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Negative Real Interest Rates Argue for New Highs in Gold

by Chris Puplava, Financial Sense:

At any given point in time there are several variables that affect the price of gold. There are times when gold’s price is driven by its perceived association with inflation and other times it’s seen as a “safety asset” or even a global currency. One variable in particular that was a constant driver of gold’s bull market in the 1970s was the presence of negative real interest rates—where inflation rates are higher than nominal interest rates—which means savers who park their cash at the bank are seeing their purchasing power eroded. The power of negative real interest rates as a major catalyst for gold has also been dominant in gold’s secular bull market this time around and currently argues for new highs. However, the USD’s strength at present has been keeping gold in check. That may soon change if the Euro begins to stabilize and money flows back out of the USD.
Gold Variables

As mentioned above, one of the strongest correlations to the price of gold is not the USD but actually real interest rates. This can been seen below in which the top panel shows the open interest for gold futures contracts, the middle panel shows gold along with real interest rates (inverted in red), and the bottom panel shows the USD Index along with gold (USD Index shown inverted for directional similarity).

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6 comments to Negative Real Interest Rates Argue for New Highs in Gold

  • duckvision

    This is a good article. The point that interest rates are the real indicator of the movement of price for gold instead of the USD is correct. All the hack pundits like Greg Mannarino keeps talking like the USD has a major influence on the price of gold. That is so elementary of a analysis and show his weakness of understanding the markets. Andy Hoffman has been screaming the the USD has absolutely nothing to do with the gold price. I agree with Andy because all currencies are going down together. This indicator of dollar strength and low gold prices isn’t important anymore but these hacks like Greg keep mentioning it. Just drives me nuts. Anyways, it’s the INTEREST RATE SWAPS that keep low, zero , and negative rates possible. PLEASE UNDERSTAND THIS!!!!! You will not put things together until people understand the rigging of the interest rates through swaps. This is the key to keep the illusion of solvency and artificial demand for US paper. Without the swaps, the illusion stops. Their is over 300 trillion in interest rate swaps by the major commercial banks and they have been loading the boat to keep rates low. Then the banks use a carry trade to buy the bonds with free money by the central banks. The banks get the spread and make easy money. Since the banks have the position of the swaps to bet that rates will go lower, rates will never be allowed to rise because it would blow up the derivatives. Low interest rates keep the balance sheets of the banks looking solvent. The banks hold huge positions in bonds and if yields rise, the bonds value falls. If the bonds value falls, then the banks become insolvent and they will default instantly. Therefore, interest rates will never be allowed to rise again. They are fixed to stay low, zero, and soon negative because if they rise dramatically, the whole system will blow. This is why QE WILL NOT COME! If the Fed comes in with more QE for the stock market, all the money will flow out of the bonds and into stocks. The yielda of the bonds will rise and blow up the interest rate swaps. That’s game over for the global financial world. The only intervention the Fed has is to keep buying the bonds directly through Operation twist and to buy up the MBS. The Fed will keep the fed fund rate at 0% for the banks to borrow at. The Fed will not and can not come in with more QE. Instead the MSM hacks and youtube idiots keep talking about QE for the stock market. Amazing that people believe these amateur hacks.

    Next week, the markets will get crushed. This artificial ramp job by Draghi was a joke. These stock pickers that went long will get smashed by Wednesday. The yields on the Spanish and Italian bonds will go back to where they were. Past 7.5% for the 10 year in Spain and over 6.5% for Italy. It was just a kick save by Draghi to stop the Euro from falling past 1.20 vs the dollar. If the euro falls past 1.20 it will light out for the Euro. The central banks will make sure they keep a floor above the 1.20 for the Euro/dollar. Also, 1.20 Swiss/Euro trade is very important as well. The Swiss franc is pegged at 1.20 vs the Euro. Very few people have mentioned the importance of that trade.

    • Glitter1

      Duckvision, your analysis has caught my eye. My understanding is that the TPTB try to maintain that the price of gold moves with the Dollar to create the illusion that the two are connected, i.e. Dollar up/Gold down, Dollar down/Gold up etc. With interest rates forced and held down below negative, what will further propell the Gold Price higher? Decoupling of the two? physical demand overtaking the paper price?Gold being used more as a currency?Announcement of QE3 will juice the Stock Market,being seen as inflationary. What is your opinion?

