Can I sell my gold and silver?

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Gold prices seem to be setting new highs daily. Of course those would be highs not adjusted for inflation or debasement of the dollar. If we were to set real highs, we would have to see gold prices rise near $2400 per ounce - maybe higher! Obviously, a dollar today is worth far less than a dollar was in 1980 when gold and silver hit long-standing record highs of $850 an ounce and $54 respectively.

Just to help you put things into perspective, in 1980 a postage stamp was $.15 cents, a gallon of gas was $1.25 and the Median Household Income was $17,710.00. Our entire Federal Debt was just $909.1 billion and government spending was a paltry $590.95 billion. Here's one more little tidbit, the Dow reached a high of 1000 and a low of 759.

These things considered, it's no stretch to say gold would have to triple its 1980 record high in order to claim the title of, "New Record Holder". Of course, most realize the $850 an ounce price marked the end of a bubble. Gold prices, as did silver, made parabolic moves higher and then quickly dropped off their highs to enter a new age of easy credit, higher wages and economic expansion. Thank you Ronny.

Is that what gold and silver investors have to look forward to again? Reaganesque growth? The stigma attached to precious metals investors is that they hope for doom, economic collapse, hyperinflation, currency failure and every other kind of market debacle. I believe the contrary. I believe precious metals investors would gladly trade gains from higher metal prices for a return to the days when real estate had value, stocks were constantly driving to new highs and jobs were plenty.

Enter budget, deficits and debt. The prospect of a return to utopia seems to grow weaker each day. Hence, more gold and silver are being bought - not less! So when do we sell? Have prices topped? Is it time to liquidate and take profit?

If we believe gold's 5000 year history as a preserver of wealth, we have to begin to compare the gold price to the markets and weigh its value in comparison to our Federal Budget our deficits and our debt. Are precious metals now working to preserve wealth? This is where it gets interesting.

Let's take the Dow for example, to buy an equivalent position in the Dow today as existed in 1980, it would cost you 12 times as many dollars.

Note: The Dow is a very convoluted and subjective measure. The Dow components themselves are subject to change by committee in order to better reflect current economic conditions. In fact, did you know GE is the only remaining of 11 original components? Then, in order to account for things like stock splits, additional calculations are made to keep the measure accurate. See this link for a complete explanation on the History of the Dow.

As we relate today's gold price to the Dow, you see why some say gold could be trading as high as $10,000 an ounce in order to pace growth in the Dow average. If we look at budgets and debt, the case for gold at an even higher price per ounce can be made. Today, Federal spending is 6 times what it was in 1980 and debt - which we could reasonably argue should pace inflation and debasement of the dollar - is nearly 16 times greater. . . and rising!

Now to the question, "Can I sell my gold and silver?"

Obviously it's a question I hear more often as prices move higher. I believe that is a question each person has to answer for themselves. I usually ask some questions in return, "Do you need the money?", "If you sold, what would you put the dollars in?" . . . and, "Why did you decide to own gold and silver to begin with?

Let's keep in mind that, really, very few individual investors own either gold or silver. (See this previous report that puts into perspective the actual size of the metals market in comparison to world financial markets.) The price has risen because central banks are buying it, countries are buying it and huge investors who see the collapse of currencies on the horizon, are all buying gold. Do you think just because gold and silver have climbed this far, (not even to inflation adjusted highs) that those big players are licking their chops to sell?

When I ask the question, "Why did you decide to own precious metals to begin with?" the answer is usually something to the effect, when the world money collapses I want something real as protection. Bingo! That is the same reason central banks and countries like Brazil, Russia, India and China (others too) are all buying gold and silver. As far as I can see, there has been no real currency collapse to this point. We still print it, spend it and use it to pay our bills and buy things. Hyperinflation is at bay. The illusion is alive.

So, if the purpose for owning gold and silver and other precious metals is to protect against collapse, wouldn't selling it now defeat the purpose? And if currencies do not collapse? Then great, the plan to print our way out of depression and collapse worked and we can all go back to work, borrow some money and speculate in real estate again.

