The Next Golden Move
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March 01, 2011
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March 01, 2011
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Long-term rates on US Treasury Bonds are rising. It's imperative you know why and how this will affect your portfolio.
First off, let's be clear that short-term US interest rates aren't going anywhere. Bernanke knows it would crush the rebounding economy and, much like the ever expanding deficit, plans on dealing with it later. Putting off deficit cuts and putting off raising interest rates are key reasons why debt in the US has spiralled out of control.
As long as the unemployment rate stays above 8%, raising interest rates will not be considered. Rising short-term interest rates is one of the only things that could bring down gold. It gives us confidence in gold knowing the US government can't afford to raise rates because it can only stay above water and function with continued low interest rates. Remember, the Federal Reserve is now the largest holder of US debt. This is extremely bullish for gold as we expect short-term interest rates to remain at historic lows for some time.
If the Fed delays raising interest rates too long and fails to reign in the money supply, a more extreme scenario will arise. Our team at Pinnacle has been preaching for years that the only way out of this extreme debt is for the US to inflate its way out - destroying the value of the dollar. This is good for commodities and even better for precious metals.
Long-term US Treasury Bonds have spiked recently amidst panic and turmoil in the Middle-East and Northern Africa. The US Dollar, believe it or not, is still considered a safe haven for many foreign central banks. Central banks have been gobbling up US debt in recent weeks. On Thursday, February 24, 2011, the government sold $29 billion in seven-year notes at a high yield of 2.854 percent. Keep in mind, the Federal Reserve bought $5.01 billion that same day in notes set to come due in 2012 and 2013.
Earlier in the week, the U.S. auctioned off $35 billion of two-year Treasury notes. The two-year security yielded 0.70 percent. Below are the current rates as of February 24th 2011.
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There is nothing abnormal about the above chart - except for the fact short-term interest rates have been hovering around 0 for a record period of over 2 years (long-term rates are always higher - this is to account for medium levels of inflation).
Why have longer term rates been rising recently?
Central banks are beginning to realize that the long-term outlook of the US dollar is bleak. There is a rising fear amongst global buyers of US debt that inflation is taking hold. Central banks around the world are demanding better rates to cover higher expected levels of inflation.
This is extremely bullish for the long-term value of gold. This gold bull-market is not something that can be smoked out in a few months. It has taken several years for countries like the US to work themselves into such dire fiscal circumstances. Even as you read this, the US is squirming and fighting its way into more debt by threatening default if the ceiling is not raised.
The debt ceiling is nothing more than the federal government's credit line. Congress gives the final nod on whether or not it will be raised. This is why Geithner and Bernanke have been making threatening remarks for weeks attempting to scare the public and politicians into raising the debt ceiling - yet again.
Congress has increased the debt ceiling numerous times over the past hundred years. It most recently increased the borrowing limit by $1.9 trillion on January 28, 2010, from $12.4 to $14.3 trillion. Congress has raised the debt ceiling six times in the past three years amidst the financial crisis and recovery. Less than 3 years ago the debt ceiling was under $9 trillion. And people wonder why gold is at $1400 an ounce. It will be going a lot higher than that in the years ahead.
We already know with absolute certainty that the US deficit will increase over the next few years. The budget has already been laid out for us. We just need to react appropriately by insuring our wealth in assets that will appreciate in an inflationary environment.
The debt ceiling exists to give foreign investors confidence the US is a reliable borrower and will repay its loans. Every time the debt ceiling is raised, that confidence is diminished.
Rising long-term treasury rates are a clear sign foreign investors are losing confidence in the US and its currency. Our team believes the US debt ceiling will be increased on or before March 4th, which is the deadline.
It all comes down to the US government's ability to pay the interest on its debt.
Low interest rates is what allows the government to borrow money cheaply and keep payments low (rob Peter to pay Paul). The US has no chance of defaulting if the government keeps interest rates at rock bottom prices.
With interest rates at these artificially low levels, the annual interest on the $14 trillion debt is just over $300 billion - easily payable as long as the economy keeps expanding and rates don't rise.
This could change if foreign investors become worried about their chances of getting paid back by the US government. The alternative is a safer or more profitable place to invest their capital than the United States.
Lately, the Fed has been buying a large percentage of US Treasury bonds, but foreign central banks have been responsible for the majority of buying. With that stated, it wouldn't take much to startle foreign banks and cause them to discontinue purchasing US Treasury bonds or demand higher short and long-term rates. What will most likely occur is investors from around the world will demand an increasingly higher return on their money which we've begun to see in long-term bond sales. If that happens, it will be much more difficult for the US to meet its debt obligations.
The false demand that exists for US debt has been created by the Federal Reserve, both in the actual purchasing of US debt and the many efforts to stimulate the economy.
The economy has been putting out some great numbers in recent months. This is easy to do when interest rates are low and money is not just easy to come by, but basically free to borrow. Read "Money for Nothing and Debt for Free" to learn more about how some American companies have taken advantage of the unprecedented low interest rates.
The Bulls Are Back
The Hedge Funds don't seem to mind this cheap credit as they have recently borrowed the most since 2007 to purchase US stocks. Hedge funds increased their net leverage in January to the highest level since October 2007. The markets went on to rally to unsustainable levels prior to the crash of 2008. This is yet another reason why we believe the markets have higher to climb.
As debt in America continues to rise to unsustainable levels, the factors of low interest rates and an ever expanding money supply will lead citizens, private investors, hedge funds and every type of money managing entity into assets that will appreciate. No one will be left on the sidelines as cash, and by that we mean the US dollar, has become one of the riskiest assets in the world. Stocks, and in particular, well positioned junior gold stocks, will have a run more widespread than most of us can imagine.
I urge our readers to remember the simple rule that inflation is your best friend when commodities comprise your portfolio.
Disclosure: I have no positions in any stocks mentioned
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