 favored selling the banks to buy the Nasdaq. Money was moving away from the interest rate sensitive sectors and towards the dollar as the sheer momentum of the tech rally pushed interest rates higher. The chart shows that one day everyone hated the banks and loved the Nasdaq while the next day the trend reversed completely.

We have argued in the past that markets or sectors that dominate into the first year of a new decade tend to weaken through the ‘2’ year. While the major equity indices did not bottom until late in 2002 or early in 2003 the ‘bear market’ was more of a relative strength adjustment. In other words for as negative as it proved to be for the Nasdaq it was more than equally positive for the Canadian banks.

Below we have included a comparison between gold futures and the ratio between the Bank Index (BKX) and the S&P 500 Index (SPX).

There are probably three ‘drivers’ that we can think of supporting or pushing gold prices higher. The weak U.S. dollar, the pressure on the banks, and extremely low short-term interest rates.

The argument is that the stronger the banks (BKX/SPX ratio) the greater the downward pressure on gold prices. In terms of the other two ‘drivers’ we will suggest that the chart below helps to support our view. The swing upwards in the U.S. dollar three months ago marked the start of a rising trend for U.S. 3-month TBill yields. We grant that a move up from .02% to .135% is not exactly a knee-buckler but, then again, we are still early in the process. If the banks are better, the dollar is rising, and short-term interest rates have at least stopped falling (near proximity to 0% will tend to do that) then one by one the arguments supporting gold prices are falling by the wayside.