Eric Sprott On The Federal Reserve, Interest Rates and Precious Metals

Eric SprottPM: Hello, everybody. This is Patrick MontesDeOca with Trading Talk. This segment is brought to you by Equity Management Academy. We have with us today Eric Sprott Chairman, CEO and Portfolio Manager of Sprott Asset Management. With 40 years of experience in the investment industry managing over 7 billion dollars, Mr. Sprott is one of the most respected industry experts who accurately predicted the current financial crisis. Sprott Asset Management is one of the top firms in the world. The firm has become well-known, not only for its performance, but also for creating a gold trust, PHYS, and now a silver trust fund, PSLV. Welcome to Trading Talk, Eric.

ES: Patrick, happy to be here.

PM: What do you make of the fed’s decision not to taper this week? Was that a signal that they know something else is wrong with the US economy that prevented them from reducing their bond buying strategy? Or, do you think the fact that the interest rates have skyrocketed recently has anything to do with the unexpected decision not to taper?

ES: Well, I think the latter comment is the most appropriate. Rates, as you know, went from 1.4 something on the 10 year up to 3%. And, when Mr. Bernanke from the Senate Committee last time, said he was puzzled by that increase, it was a very odd thing for the Chairman of the Federal Reserve Bank to say. But, he was puzzled by it. And, of course, it would throw a real monkey wrench into the US economy.

We already know that versus a year ago, the cost of carrying a house for a new buyer is higher by 50% than the year before because of mortgage increases that have occurred. Plus, of course, the price of the house is up 10%. So, it’s going to put a real damper on the housing. And, housing, of course, is the one area the US government has tried to force an improvement in and has forced an improvement in. But, we brought in buyers yet again who probably really can’t afford it. Some of these buyers and others whose mortgages are maturing and looking forward and saying, “Oh my God, when I refinance the rates are really going to go up.” It certainly puts a damper on some of their enthusiasm for spending money. We’ve already seen the refinance rate fall by 70%. I think that was the bigger concern that they had.

I had always thought there was no way they could taper simply because Central Banks, particularly with the addition of the Japanese Central Bank, are buying more bonds per day than ever in the history of mankind. And, while they are buying all these bonds interest rates went up, which is kind of perverse logic. But, that is exactly what happened and I think this was a great concern for them. Of course, they were able to use the first argument you suggested… that the economy is not really growing as expected and, as you know, they reduced their forecast for GDP going forward here.

I think they must know that housing is going to go down. I suspect that autos will go down because financing is a huge part of autos. And, the jobless numbers are weak. The consumer confidence is weak. The retail sales were weak. One has to realize that when 70% of the population is not getting much of a wage increase and inflation is higher than reported CPI, essentially everyone is going negative year over year in terms of net disposable income. I think both those factors were a big part of that decision but I think by far the more important was what would happen to the bond market if they actually tapered it.

PM: Sure. Are we looking at another mortage crisis possibly developing?

ES: I would think so, because the cost to carry has gone up so dramatically here. I think the most important thing for people to watch is what does that 10 year yield do here. As you know, after the fed non-tapering announcement, rates fell reasonably dramatically over a very short time period. But they have started to move back up here and we are gonna find out whether or not Mr. Bernanke has lost control of the bond market which I suspect he has. And, if rates ever went back up to 3% with the non-taper, then I think everyone realizes the interest rate markets are in big trouble because you won’t ever be able to taper. As many commentators have said we will have QE to infinity and that certainly looks like where we are going at this point in time.

PM: Can you give us your comments on the latest major issue here that is building up regarding the debt ceiling in about 10 days? It is due in a couple weeks. If they increase the debt ceiling, how will this impact the precious metals market and the financial markets in general? And, how will it affect the markets if they don’t increase the debt ceiling this year?

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