The Precious Metals
Versus Interest Rates & Gibson's Paradox

Douglas V. Gnazzo
Honest Money Gold & Silver Report - snippet
Apr 14, 2006

Introduction

The present paper is going to concentrate on the precious metals almost exclusively. We shall also look at interest rates in the bond market, as we believe there is an important relationship between the precious metal markets and the bond market.

The bond market dwarfs all other markets in size except the forex market, which is the largest market in the world. We are talking about the U.S. bond market - not the global bond market.

The U.S. bond market backs Federal Reserve Notes - our paper fiat currency. The issuance of U.S. Treasury Bonds/debt is the fodder from which Federal Reserve Notes rise.

These are the same Federal Reserve Notes that we exchange with China and Japan to purchase their exports to us with - which they in turn use to buy U.S. Treasury debt. It is a most unique and fascinating arrangement to say the least. It reminds us of the word: symbiotic - as with a parasite and its host.

Interest Rates

U.S. Bonds - or obligations of debt as it were - pay interest rates to the holders (buyers) of the debt. This is another fascinating arrangement: the government sells debt that others purchase by lending Federal Reserve Notes to the government.

These are the same Federal Reserve Notes backed by the same Treasury Bonds. They are the same Treasury Bonds the Fed uses to create Federal Reserve Notes with.

If you can follow that, you are doing quite well - as it still seems incredibly unbelievable to me - and God knows I have tried to understand it. Sometimes I wonder if mere mortals can understand it.

Conundrum

As we have discussed in Gold Wars: Gibson's Paradox & The Gold Standard and other papers - there is a relationship between interest rates, bonds, and gold. What that relationship is depends on when you are looking at it.

Before 1995, when interest rates went down and money supply was easy - the price of gold would rise. Interest rates and gold moved opposite to one another. Once the economy overheated the Fed would raise interest rates in response to rising price inflation. Higher interest rates would slow the economy down, and with it the price of gold.

Suddenly around 1995 this relationship reversed: as interest rates went down the price of gold went down with them. This anomalous conundrum had all but the wisest of monetary wizards wondering what was up. One thing was certain: it was not the price of gold.

Why do we mention this arcane topic, arguably best left for the new world order architects of structured finance? Because suddenly interest rates are rising and so is the price of gold. It appears that Gibson's Paradox still lives on - at least it would seem. However, appearances can be deceiving.

Before we show a chart of presently rising interest rates, we want to first show a longer-term chart of interest rates. It shows the relentless and prolonged period of falling interest rates the Fed has engineered.

As the above chart clearly illustrates - the Fed has been on a campaign to continually lower interest rates in what appears to be a Sisyphean slope to Hades. Now it appears that the slope is about to be broken. A change in trend may be about to occur - or is it?

The next chart shows the recent rise in interest rates associated with the ten year Treasury note. Ten-year yields have breached the 5% level for the first time since 2002.

The Jokester

The Jokester loves to play jokes. He enjoys confusing others by employing tricks of all persuasions. His favorite is the art of illusion.

How does one go about catching the jokester? The best way to catch him is by thinking as he does, and using that to turn the tables.

We have said and we still say - the Fed does not want the long end of the bond market to experience rising yields. If the bond market gets into trouble - the real estate market will not be far behind.

The real estate market is the crazy glue that is holding the house of cards together. Even Mr. Magoo does not want to prick the housing bubble, which is teetering on top of the debt bubble.

Somebody Is Wrong

Before 1995, if interest rates started to rise - gold would go down. Conversely, if interest rates went down, gold would go up. Gold and interest rates had an inverse relationship, they moved in opposite directions.

This is fundamentally understandable. Gold is real money. Paper fiat debt-money is just what the name says: debt. It is not real money. When interest rates go down - bonds go up in value.

Bonds are another form of paper debt, so it makes sense that if paper debt obligations are going up in value, then real money that is not debt, i.e. gold, would go up in value.

At least it made sense until 1995. Suddenly the inverse relation turned 180 degrees. As we have seen by the above chart of interest rates - yields kept going down - relentlessly.

The price of gold should have been going up; instead, it kept going down - relentlessly. If ever there was a conundrum, this was it.

Now that interest rates are going up, according to pre 1995 parameters, gold should be going down - instead it is going up. According to post 1995 parameters gold should be going up and it is.

One of the two would appear to be wrong: either gold or bond yields. However, perhaps there is more to all this than meets the eye at first blush. Perhaps either the pre or the post parameters of the relationship between interest rates and gold are wrong.

Intervention

What happened in 1995 that turned the interest rate/gold ratio upside down? Intervention 21st century style is what happened. Derivatives are what happened. Structured finance is what happened. Suddenly black was white and white was black.

The Red Queen didn't know what to do. She said to go ask Alice, when she's ten feet tall. And how happy were the people - when they printed them all: tens, twenties, hundreds, and even thousands of thousands stacked so tall.

It was intervention by the Fed and other central bankers that affected the market to reverse a long-standing inverse ratio between gold and interest rates. Lending support were the mega international players: the World Bank, the IMF, and the BIS.

... Read the full report on Doug's website. pdf

-Douglas V. Gnazzo
email: Douglas V, Gnazzo

Douglas V. Gnazzo is CEO of New England Renovation LLC, a historical restoration contractor that specializes in restoring older buildings that are vintage historic landmarks. He writes for numerous websites and his work appears both here and abroad. Just recently he was honored by being chosen as a Foundation Scholar for the Foundation for the Advancement of Monetary Education (FAME).

In March 2006 Douglas V. Gnazzo started his own Honest Money Gold & Silver Report website. Read the Open Letter to Congress.

©2006 Douglas V. Gnazzo. All Rights Reserved.

321gold Inc