Thursday, March 15, 2012

Rising Interest Rates Will Only Add Fuel To The Precious Metals Rocketship

Lost in all the "hoo-haa" eminating from "the great equity rally" we have been forced to witness this week, is the observation that the US Treasury debt appears to be be sagging.  I always thought rising interest rates were bad for the equity markets...

That is...unless they are rigged I suppose.

Obviously, the Gold market finds fear in the rising interest rates we have seen this week...but should it?  The Fed would love for the Gold market to go running off into the hills suqealing in fear of rising interest rates.  Fact is though, REAL interest rates are not rising.  And the Fed CANNOT allow interest rates to rise in any way shape or form.

"Nominal" interest rates may be rising on the edge here this week, but adjusted for inflation, REAL interest rates rermain negative.  And if negative Real interest rates are bullish for stocks, they should be uber bullish for the Precious Metals and commodities in general.

The question of why Treasuries are sagging would be salient.  Is this a downtrend developing, or just a "one time event"?  Is this just a simple mark down in price by the Treasury and Fed to bump yields up in the hopes of attracting foreign buyers back into the market?  Or is the US Treasury BUBBLE about to burst?

The Golden Truth's, Dave in Denver, has some observations regarding the recent weakness in the USTreaury market:'s a chart that should scare the crap out everyone who has faith in the U.S. dollar:

The price of the 30-yr Treasury bond looks like it could go into a freefall. Yesterday's 30-yr Treasury auction was very ugly. The primary dealers had to swallow 56% of the all the bonds issued. With current Fed QE policy still in place - i.e. operation twist - we can assume that in some slick accounting maneuver, the Fed is ultimately the back-stop on the bonds taken down by the PD's. I spot-checked the last 10 long bond auctions and there was only 1 in which the PD's took down more than 56%. In most them, the PD's were taking down less than 50%. Why is this significant? Because China, Russian, and now Japan are starting to reduce their participation in U.S. Government bond auctions. In fact, Russia has outright reduced its holding by over 50% in the last year. Japan announced the other day that, in a move to diversify their dollar reserves - they bought $11 billion in yuan-denominated Chinese Government bonds.

This is not a one-time event. This is becoming a systemic trend with large holders of U.S. dollar reserves. This is a very ominous sign for the massive U.S. Government budget deficit spending program. Either the Fed has to figure out a way to induce our large foreign financiers back into Treasuries/dollars or the Fed is going to have to print even more money to make sure the Government gets its spending heroin without sending bond yields into outer space.

On that note, since mid-December the yield on the 30-yr bond has gone from 2.80% to over 3.40%. This is a 22% increase, signifying a 22% increase in the cost to the Taxpayers of funding spending deficits with 30-yr. bonds. This is a very bad trend. Even worse, the flagship mortgage finance index, the 10-yr Treasury, has shot up from 1.85% to 2.30% - a 23% increase in the cost of 10-yr paper. At some point this higher rate will funnel through to the mortgage market. It's probably why mortgage refi applications took a nose-dive over the past couple weeks. It will place further stress on an already fragile housing market.

What the hell happened to the intended interest rate of Bernanke's "Operation Twist?" like ALL Government intervention programs it is starting to fail badly, perhaps tragically...

Clearly the Treasury [read Tax Payers} cannot afford for interest rates to rise if we are going to attempt to finance $1 TRILLION [plus] spending deficits as far into the future as we dare look.  The Fed of course, will never allow interest rates to rise.  But what guarantee do we have that interest rates won't continue to rise inspite of every effort by the Fed to prevent them from rising?  And if interest rates do continue to rise should Precious Metals investors be alarmed?

If the Fed continues to print money to buy bonds in a effort to subdue interest rates, Precious Metals investors could not be more gratified.  Fed money printing is inflationary, no matter how you spin it.  Should the Fed increase money printing to chase rising Treasury yields, REAL interest rates will continue to drop, and be even more negative than the ones "supporting" the Precious Metals markets today.

I will let Steve Saville, The Speculative Investor, counsel us on the relationship between Gold and interest rates...and lay to rest some of the myths and misinformation the financial news media maybe spewing to "explain" the fall in the prices of Precious Metals this week.

