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 red 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 Volker 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.

© 2006 Doug Casey
Editorial Archive

DOUG CASEY is the author of Crisis Investing, one of the few financial books that made it on the New York Times Best-Seller list… and spent 26 weeks there, ranking #1. Due to his contrarian views, Doug is a well-known and popular speaker at investment conferences. He is also the editor and publisher of the International Speculator, one of the world’s oldest and most respected monthly newsletters dedicated to gold and silver stocks poised to produce profits of 100% or better in 12 months or less. Read on for his outlook on Gold’s Corrections or click here to learn more about the International Speculator.


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.