We live in a strange world - the 10 year US Treasury is trading with a 2.63 percent yield. The market is presuming that there will not be much inflation in those ten years. However if there is deflation (as per Japan) then the 10 year will wind up being a very good investment (see my blog post on Japanese bond yields from the perspective of a Japanese household).
At the same time gold is appreciating very sharply - from $950 per oz to $1250 in the past year - and from $800 two years ago or $450 five years ago. On the face of it the gold price is predicting inflation.
Try as I may - I can't see any reason why both those prices are correct. I have long held the view that prices are mostly sort-of-rational - and that finding patent contradictions in pricing should be rare - because - if you can find them - there is usually a way to make money from them. But this looks wrong.
So either there is a theoretical way in which both these prices can be correct or even my weak version of the efficient market hypothesis is spectacularly wrong. But finding the way in which both these prices are correct is taxing my ingenuity.
My first question thus is can anyone tell me why these prices could possibly be consistent? Is there a rational reason why the bond market is pricing low inflation and the gold market seemingly pricing high inflation? Does anybody have the ingenious world view in which both these prices are correct?
The second question is more mercenary. If this really is as irrational as it looks what is the trade? What is the set of transactions I can place in financial markets which should make me money? My gut reaction - being a short-seller - is to short both the long bond and gold - but there are some awful tail-risks with that trade. For instance suppose money becomes suddenly near worthless - a Zimbabwe outcome. Then the gold price goes to the moon - and I have to return it - so I lose badly. And the bonds were a wonderful short in that I just made a lot of dollars - but the dollars are suddenly alas also worthless - they don't solve my problem of being short gold.
So - dear readers - thoughts?