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Gold’s Allure Tied to Interest Rates

By Michael Pento, 17 November, 2010

The continued bull market in the price of gold has been one of the staple discussions in the financial media for the better part of a decade. But, in that time, almost no consensus has emerged to explain the phenomenon. If you ask ten Wall Street pundits to explain the upward movement, you will most likely get nearly ten different answers. 

While most logically identify global currency debasement as a primary cause, others say that gold is driven by: fear of economic uncertainty, central bank gold hording, international political conflict, or the ebb and flow of the Indian wedding season. The truth is the main drivers for the price of gold are the level and direction of real interest rates and the intrinsic value of the dollar.

Most people (outside of Washington) understand that printing money dilutes the value of the currency being printed. When a currency drops, the nominal price of hard assets in that currency generally rises. But the relationship between gold and monetary expansion is not that simple.

The act of central bank money printing temporarily drives down nominal interest rates, while at the same time creating inflation and lowering the intrinsic value of the currency that is printed. Therefore, subtracting rising rates of inflation from falling nominal interest rates results in a falling real rate of interest. Once real rates become negative, the liability of holding gold, which offers no interest income, disappears. The more real interest rates fall, the greater incentive for investors to own gold.

However, sometimes other factors come into play that prevent a debased currency from losing value against other currencies. It all depends on the actions taken by other central bankers. Hence, investors cannot divine the direction of gold simply by determining the state of nominal interests rates in the US or by the dollar’s value relative to other currencies.

This brings up two questions; should owners of gold fear rising yields on Treasuries, or a rise of the dollar against, say, the euro? The answers to those questions can be found by examining whether the rise in nominal rates is also accompanied by rising real interest rates and if the rise in the dollar is due to a decrease in its supply.

For example, back in January of 1977, the dollar price of gold began an epic bull market, which ended just prior to February of 1980. Gold soared from $135 dollars per ounce to just under $860 per ounce during those three years. This move occurred while nominal rates were rapidly rising. The yield on the Ten Year Treasury soared from 7.2% in January of 1977 to 12.4% in February of 1980. But the increase in yield was just in nominal terms because the YoY change in the CPI jumped from 5.2% in January of 1977 to 14.2% in February of 1980. During that bull market in gold, real interest rates fell from a positive 2% to a negative 1.8%, despite the fact that nominal rates increased by 520 bps.

Yesterday’s release from the BLS showed the October Producer Price Index increased by .4%, while the YoY increase in PPI jumped 4.3%. However, the Fed will most likely seize upon the month-over-month change in the core rate, which registered a negative .6%. Bernanke will overlook the largest YoY increase in PPI since May and instead worry about the deflation anticipated by core prices. That means he will find cover to print more money, thus – at least for now – keeping nominal rates from rapidly rising, while pushing inflation even higher. Real interest rates should fall and the price of gold should thus remain in its secular bull market. In my opinion, there is little danger that nominal rates will outpace the increase in the rate of inflation until the Fed unwinds its balance sheet like it did under Paul Volcker 30 years ago.

Likewise, an increase in the value of the dollar against another currency likely indicates that the central bank of the other country is lowering real interest rates and diluting the purchasing power of that currency at a greater pace than the Fed. It does not necessarily indicate that the supply of dollars is contracting or that our currency’s intrinsic value has increased.

There will come a time when the Fed’s pursuit of inflation causes a massive crisis of confidence in our bond market and in our currency. A sudden and dramatic spike in nominal rates would send real interest rates rising and cause devastation in most markets, including gold. However, because the Fed’s likely answer to such a crisis would be to create more inflation, any pullback in gold should be muted as compared to stocks, bonds, and other commodities.

This article is written by Michael Pento of Europac and with their kind permission, O B Research has been privileged to publish their work on our website. To find out more about Europac, please visit:

Quantitative Easing Explained (Animation)

By Jason Hamlin, on November 17th, 2010

This is a must-watch video that explains quantitative easing, the actions of the Fed, Ben Bernanke and the fleecing of the taxpayer by Goldman Sachs. It is amazing that there is not greater outrage about what is happening, but the majority of Americans simply don’t understand these financial shenanigans.

“The printing money is the last refuge of failed empires and banana republics and the Fed does not want to admit this is their only idea.”

The Fed and government are committed to a policy of ‘QE to infinity’ as nations around the world race to debase their currencies. Your only refuge against this stealth form of theft is to own physical gold and silver. Not only will you protect your wealth and purchasing power, but you will help to force a short squeeze of the large commercial banks such as JPMorgan that have been manipulating the prices.

This article is written by Jason Hamlin and with his kind permission, O B Research has been privileged to publish his work on our website. To find out more about his work, please visit:

http://www.goldstockbull.com/

OGC Announces Appointment of Chief Executive Officer

The Board of Directors of OceanaGold Corporation are pleased to announce the appointment of Mr. Mick Wilkes as Chief Executive Officer, commencing in mid-January, 2011.