Freegold Theory: the massive revaluation of gold after the collapse of paper assets

By GoldSubject on March 12, 2010

This post describes my understanding of the so-called Freegold theory, which the brilliant blogger FOFOA has been eloquently and convincingly writing about for a couple of years. FOFOA’s blog consists of many extremely long and erudite posts that keep referring — often tangentially — to Freegold theory. This is a brief explanation of Freegold theory as I currently understand it, for those who are flummoxed by the enormous quantity of information on FOFOA’s outstanding blog.

In my last post I explained why I (along with many other people) believe that all paper assets will vaporise sooner or later, because there is not enough physical wealth in the world to satisfy the demand implied by those paper documents. The whole point of a paper asset — including fiat money itself — is that the owner can redeem it for the actual physical assets on demand. Paper assets have no value if they cannot be redeemed for the tangible assets they are supposed to represent. Sooner or later the system will have to default en masse as investors realise that all they hold is worthless paper and scramble to get out (convert the paper into money, and money into physical assets). The first few to get out will probably manage to convert their paper wealth into tangible assets; everyone else will be out of luck.

* Ultra-simple summary of the above: if you own money, stocks, bonds or other securities, you think you are wealthy because you can use these documents to obtain money and then use that money to buy houses, cars or whatever else you fancy. The problem is that there simply aren’t enough physical goods in the world to satisfy the demands of all the money and other paper wealth that exists. What would happen if everyone decided to get rid of money and other paper wealth and exchange it for cars, houses and other goods? There aren’t enough goods to satisfy all the money and paper wealth that exists. This means that much of the “wealth” represented by all this paper is non-existent. Plain and simple.

Hence the system is bound to collapse, because it is essentially a Ponzi scheme, and Ponzi schemes cannot last forever, because sooner or later an “investor” makes a claim that the Ponzi scheme cannot satisfy, at which point the whole thing collapses and all of the “investors” realize that they have lost their wealth.

The question is: when this giant default happens and worldwide confidence is completely lost in paper, how will value be stored? So far most of the wealth has been stored as fiat money, stocks, bonds and other paper assets. It was wrong to do so, because paper is too easily manipulated and cannot be trusted, but that is what happened.

So, again, when paper can no longer be trusted to store and represent wealth, how will savings be stored? The answer is that after the massive default of paper wealth — after “paper will burn”, as Another said — all of that value will be poured into gold. Gold will go back to its historic role as the best and most reliable store of value there is.

This means that they will be an absolutely gigantic, one-off revaluation of gold. Gold will become the numéraire for all the wealth of this planet, which means that it will be the unit of account used to describe the value of all goods and services in the world. The value of gold will be massively higher than $1100 per ounce. Some say the buying power of gold will increase 50-fold; others say it will increase 100-fold. Either way, this should give you an idea of how important it is to buy physical gold as soon as possible.

After the total failure and repudiation of all paper assets, paper money will still be used, but only for transactions, not for the storage of value. The long-term storage of value will be the preserve of gold and gold alone.

This means that whenever you get paid for a job, you will be paid in local currency, and you will keep part of that currency to satisfy your immediate expenses, and use the rest — the money that you want to save — to buy gold.

In one of my early posts I wrote that fiat money represents a liability on someone’s balance sheet, whereas gold is 100% equity and no one’s debt. This is why whenever you get paid, you should figure out how much of this money you intend to put away for the long term, and use that amount to buy gold. Only when you have converted fiat currency to gold can you truly consider yourself to have been paid in full.

One key aspect of Freegold theory is that the price of gold — its buying power, if you prefer — will be set by the free market instead of being manipulated by bankers and other sinister entities. I guess this is why this theory is called “Freegold”.

