What launches the Gold Bull
and what signs appear that interest rates have bottomed?
First a technical look at Gold…
What launches gold -the question from my title piece?
Answer: A break above 295 US Dollars -the 295 level must act as support on any downside moves to confirm the breakout. We're getting close.
Few other tidbits to note from the chart..
1) The MACD has broken out to a 3-year high -exceeding the level reached during the Washington Agreement (very bullish)
2) Relative strength made new highs just this week
Fundamental outlook on Gold:
Due to the attack on America, a few fundamental changes will occur via monetary and fiscal policy.
1) Monetary policy- the fed will cut interest rates further and pump up the money supply to boost the economy. The drop in short-term interest rates makes the real rate of return on treasuries zero. As you will see with the bond chart- no return on your money market and treasuries after adjusting for inflation leads to sellers of bonds.
Impact of short-term rates on gold- Well, the argument AGAINST gold is it doesn't pay any interest. On the other hand, if treasuries and money market funds in real terms yield no return-then what advantage do those investments have to gold?
Bottom Line-The move by the Federal Reserve to cut interest rates makes gold more attractive as an investment relatively speaking than before to short-term debt.
2) Fiscal Policy- Due to the attack on America, the US government will have to devote great resources to repair the damage done.
The spending will involve the following:
- repairing Lower Manhattan,
- investigating the crime and finding the guilty parties
- boosting defense spending to diminish the chance this event doesn't occur in the future
- providing an infusion of cash to airline industry in a bail-out attempt.
Please realize this list is a shortened version of spending needed to repair damage done to America.
But the point is simple: Government spending will increase and thus productivity will fall. As the government allocates a greater amount of scarce resources in the economy, productivity declines. While the repairs are needed- no new productive capacity is created- think of it as a replacement cost.
A return to Deficit Financing- due to the tax cuts this year, weaker unemployment market and proposed capital gains cuts- the US government will be taking in less tax receipts. But their spending as noted above will increase leading to a deficit.
Effect of future deficit financing on Productivity, Gold and Bonds-
If I am correct and the US government must start to borrow to fund expenditures then I will draw the following conclusion..
1) the government will crowd out the private sector for capital
-if there are 100 dollars in available loanable funds and their exist a budget surplus- the private sector has access to the total supply.
BUT lets say the government starts running deficits and must borrow $40 USD. That leaves only 60 dollars for the private sector and it also pushes interest rates up for private companies as the supply of loanable funds declines while demand stays constant.
Crowding out effect on Bonds and Gold Price:
1)Bonds- prices go lower as government borrowing reduces available supply of loanable funds in the market- interest rates go up
2) Gold Price-Productivity goes lower as government allocates a larger percentage of our nation's resources and thus the ability to contain monetary inflation diminishes- gold proceeds to rise in this scenario letting market participants know inflation's a problem.
More on the Productivity Front:
In the News, I have noticed many corporations engaging in stock repurchase programs. Simply put, I don't think helps it private sector productivity. Disney buying back stock doesn't create any Mickey dolls to be sold at a future date. US corporations don't have in many cases the cash flow to support the buyback operation.
SO they borrow to fund these repurchases. Is this any way to utilize debt? More importantly, these measures fail to produce anything for the economy. There is no productive capacity created, anything but a short-term fix instituted to restore investor confidence.
I don't like the way US corporations are spending their money. The measures taken by the US government and US companies will not generate cash flows, earnings or productivity. As corporate cash flow fails to revitalize, investors will look away from stocks and bonds and run to gold.
Bond Outlook:
1) Expansive fiscal policy- budget deficits lead to inflation and lower bond prices
2) Lower federal funds rate- money supply increases lead to heighten inflationary expectation and lower bond prices
3) No real return on treasuries- bonds don't look attractive anymore - so the opportunity for gold to siphon money away is possible
Technical look on Bonds: (the bond chart will be sent as a separate attachment)
While the potential for further gains on bonds exist if stocks weaken further, the reality is that bonds got a big bid when the surplus was around. As the surplus disappears expect bonds to lose the premium built in.
Also realize that Foreigners hold a large percentage of our treasuries. If the rate of return remains neutral or even goes negative with further fed easing- the probability exists for a sale of bonds by foreigners…pushing interest rates higher.
One last note before I present that bond chart- bonds have a weak stock market and a slowing economy in its favor. The bond market vigilante must decide which factors drive bonds. I have made my decision, Have you made yours?
Have long-term interest rates bottomed?
Take a peek:
It appears that the 30-year bond peaked on September 11, 2001 at 108. A break below 90 would confirm a bottom in long-term US interest rates.
Conclusion-Due to the Attack on America, bonds don't look attractive neither do stocks. Gold stands to benefit from the stimulus from our policy leaders and the resulting decrease in labor productivity as those programs commence.
The above statements are all opinions and in no way represent investment advice. In no way does my work suggest on intend to be a solicitation to buy or sell any securities. It's purely for information purposes. Basically, its one man's opinion- take it for what its worth.
Mario Ricchio (a.k.a. The Return Of DJB)
October 1, 2001
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