After many head fakes from the Federal Reserve, interest rates remain unchanged — essentially at zero. Free money for the well-connected; you pay retail, though.
U.S. monetary policy is clear: Rob savers of any semblance of interest on their money while encouraging immediate consumption and keeping government borrowing costs down. Capital formation? Who needs it when you’re the government and you control the only legal printing press?
“It’s the ‘Zero Trap,’” explained an acquaintance. “The Fed has kept interest rates so low for so long that the economy has recalibrated. Zero-interest is in the air we breathe. Raise rates and a lot of players across the economy will turn blue and suffocate.”
Confirming the point during a post-interest decision discussion, Fed head Janet Yellen explained that the U.S. economy seems “soft,” meaning that the nation is filled with unemployed and underemployed workers. Many new jobs in our economy are of a temporary nature, she said. Indeed, Janet… welcome to the world.
Along such lines, one of my Wall Street pals just returned from a small (and influential) tech conference in California where the subject was the looming explosion in robotics to serve the fast-food industry. What’s the investment driver? It’s the so-called “$15 per hour minimum wage.” Plus Obamacare. And the National Labor Relations Board turning franchise employees into direct reports of the parent corporation (long story).
At any rate, in a world of software and fast-evolving robotic capabilities, the new “minimum wage” and benefits package for burger flipping is going to be zero.
Allow me to digress on that last point. I’ve watched the migrant crisis recently unfold across Europe — I witnessed it personally during a recent trip to Austria and Serbia.
I’ve been trying to process the idea that Germany somehow needs armies of new foreign immigrants to serve as workers and keep its factories humming. That is absolutely NOT what I saw when I visited Mercedes-Benz near Stuttgart a couple of years ago. Indeed, Germany is moving to robots, and per Mercedes-Benz — which knows a few things about running factories — the more robots the better.
May as well note the obvious: Robots are a global phenomenon. The U.S., Germany, Japan, China, you name it. If Fed head Yellen fears raising rates in the face of “soft” employment, then we’re in for a long spell of zero. Savers save at their peril, apparently. Workers of the world? You’re fired.
One can’t discuss interest rates without also mentioning bonds, of course. Across the globe, governments finance their daily needs with bonds. Tax receipts are iffy, most days. Thus, the idea is to sell bonds, raise cash and spend it on the government priority du jour. So far, so good.
What is a bond, though? In the U.S., it’s essentially a “call” on future tax receipts, because that’s the only way our mighty government will ever raise cash necessary to pay interest, if not to pay back principal. One conventional definition of a U.S. government bond is “risk-free return.” (No snickering, please…)
Then there’s Rick Rule’s view of U.S. bonds, as “return-free risk.” That is, buy a 10-year bond at, say, a generous 3% return. Let’s say you collect interest for 10 years and then recoup the principal too. Let’s not compound (i.e., think in terms of “simple” legal interest) and just say that you recover 130% over 10 years.
Then again, what’s the inflation rate over 10 years? Let’s say — and be charitable — it’s 30% inflation over a decade. There goes your return on that bond. Net-net, you’re no better off with a U.S. government bond than if you had just bought an exchange-traded fund that tracks inflation. Hence, “return-free risk.”
Meanwhile, bond prices rise and fall. So what has raised bond prices in a general sense for over 30 years? Falling interest rates since the 1980s. OK, but where can interest rates go from here? Fall from “zero” just now to where exactly? As you can see, we’re in a monetary quandary. Indeed, if/when the Fed ever does raise interest rates, bond prices will fall. So much for “risk-free return.”
Let’s look at it from another angle. It’s a tough year for U.S. bonds. Large holders are selling. Russia has been selling bonds to raise cash and cover its national accounts in the wake of sanctions and falling oil prices. Saudi Arabia has also sold bonds to raise cash due to falling oil prices. China has sold bonds due to the need to raise cash to prop up its stock market.
When large holders sell your bonds, what’s the answer? You have to raise interest rates you pay, right? Make those bonds attractive enough that sellers and buyers balance. Thus, something tells me that the Fed’s decision this week not to raise its basic interest rate wasn’t all about the poor, under-employed proletariat of the nation. Nope… raising Fed rates would’ve been bad for the overall government balance sheet, while Uncle Sam pays higher interest rates to keep buyers buying bonds.
What do interest rates and bonds have to do with the price of oil? Glad you asked, because “cheap money” has financed the U.S. fracking boom since the crash of 2008.
Indeed, “tight oil” development is joined at the hip to capital markets. Every year since 2009, the U.S. upstream sector has outspent its cash flow. This created a funding gap that had to be filled with borrowed money — bonds or equity issue. For a while, it was no-brainer easy, because $100 oil led to low-risk opportunity. That’s how U.S. oil output soared — on the back of cheap money.
Now that oil is at $50 or so, the calculus is reversed. Cost of capital is rising across the oil biz; for weak, high-risk players, it’s rising in ways that will put them out of business.
To be sure, many “tight oil” assets are fundamentally competitive on a day-to-day basis now that they’re drilled (with borrowed money). They’ll be even more competitive when a buyer picks up these assets at a steep discount via bankruptcy sale.
Plus, I’d add that the fracking boom has a technological life of its own — it’s an industry sector that’s creating its own efficiencies almost daily. Looking ahead, will capital discipline prevail within the U.S. oil biz? Or will Fed “cheap money” maintain the distortions of the past few years? We’re seeing the beginnings of a general housecleaning, to be sure. How far it will go is still speculative. On that, we wait and see.
Let’s hit on gold prices, too. Begin by acknowledging that it’s been a tough three years for the yellow metal, after a great decade or so before. Here’s the 15-year chart.
Run-up, sell-down. Now where to go from here? Kitco chart.
Eric Sprott, and his longtime associate John Embry, had plenty to say about gold during our talks in Toronto this week. Here are some highlights.
First, all the same “macro” issues that drove gold prices up during the 2000s decade are still with us — expansionist monetary policies, out-of-control government spending across the world, growing government debt levels, counter-party risks, looming currency crises and more.
Indeed, on that last point, people in the West could go to bed “rich” one evening and awaken the next morning to a currency crisis. That means they’d all of a sudden be very poor, absent a stash of gold and silver to preserve wealth through the transformation to another currency regime.
Second, on the supply side, we’re in the midst of a major reset across the global gold mining industry. Gold mine output far exceeds new discovery, and it’s impossible to mine what has not been discovered. Meanwhile, every major miner — and intermediates and juniors — are working to deleverage and mark down or sell off noncore assets.
In other words, we’re faced with looming gold output shortfalls in the very near future. One of these days, Big Money will figure that out and make its move. As gold bugs of a sort (well… some of us are), we only have to be right once.
Meanwhile, for all the vagaries of statistics, it’s clear that China and India are major importers of gold (and silver). This adds entire new demand levels to traditional channels, which world trading simply does not acknowledge. That is, despite the physical flow of metal out of the West and into the East, “paper” prices for metals are at ridiculous lows.
I could just say draw your own conclusions, but instead I’ll come right out and pound the table to say… buy gold and silver! Physical metal. Take delivery. Really, if you don’t have some, get some.
Courtesy: Byron W. King
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