This is Freegold theory as I understand it. It is very straightforward and intuitive when one realises just how much paper assets have been inflated and manipulated, to the extent that an implosion is inevitable, at which point the only store of value that can be trusted is gold.

A corollary of Freegold is that those who buy physical gold now are making the investment of the century. I usually have a very strong aversion to using the term “investment” to describe gold, because gold is for the storage of wealth, not for its generation, but if Freegold does happen, the gargantuan increase in the buying power of gold will indeed make it the investment of the century for those who bought it BEFORE Freegold kicks in. If Freegold ever becomes a reality, it will be a gigantic transfer of wealth from those who own paper assets to those who own gold.

Ultra-brief summary of Freegold theory:

Money, stocks, bonds etc. represent more wealth than really exists –> massive default inevitable –> paper no longer trusted to store value –> only gold is trusted to store value –> buying power of gold massively increases. Value of gold set by free market; money used for transactions; gold used to store value. The biggest and most dramatic revaluation in history.

FOFOA insists that Freegold is an inevitable outcome; others are skeptical. In a future post I will consider the arguments for and against Freegold.

If you find this theory exciting, you are not alone. There is something undeniably intoxicating about the thought of buying a 1-ounce gold coin now for $1100 and then see its buying power rise to the equivalent of $50,000. I was initially excited about this theory, then thought it was too good to be true, and after much thought and research, I have come to the conclusion that it is inevitable. Buying gold to store wealth was always a good idea, but the reality of the Ponzi-scheme nature of all paper markets (including fiat money) now makes buying gold not only smart, but also urgent.

University Of Texas Fund CEO Shares His Views On Gold

Is Gold in a Bubble?

The Bedrock of the Gold Bull Rally

US Global Investors-Frank Talk

Last week I had the pleasure of participating in a webcast for Bloomberg Markets Magazine regarding gold investing. It was a very insightful presentation and I suggest you view the replay at www.bloombergmarkets.com. What struck me on the call was the negativity surrounding the gold market. Call it a bubble, a frenzy or mania, there seems to be a large number of voices in the marketplace who just are not fans of gold, whether prices are moving up, down or sideways.

Naysayers started calling gold a bubble back when prices hit $250 an ounce and though gold’s bull market has tossed and flung the bubble callers around for almost a decade now, their voices have only gotten increasingly louder as prices broke through $1,000, $1,200 and now $1,400 an ounce.

However, gold prices appear asymptomatic of the signs generally associated with financial bubbles.

For instance, we haven’t seen price spikes. Despite rising from under $1,000 an ounce to over $1,420 over the past six months, that represents only a 0.7 standard deviation move for gold prices, according to Credit Suisse (CS). The average standard deviation move of other bubbles—Japanese equities in 1986, the tech boom in 1999, the GSCI in 2005 and gold in 1979—is 5.3. Gold’s 180 percent move in 1979 represented a 10.3 standard deviation move, more than 14 times the magnitude we see today.

The reality is that gold doesn’t possess the traits necessary for a financial bubble to form. Rodney Sullivan, co-editor of the CFA Digest, has done some great research on the history of markets and bubbles going all the way back to the 1600s. He discovered three key patterns in the 47 major financial bubbles that occurred over that time period.

These three ingredients of asset bubbles are financial innovation, investor exuberance and speculative leverage. The process begins with financial innovation, which initially benefits society as a whole. In the exuberance stage, usage of these innovations broadens; they become mainstream and attract speculation. The third step, the tipping point for a bubble to form, is when these speculators pile on massive leverage hoping to achieve greater success. This excessive leverage adds increased complexity, which mixes with irrational exuberance to create an imbalance in the marketplace. Eventually, the party comes to an end and the bubble bursts.

This is what happened with the housing bubble in the U.S. as Main Street home buyers leveraged themselves 100-to-1, Fannie Mae leveraged itself 80-to-1 and Wall Street investment firms leveraged themselves over 30-to-1.

