Rising interest rates AND rising gold prices?
…equals volatility. But WHAT is the cause of this phenomenon?
Rising gold, interest rates could spell trouble
…What could spook the markets and cause market turbulence to shoot higher? The answer? A long period in which the price of gold and long-term interest rates rise at the same time, warns Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch.
“Watch for the combo of rising yields and rising gold prices to signal impending market volatility,” he told clients in a report. Both the 1973-74 bear market and the 1987 Black Monday (market crash) were “preceded by three quarters (or roughly nine months) of rising bond yields and rising gold,” Hartnett noted.
Why a Rising Gold Price is Bad News
We have written about our concern that high annual deficits and accumulating public debt will lead to higher mortgage rates and to higher interest rates in general, burdening future generations with the interest cost and jeopardizing the country’s credit rating, continuing to burden economic growth, and adversely impacting employment. The Fed has temporarily countered the interest rate risk by artificially keeping interest rates low by inflatiing the money supply, thus discouraging savings and investment, causing long-term misallocation of resources, and leading to higher commodity prices and living expenses down the road. This note explains why a rising gold price is bad news.
To compensate for sluggish economic activity and high unemployment, the Fed has undertaken a series of rounds of “quantitative easing”; that is, injecting huge amounts of liquidity into the marketplace by buying Treasury bonds and mortgage-backed securities, with the purpose of holding interest rates down and encouraging banks to lend to businesses.
But many businesses are not interested in borrowing to finance expansion, given the difficult economic situation. They are concerned that consumers are paying down debt rather than spending, are burdened by ever more regulation, and are unsettled by temporarily extended and unknown future tax rates on income, capital gains, dividends and estates. Add in the higher costs of employment benefits — particularly health care insurance costs — and you have an economic environment in which established businesses have no incentive to expand and entrepreneurs are not keen to take the risk of starting new businesses.
So the Fed’s activities result in increasing quantities of money being added to banking reserves, which finds its way into the stock and bond markets and fuels fears of future price inflation. Investors’ fears of inflation have sent gold prices skyward. Who wants to hold dollars that shrink in value daily?
Unfortunately, a rising gold price signifies trouble ahead. It’s a kind of canary in a coal mine. As more individuals become concerned that their dollars will buy less in the future and exchange them for hard assets, commodity prices such as food and fuel and metals and building materials will continue to rise. Foreign central banks that hold large quantities of depreciating dollar-denominated debt will demand higher interest rates to compensate for their loss in value or will swap out of dollars to buy gold, and the gold price will continue under upward pressure, while the value of the dollar declines.
This is a long-term viscious cycle. If it is allowed to continue, dollar holders will lose faith in the currency, eventualy resulting in a situation where no one is willing to hold dollars at all. This is hyperinflation.
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