The Relationship Between Gold and Interest Rates
by Steve SavilleThe Speculative Investor
Published : March 15th, 2012

This week’s downside breakout in the T-Bond futures market and the associated rise in the T-Bond yield has prompted us to re-visit the relationship between gold and interest rates. In the process of doing so we’ll address the question: are rising interest rates bullish or bearish for gold?

We’ll begin by noting what happened to nominal interest rates during the long-term gold bull markets of the past 100 years. Interest rates generally trended downward during the gold bull market of the 1930s, upward during the gold bull market of the 1960s and 1970s, and downward during the first 10 years of the current bull market. Therefore, history’s message is that the trend in the nominal interest rate does NOT determine gold’s long-term price trend.

History tells us that gold bull markets can unfold in parallel with rising or falling nominal interest rates, but this shouldn’t be interpreted as meaning that interest rates don’t affect whether gold is in a bullish or bearish trend. The long-term trend in the nominal interest rate is not critical; but what is of great importance, as far as the gold market is concerned, is the REAL interest rate. Specifically, low/falling real interest rates are bullish for gold and high/rising real interest rates are bearish. For example, when gold was making huge gains during the 1970s in parallel with high/rising nominal interest rates, real interest rates were generally low. This is because gains in inflation expectations were matching, or exceeding, gains in nominal interest rates (the real interest rate is the nominal interest rate minus the EXPECTED rate of currency depreciation). Also, the first decade in gold’s current bull market occurred in parallel with generally low real interest rates.


The Fed and the Treasury would appear to be trapped.  TheTreasury is damned if interest rates rise, and the Fed are damned if they print money in an attempt to buy Tresury debt to keep interest rates low.  Precious Metals investors find themselves in the very enviable "win-win situation".  No matter what happens from here forward, the prices of Precious Metals are guaranteed to rise.

America Mortgaged at an Adjustable Rate
by Peter SchiffEuropac
Published : March 15th, 2012

The Federal Reserve ran another “stress test” on major financial institutions and has determined that 15 of the 19 tested are safe, even in the most extreme circumstances: an unemployment rate of 13%, a 50% decline in stock prices, and a further 21% decline in housing prices. The problem is that the most important factor that will determine these banks’ long-term viability was purposefully overlooked – interest rates.

In the wake of the Credit Crunch, the Fed solved the problem of resetting adjustable-rate mortgages by essentially putting the entire country on an teaser rate. Just like those homeowners who really couldn’t afford their houses, our balance sheet looks fine unless you factor in higher rates. The recent stress tests assume market interest rates stay low, the federal funds rate remains near-zero, and 10-year Treasuries keep below 2%. Why are those safe assumptions? Historic rates have averaged around 6%, a level that would cause every major US bank to fail!

The truth is that higher rates are the biggest threat to the banking system and the Fed knows it. These institutions remain leveraged to the hilt and dependent upon short-term financing to stay afloat. While American families have had to stop paying off one credit card by moving the balance to another one, this behavior continues on Wall Street.

In fact, this gets to the heart of why the Fed is keeping interest rates so low. Despite endorsing phony economic data that shows the US is in recovery, the Fed knows full well that the American economy cannot move forward without its low interest-rate crutches. Ben Bernanke is trying desperately to pretend that he can keep rates low forever, which is why that variable was deliberately left out of the stress tests.

Unfortunately, rates are kept low with money-printing, and those funds are starting to bubble over into consumer prices. Bernanke acknowledged that the price of oil is rising, but said without justification the he expects the price to subside. This shows that Bernanke either doesn’t know or doesn’t care that the real culprit behind rising oil prices is inflation. McDonald’s, meanwhile, is eliminating items from its increasingly unprofitable Dollar Menu. A dollar apparently can’t even buy you a small order of fries anymore.