Gold as an asset class is far from being overbought by speculators. Eric Sprott recently did a fascinating presentation explaining how underowned gold is as an asset class. Sprott wrote that despite a 30 percent increase in gold holdings during 2010, gold ownership as a percentage of global financial assets has only risen to 0.7 percent. That’s a big increase from the 0.2 percent level in 2002, but Sprott points out that it’s misleading because the majority of that increase was fueled by gold appreciation, not increased level of investment.

Sprott estimates that the actual amount of new investment into gold since 2000 is about $250 billion. Compare that to the roughly $98 trillion of new capital that flowed into other financial assets over the same time period.

Gold equities have seen even lower levels of investment. From 2000 to 2010, $2.5 trillion flowed into U.S. mutual funds, but only $12 billion of that went into precious metal equity funds. Of course, those figures were significantly impacted by the advent of gold ETFs during the decade. Despite the growth of the SPDR Gold Trust (GLD), which held more 1,200 tons of gold as of March 31, gold remains largely underowned as a portion of global financial assets.

The bar chart from CPM Group shows gold as a percentage of global financial assets over time. In 1968, gold represented nearly 5 percent of financial assets. In 1980, the level had fallen below 3 percent. That figure had shrunk to less than 1 percent by 1990 and has remained there since. Sprott wrote that “it is surprising to note how trivial gold ownership is when compared to the size of global financial assets.”

That point is magnified by the pie chart from Casey Research. Dr. Marc Faber included it in his April newsletter to show just how small a portion gold and gold stocks are for large institutional investors like pension funds.

Investors who don’t think gold is a bubble but fear they’ve missed the boat need to look at the short- and long-term factors supporting gold at these historically high price levels. In the near-term, gold prices are being buoyed by continued weakness in the U.S. dollar.

The Trade-Weighted Dollar Index (DXY) is just above the lows experienced during November 2009 and is only 8 percent above the “critical” March 2008 low, according to BCA Research. BCA says the U.S. dollar’s weakness is driven by four factors:

• Federal Reserve balance sheet expansion via QE2
• Combination of low real interest rates, steeply upward-sloped yield curve and perky inflation expectations that should continue in the U.S.
• Plans by the European Central Bank to raise rates later this month
• Willingness of Chinese authorities to allow for yuan (RMB) appreciation when the U.S. dollar is weak

This is part of what we call the Fear Trade. This graphic illustrates that the Fear Trade is a function of two separate government policies: monetary and fiscal. Whenever there is a structural imbalance between a country’s monetary and fiscal policies, gold tends to perform as a “safe haven” currency. Currently, the quantitative easing measures implemented by the Federal Reserve and the significant size of the deficit spending by the government to increase entitlements to ward off a recession have created a significant imbalance between monetary and fiscal policies. This has devalued the U.S. dollar which, in turn, has boosted gold prices.

We believe that as long as the U.S. government refuses to trim entitlement and welfare programs and continues to keep Treasury bill yields below the inflation rate to battle deflation, gold will remain an attractive asset class.

Longer-term, our experience shows that whenever you have increased deficit spending, rapid money supply growth and negative real interest rates—that’s when the inflation rate is higher than the nominal interest rate—gold tends to perform well in that country’s currency. So far we have not seen rapid money supply growth here in the U.S., but the other two factors have been the main thrust behind gold’s record rise.

GFMS CEO Paul Walker echoed those drivers in an interview with MineWeb this week. Walker said that “ultra-low interest rates, macro-economic dislocation, fears of global imbalances…the wrath of these things still remain solidly in place and that’s really the bedrock of the gold bull rally.”

CS says the combined $6.3 trillion of excess leverage in the G4 economies (U.S., eurozone, Japan and Great Britain) means that their central banks will be forced to push real interest rates down to abnormally low levels. You can see from the chart that this is quite bullish for gold prices. Any time the real Fed funds rate is below 2 percent, gold tends to rise.

