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Interest rates today are so low globally that gold is now able to reflect fiat inflation. Also, the behavior of interest rates today is a major factor affecting the gold markets. The speculators are merely riding on the back of the monetary forces driving gold’s price increases. They are adding volatility, but are not the primary driver of gold’s price spikes. The Middle East tensions are also exacerbating gold’s price rises. But interest rates are the key. First, let us discuss what gold purchases are really for: Now gold is money, and today, real money is at a premium. You don’t make money by keeping money. You make money by investing it. The problem is, how do you invest in a gold coin? You buy it, buy its permanent purchasing power, and if it appreciates, you gain later by purchasing other things at cheaper prices vsvs gold. Gold sitting in your pocket does not pay dividends, interest, and so on. It is not supposed to do that, never has and never will. This is a key idea supporting why interest rates are now dominating the gold markets. We are now in mostly negative real interest rates world wide. Now safe money is going into gold. Gold and gold stocks are kept for financial protection, they are definitely not speculation or investment vehicles. If you buy a gold stock on the prospect of a new gold ore discovery, that is investment, and you can win or lose. But if you buy a staid gold company like Newmont Mining, you are buying gold assets they have as financial security. Gold bullion is also bought for financial security. Do not regard many gold purchases, either stocks or the bullion as anything but financial security assets. If you read the multitude of financial writers who say gold is an investment, you are probably barking up the wrong tree. But this perception is very very common, even in the gold bug community. I get very tired of seeing promises of 100, 200 or 300% returns on a gold stock prospect. Gold is really not about speculating intrinsically. This kind of promotion just does not sound right to me, nor does it fit the intrinsic reason for being in precious metals. With gold rocketing right now, you need to understand this distinction I am making, because many of you are going to be tempted by the speculation promotions coming out now about the gold markets. Speculators are not driving gold now, …this is: Low world interest rates driving gold prices The reason gold is moving strongly today is not because of mere fiat inflation. Gold is moving today because there is a very great need for real money. Not money that has a value associated with rising or falling interest rates. Paper currencies values are driven by interest rates. Real interest rates are what drive gold’s fiat prices in any currency, and the world today (everyone) has negative real interest rates. So, gold rises. The fact that there is tremendous fiat inflation in the ranges of 8% per year world wide is very significant, but only in the sense that the world productive economy cannot now sustain interest rates at a level of real positive levels. When you buy gold bullion, you are completely immune from negative real interest rates. At this time, interest rates are a primary determinant of the metals markets. The low yields world wide are forcing people into the protective aspects of the metal markets. The speculators are merely riding the back of this trend. It is possible for nations to inflate their currencies, but maintain real positive interest rates as well, and in that case, gold languishes. In the 1990s, we had that situation in the United States. In the 1980s, Japan had that situation too. They vastly inflated the Yen, but gold languished in Japan, as people there put all their ‘cash’ into the stock and property bubbles there. The point is, you can have significant fiat inflation and still have gold languish. But when you have fiat inflation combined with falling real interest rates to a negative level, then gold takes off. I have heard many times that ‘inflation is purely a monetary phenomenon’. Gold writers repeat this phrase, but don’t take into account that this has to be combined with a picture of what real interest rates are doing via a currency. To say that just creating new currency is inflation, is really only half of the picture. What we have today is world negative real interest rates combined with fiat inflation in the 8% range, and that is going to drive gold to levels that we have not seen since the old fiat dollar crises in the US during and after the Civil War here in the 1800s. If you want a really interesting study, go read about the US bank note failures in the 1800s. There were multitudes of these competing bank notes and they failed often back then. The USD crisis in the 1970’s and early 80’s was only a small opening act of what is to come. What happened in the 1800s is more of what is likely to come upon us. The producing world cannot now sustain real positive interest rates, and so together, they are going to have economic and monetary crises to come soon. If they were able to get their producing economies back into paying real positive rates, the price rises of gold would be forestalled. That is not going to happen on this go around. The world cannot and will not be able to get back to real positive interest rates before a depression. It is not going to be avoided this time, all positive economic statistics out now regardless. Back in the times of the competing fiat and bank note crises in the 1800’s in the US, there were many banks who issued their own ‘gold backed’ notes. Most of them eventually collapsed because they could not resist making more notes than gold on hand, they practiced a fractional reserve banking policy where some gold was kept for redemptions. But many notes were circulated in excess of the actual gold on hand. In the ETF and quasi gold phenomena I see today, I get the distinct impression that the same basic animal is rearing its head. As long as that animal does not become a hydra, all will be well with these quasi gold mechanisms. But I don’t like what the eventual outcome will be. I do not like quasi gold holdings, IE financial gold, ETFs and so on. However, let’s get back to the discussion of why the gold market is going up so fast right now. It is axiomatic that, when economies are doing well, and interest rates stay at or above a real return of 6%, gold languishes. In these cases, as long as there is demand for the fiat regime in question, and there is sufficient real interest gained, gold is not preferred as money. It is in these times that it languishes, loses some of its historical purchasing power, saved for later when there are the inevitable economic or political or war crises. Gold has moved rapidly this year to about 600$. It broke over 500$ in December 2005, and has had barely a pause in relentless rises, sometimes with a drop of up to 50$. But within several weeks, gold has recovered almost immediately this year, and pushed to higher levels. There is a very strong array of gold bullish forces today, not like 2005, or 2004, or even the late 1970’s and early 1980s when gold spiked to 