Two early warning signs there’s a volcano getting ready to blow in markets

Like in nature, markets often give off subtle warning signs that something is amiss. Those signals don’t always imply a permanent regime shift, as true structural changes take years to build, much like pressure beneath a volcano. However, when the break finally comes, the eruption can be explosive and the damage catastrophic.

In today’s environment, I believe gold and sovereign bond markets are those early steam clouds. Gold has accelerated sharply, rising nearly 70 per cent over the past 12 months. Long‑dated bond yields, especially in historically low‑rate countries such as Japan, have also pushed higher and in some cases set new highs. Last week, Japanese 40‑year yields briefly surpassed four per cent, something previously thought impossible for a country long mired in deflationary pressure and driven by rapidly aging demographics.

In my view, the roots of this moment trace back to the post‑2008 period and the introduction of quantitative easing (QE). QE unquestionably saved the global financial system, but the problem is that it never stopped once the crisis ended. Each time markets wobbled, central banks stepped back in. The strategy “worked,” as long as bond markets co-operated and kept yields low.

Then COVID hit, and governments got a taste of unlimited fiscal spending. And like QE, they didn’t stop when the emergency ended. Instead, wartime‑like deficits continued, including in the U.S., where last year’s deficit reached six per cent of GDP.

The issue now is that central banks appear close to implementing yet another round of QE, not to stabilize markets but simply to absorb the massive issuance of government debt. That’s where the real danger emerges: currency debasement. When a central bank prints money to finance deficits, the purchasing power of that currency erodes rapidly. This is why a dollar today buys roughly 81 cents in Canada and 78 cents U.S. in America of what it did in 2019.

Fortunately, those who owned assets such as housing and equities were able to offset that erosion through inflation in those asset values. Those who held cash, either by necessity or choice, have borne the brunt of the affordability crisis and have been left way behind with no way to catch up.

Adding to this complication is demographics. A large concentration of those assets is held by aging baby boomers who may soon need to sell. But the next generations are unwilling — or unable — to take on heavy leverage at today’s higher rates. If the bond market continues pushing back, we could face the worst possible combination: falling home and stock prices in an environment of ongoing debasement.

This dynamic could intensify if global governments continue reducing their U.S. Treasury holdings and reallocating reserves into gold. Momentum is already building: Central banks now own more gold than Treasuries for the first time in three decades.

As an investor, doing nothing is not an option. Now is an ideal time to revisit your portfolio. Start by examining your government bond exposure, especially in jurisdictions such as Canada, where the federal government holds no gold reserves and where 10‑year yields near three per cent offer little compensation for the level of risk.