Unfortunately for our brilliant Fed Chairman Pinnochio...oops, I mean Bernanke...the Fed has evn bigger hole to fill that the money pit over at the US Treasury Department:
From Zero Hedge

As we have repeatedly said in the past, the quarterly Flow of Funds (or Z.1) statement is most interesting not for the already public household net worth and leverage data which serves to make pretty charts and largely irrelevant articles, but due to its insight into the stock and flow of both the traditional financial system but far more importantly – into shadow banking. And this is where things get hairy. Because while equities may have returned to 2008 valuations, the credit shortfall across combined US liabilities – traditional and shadow – still has a $3.6 trillion hole to plug to get to the level from March 2008 (see first chart). It is this hole that is giving equities, which have already surpassed 2008 levels, nightmares. Because while the Fed is pumping traditional commercial banks balance sheets via reserve expansion (read: fungible money that manifests itself most directly in $5 gas at the pump) resulting in a $2.3 trillion rise in traditional liabilities from Q3 2008 through Q4 2011, what it is not accounting for is the now 15 consecutive quarters of shadow banking system contraction, which peaked at $21 trillion in Q1 2008, and in Q4 2011 declined to $15.1 trillion… and dropping. It is this differential that will be the source of the needed “Outside” money, discussed yesterday, and that is only to get equity valuations to a fair level! But considering the Fed’s propensity to print at any downtick, this is very much a given, much to the horror of Dick Fisher. Any additional increase in stock prices will require not only the already priced in $3.6 trillion, but far more direct Outside money injections.

While we have explained the methodology of approaching consolidated credit money in modern finance before (much more here), here is a quick rerun. In the chart below, conventional wisdom only focuses on the red line, which represents traditional commercial bank liabilities (L.110, L.111, L.112 and L.113 from the Z.1), where Fed reserves and other monetary expansion mechanisms manifest themselves. As can be seen this line is rising rapidly, as is to be expected – in tune with the US deficit spending and Fed reserve growth. That both the US debt chart and the consolidated global balance sheet have now entered an exponential phase is a topic for another discussion.

What, however, is always forgotten is the blue line, which represents the liabilities in the shadow banking system – all the credit money that has been used by various unregulated institutions to perform the traditional transformations of maturity, credit and liquidity that define a “bank.” And this line is for lack of a better word, collapsing. It is this collapse that the Fed has yet to tackle, and it is the offset of this collapse which the equity market has somehow already priced in!

________________________ why are the Precious Metals being beaten to death if rising interest rates are not a threat to them?  Great question, been asking it myself all week.  Perhaps this Zero Hedge post below is why...perhaps this same explanation might apply to the recent sell off in US Treasuries...the need for quality collateral to cover bad bank margin calls at the ECB.
From Zero Hedge

In an update of our post from a week ago, the ECB has increased its margin calls on European banks by EUR162 million this week to another record high of over EUR17.3 billion. While our pointing out of this huge jump from 'average' historical margin calls last week was met with - it's temporary/transitory due to temporary/transitory ineligibility of defaulted (and since undefaulted) Greek bonds (which given the rise this week has now been proven incorrect) or the more prosaic "don't worry, be happy", we remain concerned at both the velocity and now sustained size of these margin calls (as clearly collateral quality has dropped rapidly and remained weak). This is concerning since it would appear we had a good week for collateral (risk assets) in general, so we can only imagine what garbage is clogging the ECB's balance sheet. The side-effect of this appears to be (as we pointed out here) that Gold (the banks' remaining quality collateral) is being sold to cover these margin calls just as it was in September 2011 (though lease rates have not squeezed as much this time). We can only imagine the size of these margin calls should we happen to have a week where AAPL stock drops or BTPs don't rally (broad collateral actually loses value), but that seems impossible anyway.

ECB Margin Calls to European Banks rose once again to record highs...

And Gold remains offered as the need to fund these margin calls means finding money under every mattress and selling whatever banks have to meet the central banks demands...

Interesting that gold lease rates did not drop (soar from the other side) in a squeeze this time - as they did in September 2011.

Charts: Bloomberg
This Could Spark a Massive Move in Gold
By Jeff Clark
Tuesday, March 13, 2012
Get ready for a golden summer.
Got Gold you can hold?
Got Silver you cansqueeze?
It's not too late to accumulate!

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