The Rude Awakening
Wall Street, New York
Friday, July 21, 2006 ------------------------- - Interest rates, CPI, yield curves...it just doesn't
get any sexier than this,
- What do global trends mean for your dollars and the
price of gold?
- Plenty of graphs and squiggly lines, all the market
moves and more...
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Rising Global Interest Rates Point to Good Times for Gold
By Doug Casey & Bud Conrad 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. [Ed. Note: 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: International Speculator:
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