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Last week Fed
Chairman Bernanke raised eyebrows and denied history when he asserted in
front of Congress that gold doesn't qualify as money. Yesterday he took the
unprecedented step of announcing that the Federal Reserve would keep interest
rates near zero for at least the next two years. In very short order
thereafter it required much more of the money that he believes in (U.S.
dollars) to buy the money that he doesn't believe in (gold).
In any event,
it was beyond unusual for the Fed to make such an explicit time commitment on
monetary policy. To underscore this fact, three voting members of the Federal
Open Market Committee came out against the policy. Such dissent within the
Fed's ranks has not been seen in decades. But Bernanke's shameless
appeasement of market fears did interrupt, if only for a few hours, the free
fall on Wall Street. Wiser investors, understanding how a more activist
Federal Reserve will destroy the value of the dollar, moved to gold, pushing
the metal up to north of $1,750 per ounce.
The economic
forecast contained in the Fed statement was far gloomier than earlier
pronouncements. Bernanke sees continued sluggish growth for the U.S. economy
and subdued inflation. Normally under such conditions gold should be expected
to fall. However, as we have said consistently, these times are far from
normal.
Readers will
know already that we believe that the U.S. Treasury market is a gigantic
wealth trap. Even before the Fed's statement, investors seeking safety from
European debt fears and staggering losses and unnerving volatility in the
equities markets had flooded into U.S. Treasury securities. Nevertheless,
this week has thus far seen a stampede into Treasury securities, causing
yields to plummet. One-month Treasuries now yield 0.02 percent, making them
no better than cash; the 5-year yields 0.93 percent, 10-year 2.17 percent and
the 30-year 3.56 percent. Assuming a Consumer Price Inflation rate of 3.2
percent, all new investors in U.S. Treasury securities with a maturity of
less than 30 years are losing 'real' money. In addition, with little prospect
of further interest rate reductions the possibility of capital gains through
Treasury investments are essentially nil.
These
negative returns will eventually act as a pressure for funds to drift away
from the bloated bond market into the beaten down equity market. But the total
size of the global bond market is more than twice the size of the global
equities markets, so these fund flows, when they occur, may make an outsize
impact on equity prices.
In addition,
the Fed is debasing the U.S. dollar at an increasing rate. Despite the fact
that other nations are following suit to protect their exports, the dollar is
set to fall further. Indeed in criticizing the S&P downgrade last week,
Former Fed Chairman Greenspan said that the Fed need not be concerned about
debt service because it can just "print more money!"
Facing
negative real yields, the prospect of further credit rating downgrades and a
falling dollar, investors in U.S. Treasuries are setting themselves up to be
plundered.
On the other
hand, despite recession fears, the upward march of gold continues, with many
mainstream investment firms now setting price targets north of $2,000 per
ounce. But skepticism remains, with some analysts pointing out that the price
of gold is in "record" territory and is therefore highly speculative.
However today's gold price of $1,760 is still about 30 percent below the
inflation adjusted high set in 1980 when gold struck $850 per ounce. From my
perspective, with a sovereign debt crisis threatening, a currency collapse
looming, and a chronically persistent low interest rate regime, gold looks
positively cheap.
John Browne
Senior Market Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach, CA 92660
Toll-free: 888-377-3722 / Direct: 203-972-9300 Fax:
949-863-7100
www.europac.net
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