September 23, 2005
The beauty of being a long-term investor -- as opposed
to a short term trader -- is that I can take my eyes off my computer
screen for more than fifteen minutes without experiencing an anxiety
attack. September has been a hectic month thus far with a conference
in Las Vegas, one in Deer Lake Newfoundland, the Denver Gold Forum
coming up next week and the Toronto Investment Conference shortly
thereafter. I have spent very little time at home and far too much
at airports and hotels, which is why these commentaries have been
scarce lately. But, as I said, being in the market for the long
term has its benefits: the fact that I did not have time to analyze
each day’s change in the gold price caused me no discomfort
We all know that the US is in the midst of a real
estate bubble, however, home construction fell for the second month
a row and permits for new buildings also declined in August. The
National Association of Home Builders’ index for sales of
new, single family homes fell in September indicating a decline
in sentiment among US home builders. Freddie Mac also reported that
30-year fixed mortgage rates are on the rise again and the supply
of new houses for sale is increasing, in other words the houses
are not selling as fast as builders anticipated. At the same time
the median price for a new home fell in July. Could the real estate
market be showing signs of a top?
Although less discussed, both bonds and equities are
at lofty levels as well. Predicting the exact time when a bubble
will burst is impossible, unless you’re just lucky, and so
we will only know in hindsight when the turning point occurred.
But with all that’s going on, the risk of staying in the stock
market, owning long-term bonds, and speculating on real estate seems
just plain stupid.
Now let’s look at the Federal Reserve Board’s
actions of late within the context of these risks. This week the
Fed raised the overnight rate for the eleventh consecutive time.
Officially, the Fed says that the risk of inflation is greater than
the risk of hurting the economy by raising short-term interest rates.
But the market disagrees and buys bonds, which is why long-term
interest rates have been falling even though the Fed has been raising
the overnight rate. Since Katrina, however, long-term interest rates
have been on the rise. This could be seen as a harbinger of inflation
as the country attempts to cope with rebuilding a city and the impact
that higher gasoline prices will have on the economy and prices.
So the Fed is worried about inflation. But which inflation?
Are they worried about the increase in the money supply or are they
worried that higher gasoline prices will ultimately lead to higher
consumer prices? Remember, inflation is an increase in money supply
that can lead to an increase in prices. An increase in prices is,
by itself, not inflation. So if the gasoline price rises because
a hurricane shuts down production that is not inflation. Similarly,
if the price of oil goes up because the US dollar fell on foreign
exchange markets, it is not inflation.
Surely the Fed has to be concerned that its policy
of raising interest rates could hurt the US economy by deflating
the real estate bubble and slowing economic growth. In fact, the
abuse of leverage in the US real estate market and the extent to
which consumers, corporations, and the government itself, are indebted
should raise the risk of a deflationary collapse if interest rates
keep rising. Especially if long-term interest rates start rising
as well, which it appears they may have started doing. So how can
Fed justify its policy of increasing interest rates?
According to the Fed its policy is to raise interest
rates to a neutral position -- the interest rate at which economic
growth is neither promoted nor hindered. Currently, the Fed believes
that interest rates are still promoting economic growth, in other
words, interest rates are too low. How does the Fed know what interest
rate is optimal? It doesn’t. The Fed doesn’t even know
what money is! Alan Greenspan admitted that crafting monetary policy
is problematic because the Federal Reserve does not know how to
define money or how to measure it. If the Fed cannot even define,
never mind measure, what money is, how can it possibly be so sure
that it knows the optimal interest rate at which the economy is
neither hindered nor stimulated?
I suspect that the Federal Reserve Board Governors
know they have a problem. Could it be that they are worried about
something much larger than the devastation caused by Katrina, the
impact of higher gasoline prices on consumer spending or a slowdown
in real estate spending due to higher interest rates?
The US consumption binge, from stocks, bonds and real
estate to the money we spend in our malls on credit cards, is being
financed by foreign capital. Cut off the influx of foreign capital
and you basically switch off the life support of a terminally ill
US economy. Sustaining foreign appetite for US financial products
is arguably far more important than anything else affecting the
US economy at the moment.
Now, if the US dollar were to decline on foreign exchange
markets then foreign investors could start losing money on their
US investments even if their US investments are not losing money
in US dollar terms. And if US investment returns go south then the
losses to foreign investors are compounded.
A falling US dollar would also stoke an increase in
prices and, if you (erroneously) think that higher prices means
inflation, then you could say that a falling US dollar will lead
to inflation. Is it possible that underlying the Fed’s preoccupation
with inflation is really a concern about the dollar?
During the past year or so the relationship between
the US dollar gold price and the US dollar exchange rate has become
more widely accepted. Yes, I know that some people think the gold
price is becoming disconnected from the US dollar but… it’s
not. As more and more investors and, especially institutional investors,
realize that they can play the dollar exchange rate by going long
(or short) gold, the gold price becomes more volatile. The gold
price may also from time to time move in patterns not predicted
by the dollar exchange rate as investors establish (or dissolve)
positions in anticipation of a move in the dollar exchange rate.
Take this past week as an example. The dollar rallied
both in anticipation of a further increase in interest rates and
in response to the German elections. But the gold price rallied
alongside the dollar. Now, could it be that the gold price was rallying
in anticipation of a decline in the dollar once the initial rally
is over? Certainly if we look at Wednesday’s and Thursday’s
activity it will confirm that the gold-dollar relationship is still
intact. On Wednesday the dollar fell and gold rallied; on Thursday
the dollar rallied and gold fell. Ditto on Friday. The question
is, what happened prior to Wednesday.
One possibility is that long gold positions
were being established in anticipation of a future decline in the
dollar. Another is that short positions were being covered creating
temporary demand. Either way, it seems to me that short term trading
merely obscured the relationship between the US dollar gold price
and the US dollar exchange rate that has by now been well established.
Paul van Eeden
Paul van Eeden works primarily to find investments
for his own portfolio and shares his investment ideas with subscribers
to his weekly investment publication. For more information please
visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
This letter/article is not intended to meet your specific individual investment
needs and it is not tailored to your personal financial situation. Nothing contained
herein constitutes, is intended, or deemed to be -- either implied or otherwise
-- investment advice. This letter/article reflects the personal views and opinions
of Paul van Eeden and that is all it purports to be. While the information herein
is believed to be accurate and reliable it is not guaranteed or implied to be
so. The information herein may not be complete or correct; it is provided in
good faith but without any legal responsibility or obligation to provide future
updates. Neither Paul van Eeden, nor anyone else, accepts any responsibility,
or assumes any liability, whatsoever, for any direct, indirect or consequential
loss arising from the use of the information in this letter/article. The information
contained herein is subject to change without notice, may become outdated and
will not be updated. Paul van Eeden, entities that he controls, family, friends,
employees, associates, and others may have positions in securities mentioned,
or discussed, in this letter/article. While every attempt is made to avoid conflicts
of interest, such conflicts do arise from time to time. Whenever a conflict
of interest arises, every attempt is made to resolve such conflict in the best
possible interest of all parties, but you should not assume that your interest
would be placed ahead of anyone else’s interest in the event of a conflict
of interest. No part of this letter/article may be reproduced, copied, emailed,
faxed, or distributed (in any form) without the express written permission of
Paul van Eeden. Everything contained herein is subject to international copyright