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Does the Fed Ultimately Control Interest Rates?

By Michael Pento, September 13, 2010

In forecasting the consequences of current economic policy, many pundits are downplaying the risks associated with the surging national debt and the rapid expansion of marketable Treasury securities. Their comfort stems from the belief that a staggering debt burden will be manageable as long as interest rates remain extremely low; and, as they believe the Fed is in complete control of setting rates across the yield curve, they see no danger of rates ever rising past the point of comfort. Those who subscribe to this fairy tale forget that, in real life, there are many more hands on the interest rate steering wheel.

The Congressional Budget Office estimates that the 2010 deficit will exceed $1.3 trillion and total US debt now stands at $13.4 trillion (92% of GDP). That’s a lot of debt that needs floating. Yet, the 10-year note is yielding 2.8%– which is 4.5 points below its 40-year average of 7.3%! Experience teaches that even moderately long-term investors should be expecting rising rates. Regardless of the extreme and obvious misalignment of fundamentals and bond prices, the mantra from the dollar shills remains firm: “The US dollar will always be the world’s reserve currency, and the US bond market will always be regarded as the safe-haven depository for global savings.”

With interest rates having been so low for so long, it’s understandable that many people have forgotten that central banks are not ultimately in control of interest rates. It is true that the Fed can be highly influential across the yield curve and can be especially effective in controlling the short end. But, in the end, the free market has the last word on the cost of money.

Although the Fed has certainly created enough new dollars to send prices higher, recessionary forces are, for now, disguising the evidence of runaway inflation. But when inflation finally erupts into the daylight, it will be impossible for borrowing costs to stay low. No one can realistically be expected to loan money below the rate of inflation. To attract buyers, the Treasury will have to offer a real rate of return.

Since our publicly traded debt level is increasing while our personal saving rate is not, we must inevitably rely more and more on foreign creditors to purchase our bonds. The problem is that the Chinese have been net sellers lately, and the Japanese saving rate is chasing ours down the tubes. Europe is also clearly suffering through their own sovereign debt issues. If not the Fed, who then will buy?

At this point, many economists breathe a sigh of relief. Since the Fed has no investment objectives, it could care less how much it loses by buying low-yielding Treasuries. Given that the Fed has an unlimited supply of dollars to buy such debt, it could simply choose to pressure rates lower indefinitely, so long as that policy stance is deemed necessary for a weak economy.

I concede that the Fed can always place bids for US Treasuries, and keep those rates low, but does that mean all debt markets will follow suit? Will private banks continue to offer rock bottom mortgage rates if housing defaults soar or inflation rises? What about the corporate bond market and municipal debt? Can the Fed order a bank to loan to a company at a rate the bank does not find profitable? The only way to keep rates in all debt markets in line would be for the Fed to buy all kinds of debt, not just Treasury debt. Such a policy has never been considered, let alone attempted, by any major economic power.

And what will our foreign creditors think about such a strategy? Anyone with the ability to move investments outside the US dollar would clearly do so, to avoid the wholesale debasement that such an inflationary policy would create. Once you take the argument to its logical conclusion, it is plain to see how futile, ignorant, and dangerous an attempt to hold all rates down would be. Americans can only hope Fed Chairman Bernanke isn’t as foolish as his groupies.

Ask any historian of Germany, Argentina, Bosnia, or Zimbabwe why interest rates skyrocketed during their respective battles with hyperinflation. Why were their central banks unable to control borrowing costs?

In the end, central banks can only temporarily distort the savings and demand equation. The more the Fed prints, the higher the eventual rate of inflation will be. If mainstream pundits truly believe the Fed can supplant the entire public and private market for debt indefinitely, then I don’t want to be around when that fantasy inevitably becomes a nightmare.

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:

Endeavour Agrees to Sell 43% Interest in Crew Gold for US$215 Million Cash

Endeavour Financial Corporation is pleased to announce that it has signed a binding agreement for the sale of its shares of Crew Gold Corporation to Severstal Gold N.V. for US$215 million in cash. Endeavour had acquired its investment in Crew Gold at a total cost of US$134.5 million such that the sale of this investment realizes a profit of US$80.5 million.

Neil Woodyer, Chief Executive Officer commented:
Endeavour has accepted the opportunity to exit its investment in Crew Gold at a significant profit which is a superior alternative to remaining in a minority shareholder position. The capital derived from monetizing this investment will be used to fund our growth and build value for Endeavour shareholders. Following this transaction Endeavour has approximately US$180 million of cash and access to a US$100 million Acquisition Facility. We are now in a position to aggressively seek acquisition opportunities in the gold sector

Full release

Orvana Announces Preliminary Economic Assessment for Copperwood Project

Orvana Minerals Corp announced today the highlights of their 43-101-compliant Preliminary Economic Assessment of the Copperwood copper project, Upper Peninsula, Michigan, USA.