Current projections from the Congressional Budget Office (CBO) have the U.S. federal deficit at $1.5 trillion this year. To show the effect this has had on gold prices, we overlaid the rise in U.S. federal debt with the price of gold.

You can see from the chart that gold’s bull run began in 2002, about the same time federal debt began to rise significantly. Gold played catch up at first, but the two have tracked each other rather closely. Since 2002, gold prices have risen 308 percent versus a 119 percent increase in federal debt. This means that gold’s sensitivity to a rise in federal debt is just over 2-to-1. With lawmakers in Washington, D.C. still squabbling over where and by how much to cut the budget, it’s unlikely the federal debt level will recede any time soon.

This is very constructive for long-term gold prices, but just how bullish depends on who you ask. The team at CS sees gold at $1,550 per ounce by year end. BCA estimates gold to remain in the $1,400-$1,600 range in 2011. Walker of GFMS said he believes gold will surpass the $1,500 mark by year end because “all of the structural factors supporting gold are in place.” Perhaps the most bullish forecast has come from Rob McEwen, former gold analyst and founder of GoldCorp, who said late last year, and reiterated last week, that he thinks gold could hit $5,000 per ounce in the next three to four years.

It’s important to remember the strong cultural attraction that many people in emerging countries have toward gold. It’s a much stronger connection than that of the developed world and essential for rising gold demand.

We like to compare the G-7 countries to our E-7—the world’s seven most populous nations. Interestingly, the G-7 is 50 percent of global GDP but only 10 percent of the total global population. The E-7, on the other hand, represents roughly 50 percent of global population but only 18 percent of global GDP. We would like to point out that money supply and GDP per capita is rising substantially faster in the E-7 than it is in the G-7, 17.7 percent money supply growth in the E-7 versus 3.7 percent in the G-7. If money supply growth in the E-7 continues at a rate of 15 percent or more for the E-7, it would be a strong catalyst for higher gold prices.

In conclusion, based on the above factors and trends, we believe gold could double over the next five years.

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. M2 Money Supply is a broad measure of money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds. The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar. The S&P GSCI Spot index tracks the price of the nearby futures contracts for a basket of commodities. The following securities mentioned in the article were held by one or more of U.S. Global Investors family of funds as of 12/31/10: Goldcorp, SPDR Gold Trust (GLD).

Central Bank Gold Buying is a Game-Changer

H/T: The Wealth Cycle Principle: Mike Maloney



Over the past few years, a dramatic change has taken place in the precious metals market: the world’s central banks have shifted from being net sellers of gold to net purchasers of significant quantities of gold—and that’s only those nations who accurately report central bank transactions.

On this video blog, Michael Maloney uses the 2008 and 2009 CPM Gold Yearbooks to illustrate this market-rocking effect. As recently as 2009, central banks were projected to sell some 4 million ounces of gold; instead, when the 2009 real numbers came in, they had purchased 15 million ounces. “I can’t tell you what an enormous shift in this bull market that is,” Mike says.

“That means that governments around the world are starting to distrust the dollar; they are starting to panic. When one country blinks, that’s when this whole thing is over with. This means the dollar is toast eventually.”

The 15 million in official transactions reported by CPM Yearbook reflects only the available data, Mike continues. “This is only 15 million ounces, and that doesn’t include suspected buying by Iran and China and several other countries that have been buying under the table. They don’t have the official numbers because they don’t report them to the World Bank and the IMF and so on.”

While projected central bank purchases for 2010 were about 9 million, Mike predicts that when the official numbers are released about three days from now, actual gold purchases will be near all-time highs or even off the chart. For example, a recent Financial Times report about Iran’s buying up gold reserves to reduce its exposure to the dollar is not reflected in official figures.

“This is the big game-changer,” Mike says. “I don’t know how much longer this bull market is going to go, but I do know it’s going to be the greatest bull market in history.”

