Gold is down. Silver is down. Base Metals are down. Commodities of (almost) all varieties are down. Stocks are down. Bonds are down (and yields are up). Even the US Dollar is down (91.36 to 90.68 on the $US index over the week of April 26-30). What's up? Oil, but not by much ($US 37.12 to $US 37.37 cash basis this week).
The Dow is back in the red for 2004 and once again getting uncomfortably close to the 10000 level. The Nasdaq is back well below the 2000 level. Non US stock markets took a hit across the board this week. Gold trespassed into the $US 370s in Asian/early European trading on April 29 before snapping back. Silver gave up ALL its 40% plus $US gains made this year before snapping back on April 30. Treasury yields have been rising since mid March and accelerating upwards in April. The $US index has been bouncing around between 90 and 91.75 for three weeks but basically going nowhere. It is getting to the point where more and more investors everywhere are contemplating taking whatever they've got in cash, stuffing their mattresses with it, sticking their fingers in their ears, and taking a long vacation.
Welcome to the not very brave but new world of anticipating HIGHER interest rates.
The title of the Early May Issue of The Privateer (published on May 2) reads as follows: "ZERO PERCENT - ONE PERCENT - TWO PERCENT". These are the official rates of, respectively, Japan, the US, and the EU. Japan, with no interest rate at all, spent the first three months of this year creating 15.2 TRILLION Yen for the purpose of buying US Dollars to keep the Yen down against the Dollar. These Dollars are reserves in the hands of the Bank of Japan. Is it any wonder that the Japanese economy is now reported to be "growing" at levels not seen for more than a decade? The US doesn't need "reserves" as a base upon which to credit expand. It prints its own and almost everyone elses' "reserves' in house. Europe? It now has its own reserve currency and therefore does not actually "need" the considerable Dollar reserves it still holds. But it does NOT see it as being in its interest to rock the US Dollar boat, as it is fully engaged in expanding its European Union.
Overhanging all this is the gruesome and fast becoming depraved mess which the Bush Administration has blundered into in Iraq. To keep things in a financial context, staying in Iraq is going to cost so much in literal Dollar terms that the US markets will not withstand the pressure. Pulling out of Iraq is going to cost so much in terms of the global stature of the US that the US markets will not withstand the pressure. In this regard, what we are now witness to is EXACTLY what happened to US markets throughout the 1970s and early 1980s. But this time, the situation going in is worse by such an order of magnitude that the "solution" then - sky high rates for a period followed by a HUGE increase in government spending - cannot work now.
Given the debt loads encumbering the US and most of the rest of the world now, the only viable solution is to let the over-investments and malinvestments collapse, drastically reduce government spending, and get out of the way of REAL wealth creation. Of course, the transition to such a course of action, given the gross distortions of the past two decades plus, guarantees a wrenching readjustment which will be interpreted as either a very deep recession or, perish the thought, a depression.
While very few on Wall Street or in the big investment firms care to look at the picture in anything resembling its entirety, there are indeed glimmerings of apprehension that there is going to be no easy way out of the mess which the world in general and the financial world in particular is in. The evidence is clear in the huge financial gyrations of the month just ended, and in particular, in the last week of the month just ended, during which almost EVERYTHING one could contemplate investing in has gone down.
Now, the prevailing wisdom on Wall Street and most of its equivalents elsewhere in the world is that rising interest rates are bad for Gold and the other precious metals. Why? Simple! Higher interest rates mean higher yields on interest-bearing assets. Gold - and Silver etc - are not an interest-bearing assets. Nuff said.
This is actually a quite amazing attitude. First, when interest rates start to rise on interest-bearing assets (say bonds), the capital value of all existing bonds on the secondary markets goes down. In a situation in which interest rates are expected to continue to rise, this is not usually a good incentive to get lumbered with bonds. Second, rising interest rates ALWAYS hit the bottom line of stock "earnings" and stock markets react accordingly. That is not a good incentive to get lumbered with stocks. Three, a prolonged regime of higher market interest rates is always a signal of a continuing expectation of the purchasing power of the currency steadily falling. That is the flip side of price inflation. When prices are going up, the purchasing power of the medium in which the prices are expressed are going down.
In the 1970s, bonds fell (with fits and starts) throughout the decade. Stocks had one major swoon (in late 1974-75) and spent the rest of the decade gyrating below levels reached in the mid 1960s. The Dollar, like bonds, fell (with fits and starts) throughout the decade and accelerated downwards towards the end of the decade. Gold, and silver etc, boomed.
But the attitude described above (rising interest rates are bad for Gold, Silver, etc) has survived intact despite all the evidence to the contrary. That is not so surprising. Stumble onto any of the "neo-con" blogs and you will get a large helping of the same phenomenon. Anyway, because of this attitude, commodity prices and precious metals prices can and usually do take a varying size "hit" in the INITIAL (repeat - beginning) stages of a rise in interest rates.
MARKET interest rates all over the world have been rising in tandem for six weeks now. But OFFICIAL rates - except in such maverick nations as New Zealand, which raised its rates this week - have not yet begun to move. "ZERO PERCENT - ONE PERCENT - TWO PERCENT." Clearly such a situation is ridiculous. Just as clearly, there is a rising anticipation that it cannot be maintained much longer.
The Fed meets on May 4. After that, there are three more FOMC meetings between now and the November US elections. The more the evidence for US price inflation mounts, the greater the pressure to raise rates - and the greater the political pressure from the White House not to.
This too is scaring the markets, not only in the US but everywhere. The consensus, inside and outside the US, is that if 2004 was not a Presidential election year, the Fed would already have begun to raise official US rates. The fear is that because of political constraints, by the time they get around to getting started the "horse will have bolted". The Fed will then have to play "catch up" while knowing that with every 0.25% rise, it sends another large chunk of overindebted Americans over the financial precipice. It's not a nice thing to contemplate.
The recent dive in commodities has been partially due to a sudden realisation that the Chinese economy (which has been siphoning up the world's commodities for months) might actually be "overheating". The main reason, however, is a heightened anticipation of, and apprehension about, higher global and US interest rates. Gold, silver et al have done what they do when this anticipation begins. They will also do what they do when anticipation is no longer required, because rates (official as well as market) ARE on the rise. They will start to go UP. The extent of their rise will be proportional to the extent of the apprehension about the future viability of the currencies in which the "interest-bearing" assets are denominated.
This apprehension got pretty bad in the late 1970s, and Gold, silver et all reacted accordingly. Given the state of the financial world today, the apprehension is going to get a whole lot worse than it did way back then.