The study contemplates a 10-year underground operation that applies room-and-pillar mining. A trade-off study determined that the most economic mining method is the use of a continuous miner, which is commonly used in coal, salt, trona, and potash underground mines. Processing would be by froth flotation.

Copperwood is an attractive copper project and we will work towards applying for a mine permit next spring, said Roland Horst, Chief Executive Officer of Orvana.
The state of Michigan considers mining essential to their future economic growth, and Copperwood can definitely be a part of that growth. We are encouraged by the communities’ support to develop the deposit and look forward to working with them to put the mine into production

Full release

Oceana to Join S&P/TSX Composite Index

It is now official, as we reported on September 2nd, OceanaGold is to be included in the S&P/TSX Composite Index.
OceanaGold is not only being added to the S&P/ASX 200 index after the close on September 17, the company is also joining the S&P/TSX Composite Index. This is great news and significant when getting a valuation more in line with peers.

Executive Chairman, Jim Askew commented, “We are very pleased to be included in these three additional S&P indixes. In particular, the addition to the TSX Composite and ASX 200 indexes which are the key benchmarks for the Toronto and Australian Stock Exchanges will assist in further broadening our shareholder base and increasing share liquidity”.

Full release (S&P)

Full release (Oceana)

S&P/TSX index information page

OceanaGold in the Media

Miner tips $30m boost to profits

OceanaGold’s 2010 bottom line is forecast to be boosted by about $30 million at current gold prices due to the miner’s decision to buy back its hedge cover from March 31 this year.

The company’s investor relations vice-president, Darren Klinck, was in the South Island last week visiting operations on the West Coast and said there had been no impact on OceanaGold’s mines from the recent 7.1 magnitude earthquake.

OceanaGold had paid US$72m (NZ$99m) to buy back its hedge book at the end of March. It was making the $30m bottom-line prediction based on the fact that it now made extra upside on gold prices above NZ$1565 an ounce.

The company ran a C$85m (NZ$113m) capital raising to buy back the hedge book.

“Now we’re completely 100 per cent unhedged. We closed the book out at an average of NZ$1565 per ounce and the gold price since then has been as high as the high $1800s,” Klink said.

With gold price now around NZ$1770 an ounce, it was making $200 more an ounce than it would have under the hedging arrangement. That figure was multiplied against an expected production of 150,000 non-hedged ounces to give the $30m boost to the bottom line.

The NZX-listed company was forecasting gold production of 270,000 to 290,000 ounces in the year to December 2010.

Klinck said international institutional investors were more interested in gold companies in a non-hedged position. The stock now also had more liquidity.

OceanaGold was also aware of a lot of corporate merger and acquisition and takeover activity within the global gold miner sector.

Already Newcrest mining had merged with Australian producer Lihir Gold to create the world’s fourth-biggest gold company. Newcrest would produce in the order of three million ounces annually on an unhedged basis.

“I think companies are quite bullish on gold and looking to increase production and increase resources … the underlying sentiment is you could see continued merger and acquisition activity here as we move forward, provided the gold market remains strong,” Klinck said.

Asked if OceanaGold could be in merger talks or be a merger target of another company, Klinck said the company was focused on its own growth plans.

“As far as the M&A [merger and acquisition] goes, from a company perspective you can’t spend your time looking in your rear-view mirror. You’ve always got to look forward and run hard. That’s what we’re doing.”

The company was focused on expanding its own resource base and had 10 drill sites working in the South Island. It had in excess of 25,000 metres of drilling planned in New Zealand in 2010 both at its Macraes open cut & Frasers underground mine in Central Otago and at its Reefton open cut mine on the West Coast.

“We’ll spend between US$9m and US$10m this year on exploration. So that’s a very significant investment.”

With a market capitalisation of around A$740m at the end of last month, OceanaGold was also evaluating options for its Philippines-based Didipio gold and copper project.

It was talking to potential joint venture and strategic investment partners, and in 2007-2008 spent around US$80m on initial mine work.

“Unfortunately the capital cost to complete that project blew out of control  this is when oil was going to US$150 a barrel … we had to lock it down and put it on care and maintenance. We’ve now gone back and looked at it.”

The miner has estimated reserves of 1.94 million ounces of gold here, and 190,000 tonnes and 1.65 million ounces of gold in the Philippines.

Full article