Why is this year so critical for interest rates? Because after testing 45-year lows, a sustained upturn in the interest rate would be felt quite prominently throughout the financial system, at least for a while. This is not to say that interest rates need travel to dramatic heights, because I don't expect to see rates much higher than 6% or so in coming months. But the mere fact that interest rates have hovered between roughly 3.5-4.5% in the past two years has acclimated everyone to these extremely low rates and the accompanying easy money. A steady climb in rates back up to the highs of 2002 would be felt as a shock to the economy on a rate of change basis.
We know how this would obviously impact stocks and, to some degree, the economy. But how would this affect gold?
The Bank Credit Analyst (BCA) talks of the Federal Reserve's "punch bowl" of low interest rates and easy credit policy. BCA recently compared the gold market with a nominal trade-weighted dollar (with gold and the dollar shown along with their respective 40-week moving averages). But BCA took the analysis one step further by bringing in interest rates to the equation, which many analysts fail to consider when discussing gold. A dramatic and sustained rise in rates over a long period of time would eventually begin to weigh against gold. BCA's conclusion: "Gold is safe until the Fed pulls away the punch bowl."
The headline of this commentary asks the question, "Would they dare?" This is in reference to the Fed and other financial interveners. More to the point, the question is "Would they dare to raise the interest rate to extremely high levels over a prolonged period of time?" And I believe we can also, in this current politically charged election-year environment, apply that same question to the oil market. After all, if oil/gas prices are allowed to continue soaring in the coming months it will only add to the already considerable economic tension in the U.S. at a pivotal time in the K-Wave. To answer this question let's take a look at a couple of important charts.
First let's examine the long-term monthly chart of Treasury Yields -- the CBOE 10-year Treasury Yield Index (TNX). Notice the 4-year downtrend line in this chart highlighting the falling trend of interest rates since the beginning of 2000. This downtrend line is now being seriously challenged. A decisive close above 43 in the TNX (4.3%) would effectively break this downtrend, although a close above 45 would be preferable for a definitive breakout. There is a very reasonable chance that this could happen in the next few weeks, although considering that the long-term moving averages still haven't turned around yet it will obviously take time for rates to "consolidate" and gather enough strength to launch a serious and sustained rally. What are the odds of this happening? I would say the odds are against this happening. Why? Notice the parabolic bowl in the above T-Yield chart. Do you see the spike bottom in rates in 2003, when the rate was almost 3%? This bottom was formed to the right-of-center within the bowl. In parabolic analysis, whenever this happens it typically means the bowl will be broken at some point before prices (or in this case, interest rates) have a chance to climb too far along the sides of the bowl. In other words, a bottom beyond the "vertex," or mid-point, of the bowl means the rally is likely to abort before getting too far. I view this to be the likely course of action for interest rates over the course of the next several months since a sustained upside run in rates would be extremely damaging to the stock market and general economy -- possibly even the housing market -- and this is not at all what the Fed has in mind. You can tell this by their long-standing policy and unspoken intentions.
What about oil? Will the regulators allow oil and gas prices to soar to dizzying heights in the coming year? Extremely doubtful. This alone could wreck the economy and they do not want this. To put the oil situation into perspective I've included a long-term monthly chart of ExxonMobil (XOM), which is heavily influenced by the price of oil. Note the rather bullish bowl pattern in this chart, which unlike the interest rate chart, shows a major bottom to the left-of-center of the bowl's vertex. This is bullish. However, note the orderly uptrend channel which has kept prices bounded and prevented them from rising too far, too fast. This chart, while bullish, shows the regulators are doing everything in their power to keep the steady rise in oil prices under control. There may very well come a day when oil prices explode to the fabled $100/barrel, but this is probably a few years down the road. Anyway, the price line of XOM in the chart below shows that prices have gotten a bit too far away from the right side of the bowl, which means a pullback and/or consolidation is likely in the near future. This would also have the effect of keeping inflationary pressures in the energy markets tame.
To summarize, interest rates are likely to remain under tight control in the years immediate ahead, although 2004 will likely see at least a mild rally in rates (see my previous article on the 10-year cycle and its effects if you want to understand the necessity of letting rates, and the dollar, rise a bit in 2004). Oil is long-term bullish, but the rise in energy market prices are likely to be contained for a while in order to keep things from getting out of hand. And gold, too, is long-term bullish, which probably wouldn't be the case if the interest rate were allowed to soar to dramatic levels. As we have seen here, this is not very likely to happen. Thus, the long-term gold bull market appears to be safe.
April 8, 2004
Clif Droke is the editor of the Durban Deep/XAU Report, a daily forecast and analysis of DROOY, GLG, KGC, XAU, HUI, and GOX written especially for day traders. He is also the author of numerous books on finance and investing, including the top-selling "Moving Averages Simplified." Visit his web site for free samples of his analysis at www.clifdroke.com