Printer Friendly

eMail Article

February 22, 2008

Six Months of Fun, Fun, Fun from the Fed
by Adrian Ash

"...If Bernanke was expecting a 13% rise on Wall Street, he's got a 45% rise in gold instead - plus a real disaster in US Treasury bond yields..."

THIS WEEK marked the six-month anniversary of the Fed's first cut to US interest rates during the current world banking crisis.

And it's been fun, fun, fun ever since for hard asset investors.

Aimed at promoting "orderly conditions" in the world of finance, that 0.5% cut to the Fed's discount rate kick-started the sharpest collapse in Dollar interest rates since...well, since last time it tried to restore order to the value of US financial assets.

But while short-term money markets remain tight six months later - and the subprime panic has since spread to "monoline" bond insurers, private equity groups, pan-national banking giants and even US student-loan finance - the only order so far has come in raw materials, rather than finance.

A big fat order of whopper-sized gains, in fact, with a fried egg on top for good measure...

The price of Gold meantime - whose only real utility, unlike all other natural resources, is as a store of value - has now risen in twenty of the last 27 weeks. Spot Gold Prices have gained 44.7% since the morning of August 17th, just before the Fed announced its "extra-ordinary" rate change.

Whereas the S&P500 stock index has dropped 7.5% of its value. Which surely wasn't the plan.

"Even the casual observer can have no doubt that FOMC decisions move asset prices, including equity prices," said Ben Bernanke in a speech of Oct. 2003. "Estimating the size and duration of these effects, however, is not so straightforward."

Then a mere Fed governor, rather than the big cheese himself, Bernanke related a pile of highly detailed and utterly pointless research he'd done with Kenneth Kuttner of the NY Fed. In short:

"The statistical evidence is strong for a stock price multiplier of monetary policy of something between 3 and 6, the higher values corresponding to policy changes that investors perceive to be relatively more permanent. That is, according to our findings, a surprise easing by the Fed of 25 basis points will typically lead broad stock indexes to rise from between 3/4 percentage point and one-and-a-half percentage points."

Oh sure, Bernanke was talking about the kind of gains he'd expect to see inside one day! But slashing the Fed funds target by 225 basis points since the global banking crisis provoked him to act back in August, Bernanke hasn't even got 6.75% across six months...let alone a 13.5% rise on Wall Street.

He's got a surge in the cost of living instead, driven by basic raw material prices. And that's bad news - as in gruesome - for Treasury bond owners.

Yes, the Fed's overnight lending rate - as well as short-term Treasury bond yields - tipped sharply negative after accounting for inflation during the Greenspan "emergency" of 2002 to 2005.

But longer-dated US Treasuries - those bonds used to fund the vast bulk of Washington's on-going finance needs - only briefly failed to keep pace with the cost of living. Unlike now.

Today they're lagging inflation, and threatening to lag it badly.

The last time US Treasuries paid a whole lot less than inflation, the crisis got so bad that government bonds became known as "certificates of confiscation".

Money failed to flee into equities, however, even as the United States faced the very real prospect of being unable to find the cash to fund its government spending. To fix this mess in the world's No.1 economy, it took a collapse in nominal bond prices - driven by record-high interest rates from the Fed - and the longest recession since the 1930s depression to restore America's credit.

Just how miserable might the real returns paid to bond-buyers become if inflation keeps rising today? The runaway producer price index, backed up with $100 crude stood right behind it wearing knuckle-dusters, growls that things are about to get ugly.

And just how far might hard asset prices go as investors flee stocks, bonds, cash and property all at once...?

Yes, the current surge in Gold Prices looks a lot like that infamous "cathedral top" of 1980, right?

Gold spiked above $850 per ounce in the spot market on 21st Jan. 1980...and then fell almost every year for the next two decades.

But the move above $800 per ounce came and went inside three days. And the run-up saw Gold Prices more than triple on their monthly average in little more than a year. Here in Feb. 2008 - and with US Treasury yields turning negative once again - gold has taken more than half-a-decade to repeat that feat.

Too much, too fast? With Bernanke at the Fed - and $100 oil heading for the pumps, as well as for real bond yields - just maybe we ain't seen nothing yet.

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

Useful links: FAQs, Gold price now, Public order board, and The Case for Gold

More on BullionVault

BullionVault makes buying gold simple. It buys guaranteed, market deliverable gold bars and stores them at professionally recognized bullion vaults. The actuarial risk of loss is so small that your gold is stored with insurance included at 0.12% per annum.

On BullionVault you buy whatever quantity of gold you like, starting from as little as 1 gram. Choose where to store your gold from recognized vaults in London, New York or Zurich. Your gold will be in the form of good delivery bars, so it will retain full resale value straight back to the professional market.

As a seller at any time in the future, you will benefit by having gold of professional market status. Your top-quality warranted bullion can be offered directly to new buyers on BullionVault's highly active and publicly accessible order board. You can even quote your own prices, meaning you will earn - rather than pay - the trading spread.

For your full security and peace of mind, BullionVault also publishes a complete daily bullion audit in the world, enabling you to safely check your proven holding from an internet computer anywhere, and to prove it to the physical bar list issued to BullionVault by its vault operators.

By April 2007 - just two years after launch - BullionVault was storing for its customers cash and gold amounting to more than $68m.

For further information contact enquiries@BullionVault.com

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events and should be verified elsewhere if you choose to include it in your own analysis.

Copyright © 2006-2008 BullionVault

Image rendition and html coding Copyright © 2000-2008 SafeHaven.com

« BullionVault.com -- Buy gold online - quickly, safely and at low prices »
« Honest Money: A History of U.S. Gold & Silver Currency -- by Douglas V. Gnazzo »

« Opinions expressed at SafeHaven are those of the individual authors and do not necessarily represent the opinion of SafeHaven or its management. Articles are available via RSS/XML. Please visit RSSHelp for instructions. »