Dumb money funds dumb ideas

  • This drives prices
  • Not so bad for gold
  • Tiny gold stocks bounce back
  • A great temptation
  • Countdown to the Great Repression conference

Supposedly interest rates in the US are about to rise.

Predictions are the US Federal Reserve will raise its benchmark Fed Funds rate in December.

But whether the Fed raises rates then, sooner, or later, the effects of eight years of near-zero rates are already rippling through the economy.

Here’s an example from the Financial Times:

Hyperloop One, a US company formed to promote a radical new form of transport, has raised another $50m and brought in a powerful Middle East backer as it races to become the first to build a workable system.

The latest investment, from Dubai ports operator DP World, takes the total the company has raised to $160m, though this only represents a fraction of the “billions” it will have to attract to succeed, said Rob Lloyd, chief executive.

The idea for hyperloop transport — moving specially built vehicles inside low-pressure tubes at near-supersonic speeds over long distances — was touted by Tesla Motors founder Elon Musk in 2013. That started a race between at least three start-ups to turn the idea into reality, though none involve Mr Musk.

Don’t get us wrong, we love new technology. We love innovative ideas. We remember when the hyperloop story first broke three years ago. We discussed it with our tech ace, Sam Volkering.

Theoretically, a hyperloop system between Los Angeles and San Francisco could cut travel time between the two cities to around 24 minutes.

Compare that to the nearly 90 minute flying time, and current six hour driving time.

If Hyperloop One, or any of the other firms developing hyperloop systems, were to be successful, it would revolutionise transportation.

However, as exciting as a hyperloop transport system may be, there’s little doubt that low interest rates have a part to play in this.

Low interest rates are responsible for what the Austrian School of Economics calls ‘malinvestments’. That is, with interest rates so low, (put bluntly) even really dumb business ideas can make money.

And in an era of low interest rates, investors will look at almost any idea (even crazy ideas) in an effort to eke out a return from somewhere.

That includes ideas that will require billions of dollars in infrastructure spending…and despite all the good intentions, may end up as nothing more than an example of low interest rate folly.


Overnight, the Dow Jones Industrial Average fell 45.26 points, or 0.25%.

The S&P 500 fell 6.63 points, for a 0.31% fall.

In Europe, the Euro Stoxx 50 index fell 32.99 points, or 1.1%. Meanwhile, the FTSE 100 index fell 0.66%, and Germany’s DAX fell 1.04%.

In Asian markets, Japan’s Nikkei 225 is down 12.89 points, or 0.08%. China’s CSI 300 is down 0.5%.

In Australia, the S&P/ASX 200 is up 7.86 points, or 0.14%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$50.60 per barrel. Brent crude is US$52.03 per barrel.

Gold is US$1,257.90 (AU$1,655.69) per troy ounce. Silver is US$17.47 (AU$22.99) per troy ounce.

The Aussie dollar is worth 75.95 US cents.

This drives prices

Speaking of infrastructure spending, in yesterday’s Money Morning we addressed how infrastructure can have a huge impact on property values.

We used the example of London’s East End, following upgrades to rail networks. The conventional wisdom seems to be that the building of the Olympic Stadium was the catalyst to rising property values.

But it’s not. It’s the infrastructure. By building a major station for the Eurorail, and extending the Jubilee Underground line to Stratford, it made that part of London all the more attractive to businesses and individuals.

This idea won’t be news to those who read Cycles, Trends & Forecasts. The importance of building and infrastructure is a key theme in the writing of Phil Anderson and his team.

If you haven’t already checked out Cycles, Trends & Forecasts, you can do so here.

Not so bad for gold

Whenever we mention interest rates, it’s impossible for us to not mention gold.

As we’ve mentioned previously, we believe that investors are at a ‘reset’ point for gold.

The gold price has fallen in recent weeks, on the prospect of higher US interest rates.

The theory is that higher interest rates are bad news for gold. Higher interest rates will draw investors out of gold and into cash.

On the surface, it’s not a bad theory. But when you think about it a little deeper, it doesn’t necessarily make sense.

As we see it, the reasons for an interest rate rise also happen to be sound supporting arguments for buying and owning gold — higher inflation.

We’re not the only one to believe this. Jim Rickards, the strategist behind our new trading service, Gold Stock Trader, wrote this:

Last month, I saw a headline that stopped me in my tracks. It read, “Gold Down on Hints of Inflation”. Huh? That made no sense. Obviously, gold is an inflation hedge — the best there is, some say. Gold prices rise sharply when inflation strikes. So what’s up with that headline?

Here’s the logic, as best I can make sense of it. Central banks have been pursuing zero or negative interest rate policies for eight years. Across the world, the only major central bank that’s in tightening mode right now is the Fed. They raised rates once, last December. They’ve been threatening to do it again all through 2016, but so far, they’ve never actually pulled the trigger.

The Fed has two hurdles to raising rates. The first is job creation; the second is inflation. Job creation has been strong, albeit in lower-wage employment sectors like bartenders and motel maids. But inflation has been nowhere to be found. That’s why the Fed hasn’t raised rates since last December.

Any hint of inflation might give the Fed a green light to raise rates. That’s supposed to be bad for gold. Some people say gold has “no yield”, and, by definition, higher interest rates give investors some yield. Supposedly, if the Fed raises rates, investors will sell gold and buy Treasury notes for yield. Therefore, gold goes down.

