Zeev's Turnips Patch-No Politics (ZEEV)

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*** Waiting for the Interest Rate Boom ***


Waiting for the Interest Rate Boom

By Tim Wood
24 May 2005 at 10:29 PM EDT

NEW YORK (ResourceInvestor.com) -- Hard asset bulls returned to a canter on the final day of the New York Institutional Gold Conference, providing succour to gold bugs surprised by the earlier pessimism of Robert Prechter.

However, before tossing out some mildly raw meat, Richard Sacks of Brick Capital in Chicago reminded delegates of their pain – gold equities have retraced to values last seen in 2003 when the gold price was considerably lower than it is now.

The volatility has scared off many institutional investors, but Sacks says the sell down can be boiled down to three factors: the lack of anticipated profits, a rise in short-term interest rates, and the US dollar rallying on the back of sovereign spreads improving in its favour.

At the same time, the mass media had got hold of the weak dollar story with a Newsweek lede signaling a bottom in the currency’s slide. “It was a sure sign of overcrowding,” said Sacks.

He is not expecting gold to resume its upward run until the Federal Reserve stops raising interest rates. Like many presenters at the conference, Sacks says investors can count on the “debt monster” to interrupt the Fed’s current policy of incrementalism. At that point gold will resume its ascent, and he’s targeting 2006 for powerful gains as the US heads back into recession.

Apart from gold, Sacks is also very bullish on uranium though he warns to avoid producers, which his firm went short on recently.

Tuesday’s conference keynote speaker, Dr Martin Weiss, expanded on similar themes highlighting the “traumatic impact on interest rates” resulting from the second downgrade of General Motors debt. The sheer size of its book means that the market has suffered the equivalent of having 1 in every 10 dollars dispatched to the junk bond heap.

“There’s a massive rush to quality going on,” said Weiss pointing out the unusual circumstance of rising short term rates and falling long-term rates.

Weiss is convinced that an interest rate boom is in the offing as the Federal Funds rate remains below inflation. Negative real interest rates are a reliable indicator of firmer gold prices. The analog for negative real rates is “free money” which manifests in zero percent financings, multiple equity mortgages and general asset inflation.

He sees a firm parallel with September 1977 when inflation was 35 basis points higher than the Fed Funds rate.

“No-one had any inkling of what was to come. Free money was like a drug. . . soon the nation’s inflation monster will be back with a vengeance,” said Weiss.

He reminded the audience of the situation in the late 1970s when the Fed was pursuing incremental rate increases, but was eventually forced to overtake inflation with a single whopping 5 percentage point increase in the Fed Funds rate in January 1980. That took rates from 15-20% overnight, and capped a 15% increase in rates in less than three years.

Whilst Weiss is sure we’re in for another interest rate boom, he doubts it will exceed the 1980 highs. He sees a high range of 10-12%.

His confidence is borne of further contrasts with 1977. Then the budget deficit was $54 billion, or 3.1% of GDP. In 2004 it was $412 billion, or 4.5% of GDP which was more than a hundred billion better than early projections for a $521 billion deficit. The trade deficit 28 years ago was $27 billion, last year it was $617.7 billion.

“This is the great scandal of our time,” said Weiss, adding that back then the trade deficit amounted to one and a half pennies for every dollar of GDP. Now it is five and half pennies; a massive increase.

“Now there is triple the damage,” warned Weiss whilst also cautioning about the level of obligations accumulated by foreigners who are likely to slow or perhaps even stop their purchases of US securities.

Since the Fed will need to accelerate lending rates past inflation, Weiss believes gold will do very well along with oil and other commodities. He recommends avoiding financials and insurance stocks, anything tied to mortgage lending and derivative real estate bubble beneficiaries like construction firms and home improvement outlets.

Weiss is predicting a panic in the bond market, but believes there will be an opportunity to lock in safe high long-term yields for the next two or three decades.

Where Weiss was aligned with Prechter was in his fear of deflation for which he sees a strong likelihood once the interest rate boom is over.

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