Tuesday, December 06, 2005


Today, Canada and Indonesia raised short rates. Canada .25 and Indonesia .50. I have forgotten but I believe it was Taiwan that raised yesterday and the Euro-land increase was in the past few days. The Gold bugs see great demand for gold but gold has a way of "showing up" when real interest rates turn high.

Real rates were unusually low for an extended period after the 2001 recession. Now, each bump or anticipated bump in the US is putting pressure on foreign currencies. Early this morning, the pound sterling took a hit. The Yen has almost been in free fall. The US dollar is strong.

Oil prices are acting like additional rate increases around the world (with the exception of the exporters). Oil price increases and money price increases put the pressure on consumers and businesses to tighten their belts. One of the results was reported this morning in the US; productivity is exploding upward, 4.7% annual rate!!

Wow! Business is "leaning down". Costs are being cut. Profits margins are being maintained even in the face of rising costs. Energy price increases are not being passed through. Core inflation is staying low and even head line inflation numbers are now coming down.

One of the sensitive leading economic indicators that I like very much is the wage rates reported by temp workers. These wages lead permanent workers wages which do not adjust nearly as quickly. Temp wages are rolling over; inflation is not a problem. While it is true that Greenspan has been raising rates because we are moving into the part of the economic cycle where wage inflation can get into a race to beat the increases in the cost of goods and services, it appears that the bumps already made have largely done their job. We are truly in the 8th or 9th inning of the rate increase game.

The only missing link is the price of Gold. The metal has gone up on momentum and has even risen faster than the mining stocks. The cost to carry is going up. This concept is very simple but not as widely understood as you would expect. If you buy an ounce of gold for $500 and I buy a CD for $500 paying 3.5% interest, at the end of one year if your gold is still worth $500 then I am ahead of you by $17.50. At any price less than $517.50, you lose. If I invest in a money market account, it is possible that my rate will go up during the year. Let's say it goes to 4.5%, then you must believe that gold is going to jump another 4.5% over the next year.

Some folks, the worry warts, will buy gold even when they know real interest rates are high because they believe the economy is about to collapse. They consider owning a certain amount of gold as an "insurance" against collapse. I buy as little insurance as I can. My house has a $2,000 deductible and my car has a high liability rider but no collision.

The gold insurance is going to be very expensive insurance if real interest rates stay high. It is the same old story told by the "old bankers saw" which is "those who understand compounded interest collect it and those who do not understand compounded interest pay it". Any person who has held a substantial amount of gold for the past 30 years has lost a fortune in opportunity. The value of the same money invested in the S&P 500 index would be many times the value of the gold in today's dollars.

The economy is strong, it is not about to collapse. The central bankers realize the economy is strong. Even the ECB has recently raised rates in the face of 8.3% unemployment in Euro-land. Gold is not going to go out the roof from here if one assumes that the FOMC is sticking to its guns and raising rates again next week. My bet is that gold will be substantially lower in price one year from today.