What’s wrong with this logic? Just about everything…

The Fed will not raise rates for the fun of it. The Fed wants to keep inflation under control, but what the organisation really wants is negative real rates. That’s where inflation is higher than nominal rates.

An environment of 2% inflation and a 1% Fed funds rate would be perfect from the Fed’s perspective. That gives you a negative 1% real rate (1 – 2 = -1), which is supposed to stimulate investment and spending. It does the Fed no good to raise rates unless inflation is going up even faster. Yet that’s exactly when gold does its job of preserving wealth.

The other problem with market logic is that it will take more than a “hint” of inflation to get the Fed to move. The Fed wants to see higher inflation on a sustained basis, not just from one report. The Fed also want to ensure that it doesn’t kill inflation as soon as it appears.

And while it’s still early days, and despite the 65.9% chance of a Fed rate rise, investors don’t appear to be in much of a hurry to sell gold.

As Bloomberg reports:

Gold held a two-day rise at the end of a week that’s demonstrated the metal’s resilience, with holdings in exchange-traded funds extending a run of gains to the highest since 2013 even as investors see increased prospects for higher U.S. interest rates.

You can see the chart of gold ETF holdings below.

chart image

Source: Bloomberg
Click to enlarge

Total holdings now stand at 2,050 tonnes. That’s the highest level since June 2013. Of course, it’s possible there’s a lag between when folks decide to sell their gold and when the price falls.

That makes sense. If the price peaked exactly when gold holdings peaked, it would suggest investors knew when it was the top of the market and when to get out.

That’s not how markets work.

Anyway, we like Jim’s reasoning on this. Investors are in ‘reset’ mode on gold. And it could take several more weeks or months for this to play out, regardless of whether the Fed raises rates in December or not.

Tiny gold stocks bounce back

Just as the gold price appears to have settled into a new price level (around the US$1,250 mark), so have tiny gold stocks.

One of the key gold indices we follow closely is the VanEck Vectors Junior Gold Miners ETF [NYSEARCA:GDXJ]. The name of the ETF tells you what it’s all about.

It invests in a number of small-cap, mostly Canadian, gold stocks. Although, nearly 15% of its holdings are small-cap Aussie gold stocks.

Interestingly, overnight, as the gold price remained steady, this ETF piled on the gains, closing up more than 2% — beating the negative daily return for the S&PO 500.

Sure, one day of gains doesn’t a bull market make — but be sure, there are opportunities in the gold stock sector. After the recent fall, now could be the best time to speculate, before prices go up again.

Our own ‘mystery gold stock picker’ doesn’t yet have any Canadian gold stocks on his radar, but he does have plenty of Aussie gold stocks that he’s pegged for big returns.

Details here.

A great temptation

This week the Australian government sold its first every 30-year bond. It pays a coupon of 3%, and had a yield-to-maturity of 3.27%.

As stunning as it may seem that investors would gladly accept 3.27% per year for 30 years, especially when they don’t know how inflation will affect the yield, the latest analysis suggests this won’t be the last super-long bond sale.

As Bloomberg reports:

The Reserve Bank of Australia may ease further to support the economy, spurring at least a 100 bps drop in the yield of the nation’s first-ever 30-year debt over the next six months, says Japan’s Asset Management One.

If the folks at Asset Management One are right, it means the yield for Aussie 30-year debt will sink to somewhere around 2.2%. You can only imagine what that would mean for shorter term government and corporate debt yields, and what it would do for term deposit rates.

And don’t forget the impact it could have on the stock market. Could we see a repeat of the 2012­–2013 ‘hunt for yield’, which sent dividend-paying stocks skyrocketing?


But more than that, it will be a very disciplined government that doesn’t fold to the temptation of lower interest rates.

First, why not refinance as much debt as possible, which may be paying out coupons of 5% or 6%, and replace it with longer term debt paying 2–3%?

For instance, the government has nearly $12 billion of outstanding bonds due to mature in February next year. It’s currently paying a 6% coupon. Why not refinance that at one-half or one-third the interest rate for 20 or 30 years?

Not only that, but as interest rates fall, another temptation faces the government. They figure they can borrow twice or three times as much and pay the same interest expense.

As we say, the temptation to do so will likely be too much.

For a long time after 2008, we heard how Australia was different…how its governments were much more responsible…that we didn’t have to worry about high debts.

Well, turns out we do. Australian federal government debt now stands at $450.8 billion. And with low interest rates set to go even lower, that debt pile will sure grow.

Countdown to the Great Repression conference

It’s now less than two weeks until the Great Repression investment conference in Port Douglas.

We’re looking forward to being there, catching up with great investors like Jim Rogers, and chatting to great minds like Jim Rickards.

We’re also looking forward to seeing our old pal, Dan Denning (former publisher here at Port Phillip Publishing), for the first time in more than a year.

But the biggest, best, and most valuable thing of all from the conference, will be the hours of presentations we’ll get to see.

So it would be a shame if only those in the room could get to hear the insight from our all-star cast of speakers. Fortunately, that’s not how it is.

We’ve arranged to ‘bug’ the room with cameras and microphones so that more than the 650 expected attendees will get to hear and learn from the investment solutions delivered by our quality line-up of speakers.

If you can’t be there in person, then catching the event on film is the next best thing. We’re putting together the final details of the video package now. You’ll receive details in your email inbox tomorrow.