After a "rocky" start to the Treasury's quarterly refunding on August 5 - when the "bid to cover" ratio on the three-year paper was a woeful 1.32:1, the Dow tanked 150 points, and Treasury yields blew out across the curve - the rest of the auction went off without the sky appearing to even move, let alone fall. In fact, the only big mover on the week was Gold, which rose $US 10.20, and Gold stocks, with the HUI hitting a new six-year high on August 8.
As you probably know, the past three weeks have been "volatile" for Gold. Over the week of July 21 - 25, Gold rose $US 15.50. Then, over the week leading up to the Treasury refunding - July 28 - August 1 - Gold was put firmly back in its place, falling $US 16.70. Now, over the week just ended - August 4 - 8 - Gold has regained $US 10.20. Never a dull moment!
What has REALLY got the attention of the "gold bugs", and even the non "gold bugs", is the performance of Gold stocks over the past three weeks. Gold stocks have prospered on Gold moving up while all but ignoring its sudden move down in the last week of July. And now, as already stated, US Gold stocks have climbed to heights last seen in 1997. Aussie Gold stocks are VERY close to those heady levels too, but they have not yet had a chance to react to Gold's $US 3.80 rise on August 8 in New York. For more on Aussie Gold stocks, see the $A/$US Gold page.
The other notable feature of the past three weeks, in fact of the period since the beginning of July, has been a sudden and huge surge in the uptake of new mortgages - while mortgage REFINANCING has been plummeting, new mortgages have been soaring. On top of that, there is growing anecdotal evidence of a surge in many types of retail sales.
The reason for this is obvious. US consumers watched aghast as US interest rates of all descriptions rebounded from 45 year lows in the last half of June. When the Fed lowered its Funds rate by a "disappointing" 0.25% to 1.00% on June 25, the upward surge of US rates accelerated. The conclusion was not long in forming - THIS IS THE BOTTOM! (for interest rates). Having come to that conclusion, everyone who could started to storm the banks in early July to borrow NOW - BEFORE RATES ROSE FURTHER.
This is the classic reaction. Perversely enough, as far as Central Banks are concerned, if you want to create a REAL borrowing boom, hint about raising interest rates, especially after a long period of declining and then static official interest rates. Of course, the Fed is NOT hinting about raising rates, but the market is doing much more than hinting. Market rates ARE rising and have been doing so for nearly two months now.
The problem, for the Central Banks, is that a borrowing boom in anticipation of HIGHER interest rates is absolutely unsustainable. And once that boom dissipates, once consumers pull back, begin to try to repay debt, and even begin to try to "save" because of the higher rates on offer, an economic slowdown of varying but always painful magnitude is absolutely assured.
That is what is now staring the US, and the rest of the world, in the face. The bigger the economic imbalances caused by the previous credit-induced borrowing binge, the deeper and more protracted the slowdown always is.
If that was all there was to it, then the US and the world would be faced with the prospect of merely hunkering down until the "slowdown" ran its course. The higher interest rates would discourage uneconomic investment, reward thrift, rebuild genuine capital savings, and clear the way for a restart. The problem arises when the level of the previous excesses are so grotesque that the brakes cannot be slammed on without putting the entire financial system and the currency at risk. That is what we are facing now. And with that in mind, it is a good time to revisit the last era when we faced a similar (although vastly smaller in comparative magnitude) problem. That era was the second half of the 1970s.
The table below covers a four year period from January 1976 to January 1980. The second entry, August 30, 1976 was Gold's low point in the bear market which began at the beginning of 1975. The subsequent entries are the dates when Gold first hit the given figure on its way from its $US 102 low in August 1976 to its $US 850 high in January 1980.
The one obvious feature of the entire table is that Gold (and Gold stocks) were rising in a climate of ever RISING interest rates throughout the period. You will note that the rates listed are almost static over the period when Gold surged from $US 500 to $US 850. Taking a closer look, that entire surge took place over a period of THREE WEEKS.
The late 1970s are notorious as an "inflationary" period. So they were - take a look at the M1 money supply figures in the table. But what people mean by "inflationary" is, of course, that prices were rising throughout the period. So they were, the prices of REAL goods. Interest rates were rising for two reasons. First, the premium demanded by lenders for compensating for the perceived credit worthiness of the borrower rose. Then, on top of that, the premium demanded by borrowers to offset the perceived lower future purchasing power of the currency rose.
It was this second component of the rising interest rates - worry over the future purchasing power of the $US which had, by mid 1979, become worry over the SURVIVAL of the $US - that led to the Gold blow-off in December 1979/January 1980. Back then, Gold was only "reined in" by 18 months of 20% plus market rates which compensated US investors for these fears and gradually, over time, lured them away from REAL goods back into financial instruments. The result was the recovery of the $US, which was followed, when interest rates started to subside again, by the start of an almost 20 year stock market boom in August 1982.
All those "booms" are now over. The stock market boom ended in early 2000. The $US boom ended in January 2002. The bond market and mortgage refinancing boom ended in June 2003. The actual mortgage boom now going on will end very soon. All booms turn into busts. The soaring market interest rates since mid-June put the writing firmly on the wall.
"The longer the Gold supression is maintained in the face of the current situation, the more obvious it becomes. Many have noted the extreme reluctance of Gold stocks to follow Gold down this week. The longer the Gold suppression is maintained in the face of the current situation, the more violent the snap back will be when further mainainance proves impossible."
(Gold Last Week - August 1)
Many have noted Gold's recovery this week. Many more have noted the surge in Gold stocks to six year highs. Now, with the turnaround in interest rates almost two months old, the very last surge of consumer borrowing - for new mortgages - is taking place. Yes, government will try go on trying to "substitute" budget deficits for the drying up of consumer and corporate borrowing. No, they will not succeed. What they WILL do as the deficits increase is cast more and more doubt upon the creditworthiness of the borrower - the Treasury and the currency in which the debt is denominated - the US Dollar.
Such a situation is absolutely PERFECT for Gold (and Gold stocks). "Further maintenance of the current situation" (see the quote above) is becoming more difficult by the day.
