“I don’t fully understand movements in the gold price…” That’s what Fed Chairman Ben Bernanke admitted last week. But if he were to look at what’s actually going on and every move gold has made since 2008, he would understand the price of gold and where it’s going next.
There’s no doubt the financial world is facing a lot of uncertainty. The failure of the Euro experiment, ballooning government debts and deficits, and a general economic malaise have all sent investors running into the perceived safety of corporate and government bonds (they seem safe now, but rising interest rates will destroy their value).
This flight to safety has actually been the greatest catalyst for gold prices. Investors piling money into bonds have kept long-term interest rates very low and Bernanke has kept short-term interest rates near zero. And low rates have been driving gold prices higher.
We’ve written before that the main driver for gold prices is real interest rates. Real interest rates are calculated by taking the nominal rate of interest (what is actually paid) and subtracting inflation. Right now real interest rates are negative. They’re below zero. And the impact of negative real interest rates is always the same asset bubble.
And when there’s no predominant “story” like China will take over the world or the world is running out of oil, investment dollars inevitably turn to gold and where this precious metal is headed…
Gold Vs. Treasury Bonds
Despite Bernanke’s confusion, this is what we’re seeing play out with gold prices right now.
The chart below shows gold compared to the yield on the benchmark 10-year U.S. Treasury bond:
There’s a clear correlation over the long run: interest rates down, gold up.
And this trend isn’t about to change anytime soon.
Bernanke’s Bind: Kill the Recovery Or Eliminate the Gold Bubble
There’s just no politically feasible way out in the short-term. All of the stimulus money, welfare/unemployment spending, and other efforts to delay the inevitable debt liquidation have put Bernanke in a bind.
He has two options:
- He can keep interest rates low, allow the economy to trudge along dipping in and out of recession, and keep investors buying bonds.
- Or he can raise rates and induce a Volker-style recession to eliminate the capital misallocations.
The choices are killing the economic “recovery” or eliminating the forming gold bubble.
Regrettably, for long-term focused investors, the short-term, politically viable option of keeping interest rates low and hoping everything works out has been, is, and will be, the preferred solution for a long time to come.
The Gold Bubble… There’s No Way Out
There’s no way out of the gold bubble at this point. There has been so much money created, the savings rate has increased so much, and it will be nearly impossible to draw it all back in once credit demand returns and the money multiplier effect gets rolling.
Sure, government debts and deficits are getting all the headlines, fears over the tax increases looming next year kicking off the second dip of a double dip recession, and a general lack of faith in fiat currencies has contributed greatly to gold’s rise, but it’s extremely low interest rates that will keep the gold rally going for years to come.
It’s simple really. Bernanke may not get it, but we do. And this situation has “bubble” written all over it so different rules apply.
Value doesn’t matter, price does. Housing, tech stocks, Asia, oil…they’ve all been the same. The more they went up, the more people wanted them. Gold won’t be any different. No one wanted gold at $300 or $500 an ounce, but there has been considerably more interest at $1,000 an ounce. The record run-up to $1250 an ounce has only compounded demand. As the trend continues, gold demand will increase exponentially as it rises to $1500, $2000, and beyond.
Unless you’re expecting a bit of honesty and courage from politicians, buy gold and silver for safety and buy undervalued gold and silver stocks for superior gains.
Syndicated at Stockhouse.com. Andrew Mickey, Chief Investment Strategist, has quickly emerged as a leading publisher of investment ideas and recommendations.