Inflation to continue rising; gold to benefit

H/T: Mineweb

In recent months we have seen some strange activity in certain markets. For example, after being hit by a series of disasters, the Japanese yen climbed so high against the other majors that a group of central banks were called to intervene in the market. But, these natural disasters do not normally have a positive effect on the country's currency.

Then, despite the fact that the Eurozone has some major problems, the euro has gained on the back of a probable rate hike expected this week. And, after US employment recorded a second straight month of solid gains in March, the US dollar failed to rally on this positive news.

While investor sentiment seemed more positive resulting in a general upward move of most equities and commodities, in the US, and after non-farm payrolls showed a larger than expected increase in March and rose by 216,000 while the unemployment rate dropped from 8.9% to 8.8%, hitting a two year low, the greenback failed to move upwards.

Although the greenback attempted a rebound in the middle of the week on the back of some hawkish comments from Fed officials, it later dropped after comments from New York Fed Dudley, who has a permanent voting seat on the Fed's policy-setting panel, unlike other regional Fed officials who hold voting seats on a rotating basis. Dudley's warned that Fed was "still very far away" from achieving its' dual mandate of price stability and full employment and there is no reason to reverse course yet.

Lately the data that usually has a positive impact has had a negative impact and the data that usually has a negative impact, has had positive impact. There is something else at play here, and that missing link could well have something to do with the changes in monetary policy and the effects thereof.

The euro soared against other European majors as well as the yen last week, and at the same time, it remained firm against the dollar. Recent stronger-than-expected inflation data strongly suggests that the ECB is likely to raise rates in April and probably rate hikes in the future. The Eurozone CPI rose from 2.4% to 2.6% year-on-year in March, the highest level since October 2008 when CPI was at 3.2% year-on-year. This was also the fourth consecutive month that inflation has remained above the ECB's 2% target. It is widely expected the ECB will raise rates this week by 25bps from historical level of 1%. The upcoming ECB meeting this Thursday will be a closely watched event and President Trichet's comments at the press conference after the announcement will surely move prices.

While the next FOMC meeting will not be held until April 24, speeches from Fed members will be closely watched. Recent comments from Fed presidents have turned more hawkish. Philly Fed President Charles Plosser said "signs that inflation expectations are beginning to rise or that growth rates are accelerating significantly would suggest that it is time to begin taking our foot off the accelerator and start heading for the exit ramp". He also added 'it's certainly a possibility' for the Fed to raise interest rates before the end of the year. The issue is 'definitely on the table but it will depend on how things play out over the next few months'. In a separate statement, Dallas Fed President Richard W. Fisher said it 'makes a lot more sense' to stem stimulus measures as unemployment fell and the US' growth is 'self-sustaining'.

According to a report released by The Bank of Japan (BOJ) on Monday, the monetary base in Japan surged 16. 9 % in March from a year earlier, rising for the 31st consecutive month.
Huge amounts of extra liquidity were pumped into money markets following the massive March 11 magnitude-9.0 earthquake and ensuing tsunami that devastated homes, business and infrastructure in the northeast of Japan, as well as sparking an on-going nuclear crisis.

The BOJ pumped in the funds to ensure there was enough liquidity for banks and other institutions affected by the catastrophe to continue lending to each other.

The central bank maintenance of very accommodating monetary policies as well as injecting emergency funds into markets has helped facilitate the increase in Japan's monetary base in March.

With this expansionary monetary policy plus those of the US Fed and the ECB, inflation is set to increase, and the value of three of the most important currencies is set to decline. Add this to the rising prices of oil, and the logical conclusion is higher gold prices.

The price of oil jumped to a fresh 30-month high, on Monday and traded above $108 a barrel as fighting in Libya and unrest in the Middle East continued to raise doubts about future supplies.

Benchmark crude for May delivery reached $108.80 per barrel, the highest price since September 2008. In London, Brent crude increased by $1.35 to $119.70 a barrel on the ICE Futures exchange. While Libya's oil exports have come to a halt, rebels are trying to ship some oil to help finance their uprising. Libya supplied about 2% of the world's oil supplies, most of which went to Europe.