870$ an ounce in 1980’s dollars. These include low interest rates world wide combined with over 8% fiat inflation. I wish to point out that gold’s present rises are for monetary reasons in the sense that people are seeking the real money aspect of gold now. The main force today is that interest rates are almost negative world wide. Surely, the speculative forces such as hedge funds and ETFs, options, and so on with gold, are adding great fuel to the fire. But I say again, what is driving gold now is not investing motivations per se. What is driving gold now is that there is an emerging desire for real money, even if it pays no interest. IE there is a strong emerging desire to get money parked in real money, gold, and to forego the desire for an interest or investment return. The speculators are merely riding the back of the preeminent driving force to buy real money. The rising tensions in the Middle East are also very gold bullish, and are part of the reason for flight to safety gold, i.e. Gold as real money, immune from market forces. Again, I say that you should be buying gold and gold assets for monetary reasons today, and if you are doing this, you will escape the inevitable problems and risks that come from speculating. If you are primarily seeking ‘investment’ reasons, you are also going to get false signals from the gold markets. If you are buying gold and gold related assets for ‘investment’ purposes, you are likely to find it not acting the way you think it should. The investors are only riding on the back of the monetary forces raising gold’s prices and greatly increasing volatility, and are not driving gold primarily. The fact that there is now great investor interest in gold vehicles is beside the point. They are putting money into the gold markets because the gold markets are going up continually now. Only when the gold market is seen to really begin to take off do we see this kind of public interest, hedge fund interest and so on in gold. Gold is moving up regardless, and the speculators are just adding a lot of volatility. This is one aspect of this gold market that everyone should be very careful of. In any case, I would say, that we are at the crux of a very big bull market in gold. That sounds funny, doesn’t it, because the whole gold community has been writing about the ‘gold bull’ market for the last 4 years. (Remember, when I say gold, I mean all precious metals and this is always the way I address the precious metals, when I say gold I mean them all.) The fact of the matter is that we are not presently at a gold bull market like we saw in the early 1980’s. I wrote several issues ago that gold at 500$ an ounce is only one third the real dollar price it was in 1983 dollars. Back then, the prices of many real things were about one third the price they are today, I used pickup trucks, gold, oil, and housing in that calculation. See the newsletters and public articles talking about inflation adjusted gold and silver prices. For gold to be at the point it was in the early 1980’s, when it hit 870$ then, it would have to be three times that now, ie about 2500$. First, we are now seeing a gold market driven by negative real interest rates world wide, combined with world fiat inflation in the range of 8% per year. This is the primary motivator, and is why gold prices today in any currency react very strongly to minute changes in the interest rate environment. And the currencies that have central bank interest rate increases, even minute ones, strengthen significantly the very day of the event, and stay strong as long as there is a perceived rising interest rate environment. This is why, as long as the US is perceived to be in a rising interest rate environment, the USD stays strong. There are a lot of people who in 2005, and now 2006, have called for drastic drops in the USD, have gotten their heads handed to them in the Forex markets. Contrarily, whenever the US economic statistics are bad, the dollar suffers at times, because of the perception that the Fed is going to cease raising US interest rates. Follow the news of events that suggest the Fed may slow its interest rate increases, and that very day, see the USDX drop significantly. To further illustrate why interest rates at this time are a primary driver of gold prices, look at the recent activity (discussion only) by the Bank of Japan, BOJ, and interest rates. First, at the end of last year, the BOJ started hinting that it intended to raise rates from zero to some small positive increase. The value of the Yen immediately rose, even when the BOJ subsequently said that it is not quite ready to enact that increase in interest rates. The Yen has risen whenever there is speculation the BOJ will raise rates, even when stories are out that the impeding interest rate increase will be only one tenth of one percent! (ten basis points). That is how powerful the interest rate multiplier for currencies is right now. Just mere perceptions of interest rate decreases or increases greatly affects currencies, even when the magnitude of those increases is virtually nothing! The US is using 25 basis point moves, and Japan is indicating they will use 10 basis point moves. These are not enough to slow an economy rapidly, rather they assure the maximum growth of the asset bubbles before they pop However, there is so much new mortgage money, leveraged stock positions, trillions of dollars of new derivatives, that when there is even a minute change in interest rates, currencies rise or fall that day up to 1 to 2 percent, while the interest rate change that caused that 1 to 2% change in a currency is only .25% or .1%. Interest rate changes cause currencies to change by over a factor of 4 now for the US and Japan. Today, there is an article out about why the USDX dropped over 1 point. The key reasons given are that China is looking again at buying less US treasuries, and here it is- US interest rates are expected to peak soon, at least according to some of the Federal Reserve policy makers. The markets are reacting to the fact that the US may stop raising interest rates soon, and just a mere change of 25 basis points, or .25% of less increase resulted in a drop in the USDX of over 1 point as of this writing, Monday, April 17, 2006. Interest rates are determining the prices of gold and the USD right now, and this is going to continue, not only for the USD, but for the YEN and the EURO. Here is a link to a pertinent article… In it, notice that China’s comments on US treasuries are noted. Also note, that members of the US Federal Reserve are considering stopping the increases in US interest rates. That is what is forcing the USDX down today. Gold rallied almost ten dollars on this news today, Monday, April 17, 2006. IE, the fact that the FED would consider stopping the interest rate hikes, and then the China comments, again about buying less US treasuries. “Sentiment
toward the dollar also took a hit after an article in The Wall Street
Journal said not all Federal Reserve officials are convinced that much
more monetary tightening is required, traders said.” © 2006
Christopher Laird CONTACT
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