“ALICE laughed: ‘There's no use trying,' she said; ‘one can't believe impossible things.' ‘I daresay you haven't had much practice,' said the Queen. ‘When I was your age, I always did it for half an hour a day. Why, sometimes I've believed as many as six impossible things before breakfast.'”

Occasionally investors can believe impossible things, as they did when dotcom stocks with no profits were valued at more than flourishing multinationals. But they can also believe in incompatible things, which is even more striking.

Take the recent surge in the gold price to a nominal record of $1,251.20 an ounce. Owning gold is traditionally seen as offering protection against inflation. And inflation is very bad news for owners of government bonds. But the ten-year Treasury bond yields just 3.3%, a level that is towards the low end of the historical range.

There is something remarkable about this combination. You would expect the performance of gold and Treasury bonds to be inversely correlated. When gold was at its real all-time high in 1980, the ten-year Treasury-bond yield was 10.8%. Fixed-income investors had suffered years of negative real returns in the 1970s.

Adding other assets to the mix does not solve the dilemma. David Ranson of Wainwright Economics, a consultancy, has examined how gold and corporate-bond spreads have worked as a guide to asset allocation since 1978. The gold price is an indicator of inflationary pressures. Bond spreads are an indicator of growth: investors are happy to take the risk of owning corporate bonds, and spreads come down, when the economy, and thus business revenues, are strengthening. Over the year to end-May gold was up by 25% while corporate-bond spreads narrowed sharply. History suggests that such a combination should be bad news for government bonds.

So what explains the current situation? Both gold and Treasury bonds could be classed as “safe haven” assets that investors buy when they are risk-averse. But if not inflation, safe havens against what? Investors did buy gold in 2007 and 2008 when they were worried about the health of the banking system. Some thought that physical gold would be a lot safer than a deposit in an insolvent bank.

In recent weeks there has been a rise in both LIBOR (a gauge of banks' borrowing costs) and the credit-default-swap spreads on bank bonds (the cost of insuring against default risk). But in neither case are things as bad as they were in the autumn of 2008, when Lehman fell and no bank seemed safe. Gold was only around $900 an ounce during that burst of risk aversion.

Of course, safety is relative. The finances of Germany and America look better than those of Greece or Spain. Some say banks have been demanding German bonds as collateral for financing and refusing to accept the bonds of other euro-zone countries. This could be holding down the yields of the most liquid markets.

But that raises a related point that investors seem to be overlooking. Many people argue that Britain and America, for example, are in a better position than euro-zone members like Greece because they can depreciate their currencies. That may be good news for the governments concerned but it is bad news for investors. It does not take much depreciation to wipe out an annual yield of 3-4% a year. For hedge funds and other investors which will not be holding bonds to maturity, currency movements may determine their return. They ought to demand extra yield as compensation for the risk.

Then again, private investors may not be setting the price. Government-bond yields are being held artificially low by central-bank actions. In some cases (the European Central Bank or the Bank of England) this is because of direct purchases of bonds. In others it may be because central banks have rigged the yield curve, holding short-term rates artificially low and inducing banks to make money by buying longer-dated government bonds. A third factor is that Asian central banks are big buyers of Treasury bonds as part of their exchange-rate management policies, and are relatively indifferent to future returns.

Perhaps the explanation is simpler. Martin Barnes of Bank Credit Analyst, a research firm, points out that the direction of official policy (low rates, quantitative easing, big deficits) looks inflationary but the economic fundamentals (a big output gap, sluggish credit growth) look deflationary. Faced with this dichotomy, investors who buy both Treasury bonds and gold are not displaying cognitive dissonance. They are just hedging their bets.





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