In Yemen, security forces opened fire on protesters in another violent anti-government skirmish. Yemen doesn't produce much oil, but an extended conflict could disrupt nearby shipping lanes for tankers carrying nearly 4% of the world's oil.

While gold prices will be very much influenced by changes in monetary policy, I also expect prices to remain firm and well supported by robust physical demand which will increase during price corrections. I also expect to see strong physical demand to continue from India and especially China. The People's Bank of China (PBOC) recommended in the annual Financial Markets Report to buy gold as a hedge against inflation and as value preservation in a world where major currencies were declining in values against the precious metal.

In Hong Kong the demand for physical gold has been exceptionally strong with prices recording new record highs. Many experts and dealers in the bustling city remain very optimistic about gold mainly because of the Eurozone debt crisis and on-going political unrest in the Arab world.

In the medium to long-term, I believe the outlook for the yellow metal remains extremely bullish and the price will soon make new highs.

TECHNICAL ANALYSIS

The price of gold has come up against resistance at around $1440. However, once it breaks this level the price could move rapidly to $1480.

About the author

David Levenstein began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients. www.lakeshoretrading.co.za

Will gold price go down if interest rates rise?

H/T: Mineweb

So frequently today we rely on economically established perceptions that fail time and again, simply because the conditions in which they were established have changed. One of the economic clichés is that exchange rates will rise if interest rates rise. You can be sure that if there was still a Spanish Peseta or Greek Drachma and they were paying the sort of interest rates their sovereign bonds were paying now, these currencies would still be falling, why? Many feel that if interest rates rise, gold would automatically fall. But is that going to be true? There's a great deal more involved to this story than just interest rates!

INTEREST RATE RISES IN A GROWING ECONOMY

In an economy like China's, borrowers tend to be businesses enjoying the remarkable growth rates of around 10%. Their businesses in general are thriving and income is either steady or growing with the potential to grow more, or easily pay down debt. If you throw 5 and 7% inflation at them on certain items, their ability to absorb those costs is enormous. These items may include oil and food which do absorb a large portion of discretionary spending, but are accepted as one of life's burdens that we all must endure. Usually, they can pass them on to their customers without them being driven away.

In such an environment, interest rate rises then have the desired effect of tempering growth without stifling it. Overheating, at the risky end of the market, is restrained and that along with a remarkable cooperation with government objectives in the economy has the desired effect of keeping the economy growing without excessive strains in one part or the other.

INTEREST RATE RISES IN A SHRINKING ECONOMY.

Where an economy is in recession and inflation starts to rise from food and energy inflation, the economy finds it extremely difficult to absorb such inflation, in all areas of the e economy. Traditional economics would have central banks attempt to ensure that such inflation does not flow into other areas, but it can only use interest rates to do it. This is like a misdirected sledgehammer in so many cases as it now imposes yet another burden on businesses that are struggling to survive and ensure minimum profitability.

The effect of interest rate rises in this climate is to curtail business activity even more. At its worst, it can eventually precipitate a depression. By damaging already weak consumer confidence, its impact is that much greater and that much more difficult to recover from. If confidence is already undermined, then such further cost pressures send it spiraling downward. The U.K. may experience this situation in 2011 and 2012.

INTEREST RATE RISES IN A ‘STAGFLATING' ECONOMY

Now let's take a situation not quite as drastic as that above. There is little to no economic growth and the economy suffers from the impact of food and energy inflation. Energy inflation is imported, so there is usually no way to restrain such price increases. Food inflation in economies that are not self-sufficient has the same effect.

Now along the lines of traditional economics, inflation is the one factor that prompts rate increases. Whether it is a one-off spike, or a persistent rising of the oil price does matter, but these days there appears to be no respite from these, which now drive the price of oil to $113 per barrel.