Mick Wilkes is a mining engineer with 26 years of broad international experience, predominantly in precious and base metals across Asia and Australia. Most recently, he had responsibility for the evaluation studies and construction of the Prominent Hill copper gold project ($1.2B) in South Australia, which is one of the more significant recent resource developments (100,000 tpa copper and 200,000 ozpa gold) in Australia.

Previously he was General Manager of the Sepon gold copper project for Oxiana in Laos where he was responsible for operations, leading the site team that built and commissioned the first international standard mining operation in the country. His earlier experience was in Papua New Guinea in various senior roles and, at the outset of his career, at Mount Isa Mines in operations and design.

Mr. Wilkes (BE, MBA) is a member of the AusIMM and currently a Board member of Aboriginal Enterprises in Mining, Exploration and Energy, and the South Australia Chamber of Minerals and Energy.

Jim Askew, Executive Chairman commented “Mick joins OceanaGold as we engage in our next phase of growth in the Philippines, underpinned by our solid production platform in New Zealand. He brings a record of recent successes at Prominent Hill and Sepon, together with broad operations experience in both Australia and across Asia. The benchmarks he has set with local communities in Asian environments are also welcomed. Together with other recent additions to the senior executive team at OceanaGold, the Company has strong leadership fully equipped to consolidate us as an intermediate sized, low cost gold producer.”

Full release

Anticipating Volatility and the Rise of Emerging Markets

By Frank Holmes, 15 November

Life is about managing expectations and we believe understanding market cycles helps investors navigate through the volatility of their investments. We often remind investors to “Anticipate Before You Participate” and I strongly urge you to read through our special presentation on managing volatility.

This table shows the monthly volatility based on 10 years of data for a number of different investments. You can easily see each asset class has its own unique DNA of volatility.

For gold stocks, it’s a normal event to see a positive or negative move of 11 percent over just one month’s time. For emerging markets, it’s just over 7 percent. Understanding this volatility is essential to removing emotional reactions and making the best investment decisions.

Recently, I’ve noticed many new faces on business television commenting about a bubble forming in commodities due to the Federal Reserve’s Quantitative Easing (QE2) policy and resulting weakness in the U.S. dollar. Both of these are a part of the commodity equation but focusing on them omits several long-term factors driving commodities.

I do not see a bubble at this time but our quant models are showing we are due for a short-term correction. Investors need to anticipate this correction and not lose sight of the long-term trend.

We believe government policies are a precursor to change, and as a result, we monitor and track the fiscal and monetary policies of the world’s largest countries both in terms of economic stature and population.  

This table shows the population size and economic stature of the emerging world—represented by what we like to call the E7—versus the developed world—the G7.

You can see that the emerging world currently holds roughly half of the world’s population but less than one-fifth of its economic clout. Already we are seeing a tremendous transformation of the emerging world and we don’t think this imbalance will remain the case for long.

Most significant has been the doubling of the world’s population since 1970, with 40 percent of the world’s population being in China and India—we affectionately call this region Chindia. Chindia has evolved from being isolationists 40 years ago to center stage on the global scene today.

With this population surge and integration into the global economy comes a need for new and improved infrastructure. Did you know that when the U.S. built its Interstate Highway System in the 1950s it consumed roughly half of the world’s available commodities?

Today’s equivalent of President Eisenhower’s highway buildout is the network of subways and rapid transit systems China is constructing. This graphic from CICC charts the world’s top ten cities by total length of rapid transit. With 410 kilometers of tracks, Shanghai reigns as king over cities like London, New York, Tokyo and Madrid.

Even more surprising is the pace at which they have been able to lay so many tracks. The first subway cars rolled down the tracks in London and New York during the 1860s but Shanghai’s first subway wasn’t operational until 1993. That means it took China 17 years to build what it took the UK and the U.S. 150 years to construct.

Shanghai and Beijing are the largest systems in China but recently many of the smaller cities, often referred to as Tier 2 cities, are hopping on board. The Chinese government has already approved construction for 28 rapid transit systems and 36 other cities have submitted applications for construction, according to CICC.

Our China analyst Michael Ding witnessed this firsthand while traveling in China last week. Michael was surprised to see a subway being constructed in his hometown of Dalian, a city of about 6 million. I had a similar surprising experience in New Delhi a couple of years ago when I traveled on the city’s new, pristine subway system. 

While short-term factors like the U.S. dollar’s volatility and the Federal Reserve’s QE2 program seem to grab the most attention, I believe the doubling of the world’s population, massive infrastructure expansion like China’s subways and the “free market policies” being embraced by the government leaders in the emerging world are much more significant.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI) is a modified equal dollar weighted index of companies involved in gold mining. The HUI Index was designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar.

This article is written by Frank Holmes and with his kind permission, O B Research has been privileged to publish his work on our website. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. To find out more about Frank Holmes’ work, please visit: