China's Gold Bugs Are Spooking The Bond Market

Call it the Chinese connection. According to economist David D. Hale of Kemper Financial Services Inc., participants in currency and financial markets would be well advised to keep an eye on Chinese economic policy.

The reason: Hale says it was strong demand for gold from China's overheated economy that sparked the interest of investor George Soros and led to a runup in gold prices that spooked the bond market. And he claims it was fears that the gold price surge and bond market drop could trigger a flight from dollar assets by Japanese investors that led the Treasury to abandon its hands-off policy and intervene in currency markets in early May to prop up the dollar against the Japanese yen.

What's more, since the surge in gold prices was followed by some bad U.S. inflation numbers, it has reinforced the view that gold prices are an uncannily accurate signal of underlying inflationary pressures. Thus, "gold, which is really reflecting demand from Chinese buyers rather than U.S. inflation, is likely to impact bond-market sentiment even more in the months ahead," argues Hale. And both the Treasury and the Federal Reserve will have to adjust their policies accordingly--until China acts to curb its double-digit inflation and the gold purchases it is fueling.

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