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The prospect of higher interest rates looms large.
New
Zealand increased
short-term interest rates to 8%. South Africa will follow soon and
a string of other countries has threatened to follow suit.
The cover story is that the economies of the world
are so strong that Central Banks have to raise interest rates in order to
cool down inflationary pressures. We find the prospect of higher rates (in
light of Central Bank printing) akin to Dracula running a blood drive because
supplies are low!
Since 2002 we have witnessed the largest blizzard of
paper money the world has ever seen. Almost all OECD countries (and much of
the developing one's as well) have been expanding their money supply by over
10% per year. That's an awful lot of money which has subsequently found its
way into Stock Markets, Real Estate, Commodities, Bonds and collectibles.
So when Central Banks come out and say that the
world economy is on steroids they should know, they put it there. What they
are really saying is that that the effect of their money printing is now
finding its way into more visible consumer prices. Which means money printing
is becoming less effective as it is being seen for what it really is -
currency debasement.
Remember, the definition of inflation is not the
increase in price levels but the increase in money supply. The general public
has been confused into naming price increase as inflation instead of it being
recognized for what it is, the result of too much money being printing.
The main areas where consumers notice price
inflation are in Gas and Food.
Chart 1 - Agriculture price index (top); Crude Oil (middle); 2-year yields
(bottom)
As can be seen in the above chart, agriculture /
food prices (top) have trending higher since 2002 and have been in a steep
uptrend since 2005. The price of oil (below in green) has also been trending
higher since 2002. [We won't even mention the disastrous effect that
switching the Corn crop from a food source to Ethanol based fuel is having on
the price of these commodities.]
At the bottom of the chart are the yields on 2-year
Treasuries. The rise in Food and Oil prices is causing short-term interest
rates to rise.
So why have we remained so complacent about
inflation up to now? And how do we measure inflation expectations anyway?
We have been conditioned to think that inflation
will show up in interest rates (which they do) and the most watched interest
rate in the US
is mortgage rates.
Chart 2 - 30-Yr Fixed Mortgage Rates
Now 30-year mortgage rates have not shown the
massive increases that lets say the 2-year rates above have shown. And that's
because recycled foreign money has been keeping long-term interest rates
artificially low. So here's one reason that inflation expectations have
remained low whilst Central Banks have been able to pump away.
So how do you measure inflation expectations anyway?
One way is to compare the performance of inflation
protected bonds versus unprotected bonds of the same maturity.
Chart 3 - Treasuries vs. Inflation Protected Bonds (red); 10-yr yields
(green)
When the red chart if falling it means unprotected
bonds are outperforming inflation protected bonds and visa-a-versa. As can be
seen investors have not deemed it necessary to purchase inflation protection
as 10-year rates have been falling (green line). It is also worth noting that
inflation expectations (red line) follow 10-year rates with a 2-3 month time
lag. 10-year rates took off northwards in March so inflation expectations are
only starting to reflect this increase.
What the above chart says is that the public are
about to become a lot more aware and vocal about the issue of inflation.
Gold
The uniqueness of Gold is that it understands
inflation very well. Better than any other instrument. Gold also understands
inflation in its purest sense and that is the increase in money supply. Hence
we have seen Gold prices rise steadily since 2002 in line with an
increase in money supply. [And it is now obvious why certain powers would
prefer the price of Gold to remain low.]
Yet now we see Gold falling (inexplicably) in the
face of rising price inflation (and Central Bank sabre rattling).
The reason is that Central Bankers can only remain
in business if their money shenanigans remain hidden from the masses. That
is, if inflation expectations are high, their money games have little effect
as people move to protect themselves ahead of Central Bank transparent
printing.
With inflationary expectations now rising, Central
Banks have to ease off the pedal and slow their support of asset markets. Money
supply growth will slow and Gold will/is falling.
And here's the final word:
The fundamentals are therefore short-term bearish
for Gold and we will probably see further weakness over the next couple of
months (Gold is seasonally weak in Summer). But once the Central Banks have
curbed inflation expectations sufficiently, it will be business as usual and
time to back up the truck on those juicy undervalued Gold Juniors.
Keep some powder dry!
More commentary and stock picks follow for
subscribers...
Greg Silberman
CA(SA), CFA
greg@goldandoilstocks.com
February 15, 2007
I am an investor
and newsletter writer specializing in Junior Mining and Energy Stocks. Please
visit my website for more free articles and analysis
Click here: http://blog.goldandoilstocks.com
This article is
intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult
your financial advisor before making any investment/trading decision. No
responsibility can be accepted for losses that may result as a consequence of
trading on the basis of this analysis.
Information contained
herein is obtained from sources believed to be reliable, but its accuracy
cannot be guaranteed. It is not intended to constitute individual investment
advice and is not designed to meet your personal financial situation. The
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