 Rising Global Interest Rates Point
to Good Times for Gold
By Doug Casey & Bud Conrad
The
International Speculator
Jul 21, 2006
Interest rates around the globe are going up because inflation
and default risk are going up. Lenders want to be compensated
for the chance they might not be repaid. When the currency seems
to lose purchasing power, lenders want to recover the loss by
collecting more interest, and borrowers are willing to pay it,
in anticipation of even more currency depreciation.
In the case of government debt,
default risk is minimal since, if need be, the debtor government
can always print what it owes. So rising interest rates on government
debt are a clear reflection of rising inflationary pressure.
And that's unquestionably a positive for gold.
The chart above shows that
interest rates on 12-month government debt have been on the rise
for 3 years, an indication of rising inflation expectations consistent
with the strength in gold and silver over the same period.
This chart and the next should
debunk the theory you may have heard that rising interest rates
are bad for the price of gold. The reality is quite the opposite.
The chart above tracks an average
of yields on 12-month notes issued by the governments of the
United States, Japan, Canada, Australia, New Zealand, United
Kingdom, Switzerland, Sweden, Denmark and the EU.
The above green line shows
what the price of gold would be in 2006 dollars as corrected
for inflation measured by the CPI.
A key measure of interest rates
is how high they are after subtracting inflation. By that standard,
they aren't high now. Even though rates have risen, inflation
has also risen, so the effective real rate is still low. But
higher inflation is going to lead to higher rates.
In the past 12 months, the
CPI has risen 4.2%, and it is running at a 5.2% annual rate so
far in 2006, accelerating to a 5.7% annualized rate over the
last 3 months. Yet, with rates on short-term Treasuries around
5%, they are still close to zero after inflation.
And real interest rates are
almost certainly lower than they look. To avoid reporting high
inflation, the Commerce Department has been cooking the books
over the last few years. One example is that it uses residential
rents in its CPI calculation rather than the cost of houses,
simply ignoring soaring housing prices. But from here on, that
accounting slight of hand may have the opposite effect, as rents
continue moving up and housing prices stall. There is more: the
rental equivalent rate included a deduction of the utilities
included in rent, so as energy prices rose, the rental equivalent
rate was calculated to be lower than the actual rents. We could
write a book on government deception, but the bottom line is
that inflation is higher than the government indicates. Going
forward, this means that one of the most watched measures of
inflation has some big rises already baked in. When the general
public is shocked by higher inflation numbers, interest rates
will reflect that.
When viewed from this perspective,
the recent short but sharp fallback in metals has little importance
for investors. Gold ran ahead of itself, over-leveraged traders
profited and then panicked, and the price took a dive.
But there's been no change
in the big picture for gold and silver. The world continues to
be awash in a sea of debt, with sea levels still rising from
the rivers of spending by the U.S. and other governments. The
debt-heavy governments are egged on by organized constituencies
and prevented from cutting spending - even if they ever wanted
to - by statutory entitlement programs, entrenched bureaucracies
and, in the case of the U.S., the war against Islam.
In fact, the situation is much
worse - "intractable," as Paul Volcker recently
put it - than it was leading up to gold's bull market in the
1970s. Back then, the economy wasn't perched on a housing bubble
perched on a pin. Back then, the world's central banks still
sought dollars. Back then, you didn't have hundreds of trillions
of dollars in exotic derivatives.
And back then foreigners, many
of them now truly hostile to the U.S., weren't holding trillions
of dollar assets as reserves.
What To Do and When To Do
It
While it is heartening - speaking
strictly as a speculator with a current interest in the 10-to-1
leverage offered by high-quality but low-capitalization gold
shares - to see gold's price rally in the face of yet more turmoil
in the Middle East, or when North Korea shoots missiles and talks
about immolating its neighbors, it is important not to expect
too much, too fast.
Even as we write, the war rally
has stalled, with traders selling gold due to the laughable contention
that the U.S. dollar is a "safe harbor" currency, and
because of the misperception that higher interest rates are bad
for gold.
The fact of the matter is that
we are still in the traditionally slow season for gold, with
Indian wedding season buying of gold still a month or so away.
And while the now inevitable monetary crisis is coming soon,
it likely won't come in the next month or two. Meaning the summer
will continue much as it has, with weak volumes in the gold stocks
and interim price swings as gold positions itself for a breakout
this fall.
Therefore, the best advice
I can give for the next couple of months is to buy gold and quality
gold stocks only on dips, and not on bomb-inspired rallies.
In time, you'll know when the
pieces have fallen into place for the next phase in this bull
market of a lifetime. When it happens in a year or two years
from now (I doubt it will be longer than that), inflation will
be soaring, traditional equity markets in ruin, bond holders
left holding empty bags, and gold will be trading well over that
of the peak in the previous secular bull market. If you don't
buy now, you may not regret it for the next month or two. But
you'll regret it soon. And for the rest of your life.
Between now and then, by being
disciplined and only buying the quality gold and silver stocks
on the dips, you'll have multiple opportunities to make life-changing
returns.
About the Authors
Bud Conrad holds a Bachelor of Engineering degree
from Yale and an MBA from Harvard. He has held positions with
IBM, CDC, Amdahl, and Tandem. Currently, he serves as a local
board member of the National Association of Business Economics
and teaches graduate courses in investing at Golden Gate University.
Mr. Conrad, a futures investor for 25 years and a full-time investor
for a decade, is also a regular lecturer for American Association
of Individual Investors. In addition he produces original analysis
for Casey Research, including unique charts and research on the
economy and investment markets.
Doug Casey, Chairman of Casey Research, LLC.,
is a best-selling author, international investor and entrepreneur.
He travels the world looking for exceptional opportunities in
real estate and undervalued companies in the natural resource
sector (precious metals, oil and gas and more). The author of
four best selling books, his Crisis Investing was #1 on
the New York Times best-seller list for 29 consecutive weeks.
Each month he provides subscribers to his publication, the International
Speculator with his best ideas on the world's best precious
metal investments. For a risk-free trial membership, click
here.
-Doug Casey
The International Speculator
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