An interest rate increase, when it comes, becomes an additional drain of income, thus adding to the burden of a business that is struggling to survive and doesn't see any economic relief. The result is that the business now begins to suffer. It targets cost cutting, which in turn ensures the overall economy of the nation either continues to stagnate or declines into recession or worse.

THE IMPACT ON CURRENCIES OF RISING INTEREST RATES

The theory that is usually accepted is that if you raise interest rates you raise the value of a currency internationally. This is true where an economy is growing in a sustainable way, provided exchange rates are not managed by the central bank or government. The ‘carry' trade has the function of borrowing money from a low interest rate nation and placing it on deposit in a high interest rate paying nation, so placing downward pressure on one exchange rate and upward pressure on the recipient currency. It is another source of gain if the prospects for the currency where the funds are borrowed are poor and it is declining anyway. This allows interest gains to be enlarged by a capital gain on the exchange rate.

Where interest rates are rising but inflation is higher there exists a ‘negative real' interest rate which will lead to an exchange rate decline. Where the decline is due to economic fundamentals, then rising or high interest rates may well not look attractive to outside lenders. This negates any benefits from interest rate hikes.

ILLUSTRATION

Take for instance an individual that is over-borrowed and his business declines to the point where he cannot service his loans. The bank would usually call in those loans and if unable to, will sell the clients assets in an attempt to cover the debt. If that man were to approach another bank for more loans with which to delay sequestration it may be that he gets the loan, but to what impact on his balance sheet? He will, of course be forced to pay a higher interest rate. This will ensure the likelihood of repayment is reduced. The higher interest rate will by no means raise his credibility in the market place.

Greece, Ireland, Portugal and Spain have moved into that category. The U.S. debt situation has recently been likened to Greece's. So to attract more foreign capital, would higher interest rates add credibility to the U.S. debt position? In that case no.

THE U.S.

If the U.S. were to attempt to ensure zero ‘real' interest rate levels by raising interest rates to that of internal inflation [including food and energy inflation], the impact would not be to make the dollar more attractive but to at best stave off the speed at which the dollar is falling in foreign exchange markets. What would happen is that state and federal borrowing would have to offer higher interest rates. This would hammer the bond market and frighten off foreign lenders as well as cause the economy to move into ‘stagflation.'

Certainly, no such rate hikes will take place until the U.S. economy is able to maintain growth in the face of such rises. This may well take some time longer.

THE EUROZONE

The E.C.B. has let it be known that they will impose three interest rate hikes in 2011 in an attempt to rein in inflation primarily from food and energy. The E.C.B. is clearly of the opinion that the stronger Eurozone economies are able to bear these rises. Economic activity is concentrated in the stronger E.U. economies.

While the E.C.B. is aware that such interest rate hikes will hurt its southern members, their relevance to the overall E.U. economies is not of significance. They are trading on the belief that the woes of these nations will not undermine confidence in the euro itself. In fact, the joy of having weak members in the Eurozone is that they help to keep the euro exchange rate down and the stronger members competitive internationally.

We feel they may have miscalculated in that the confidence in the euro may well prove mercurial should any more members need financial assistance to meet their debt obligations. Their inability to date, to finalize the composition and strategy of the bailout fund, may well lead to them being overextended on their balance sheet. Should the Eurozone subsequently slip into stagnation, they will be seen to be overextended.

WILL THE GOLD PRICE GO DOWN AS INTEREST RATES RISE?

Again it comes back to confidence and the waning of instability. If U.S. interest rates move into real positive territory on the back of a sustainable recovery then the dollar will offer value. If the recovery has not gained real traction and rising interest rates still leave them negative ‘real' rates, then the dollar will not offer value. In the former case U.S. gold investors may well liquidate their holdings to some extent. In the latter case there is little reason to sell gold holdings.

Julian Phillips is a long term analyst of the global gold and silver markets and is the founder and principal contributor for Global Watch - Gold Forecaster - www.goldforecaster.com and Silver Forecaster - www.silverforecaster.com