  • duckvision

    Glitter1, thank you for the reply. First off Jim Rickards has said in the past it’s not the price of gold going up that strikes fears in central banks, it’s the price going up rapidly. Gold is considered being a Tier 1 asset on the balance sheets of the banks. This is hugely bullish for gold because it will force the banks to buy gold. All currencies are going down in price at the same time and rate. Low,zero, and negative yields on the bonds will force gold higher not some number representing price on the currencies. The central banks are in a zero interest rate policy regime.(ZIRP) With the debt loads at these levels, they cannot and will not allow rates to rise. The whole system will collapse when other countries (BRICS) dump and trade outside the dollar. This is happening right now and will continue. Bi-lateral trade agreements outside the dollar will force rates to jump because the perception of the dollar will be challenged. Right now, hedge funds and countries are forced to hold dollars because it’s the best of the worst. They will soon come out of the dollar and go into gold since gold has no counter party risk (physical gold, not ETF’s). This will crush the bullion banks and the dollar at the same time. The only option left for the FED is continuous buying of the debt. The central banks will buy all short term and long term paper to keep the illusion alive. Basically, gold goes higher when perception and reality sets in. The perception of stability is set by low interest rates of the bonds. This is done by the interest rate swaps. The swaps go to the heart of the Libor scandal. Since rates are low, people think there is huge demand for US paper. Please watch a video by David Stockman by Casey Research that was just released a week ago. Amazing amount of critical information that Stockman said. The Fed increase their balance sheet by 3X in 13 weeks in 2008. From 1915-1960, the Fed had 30 billion on their balance sheet. From 1960-2008 it increased to 900 billion. In just 7 weeks in 2008 the FED increased their balance sheet another 900 billion. In 7 weeks, the FED doubled their balance sheet that took them 93 years to create!!! Then they added another 900 billion in 6 more weeks. That is insane. The balance sheet of the central banks have exploded since 2008 market crash. The whole system died in 2008. Capitalism and the free markets are gone forever until the system is changed. Not 1 single number you see on CNBC is real. Not one!! When you rig the interest rates, the market is dead. Every transaction happens because of interest rates. JP Morgan increase their interest rate swaps by 7.5 trillion dollars in 2007 when the Libor rates blew up and yield rose. The Fed give the banks money at 0% and the banks buy interest rate swaps to lower the rates. The banks keep the spread (carry trade) and the banks make free money. JP Morgan’s derivative book is currently at 70 trillion dollars with 50 trillion coming from swaps. Morgan Stanley increased their book by 8 trillion in 1 quarter recently. Their is over 300 trillion in swaps by the major banks. The banks are out of control and the government is in bed with the central banks to keep the illusion alive. Believe me, China and Russia understands all of this. That is why China is buying gold faster then ever. They understand the end is near for the dollar. The FED has lost control and it will soon blow up. Like I said, QE3 will not happen to boost the stock market. The FED will continue to buy MBS and monetize the bonds because with China out of buying US paper, who can continue buying 1.5 trillion in new issued debt per year? The FED is the end buyer of the bonds. The stock market just got ramped up to 13k this week on some bullshit rumor by Draghi. They will just keep doing this if the idiots buy this information. Everyone is front running the FED because they hope and pray the FED will save the stock market. The FED can’t save the stock market because it will blow up the bond market. All the money will flow out of the bonds and into the stocks if QE3 comes in. The bond market is 2.5 times larger then the stock market. IF rates rise on the US paper, the swaps blow up. Just won’t and can’t happen. That is why I get pissed off at all of these pundits on youtube and MSM. They don’t get why and how rates are being suppressed. Make this simple, zero interest rates is the biggest factor and key of a bullish metals markets. The central banks are trapped and can’t get out. They painted themselves into a corner. The only thing left is illusions and rumors to keep the perception that the markets are stable. The FED lost control in 2008 and all we have now is a 100% manipulated markets. The game already ended and our future has already been determined. It’s just a matter of time before it blows apart. When you see yields rise on the 10 year and 30 year bond on US paper rapidly, it’s time to pack your bags and get your guns loaded. That will signal that they just pulled the plug.

    • Glitter1

      Appreciate the explaination.I’ve been tracking gold and silver since late 1990′s. Started with buying miners then went to physical in 2006. I’ve read every commentary out their and still do daily. My preferred right now is Jim Willie cause he is giving same explaination as yours.Fed is in the treasury & bond markets purchasing directly,therebye holding yields down. I don’t think we have long to go before it all comes unraveled, probably by end of the year.I feel I have my bases covered, bullion,miners and prepped.

  • duckvision

    Glitter, this is from Rob Kirby. He is a master at understanding what the FED is doing with interest rate swaps.
    http://www.financialsense.com/contributors/rob-kirby/2012/01/13/the-dollar-centric-derivatives-complex

    Some highlights and I miss quoted you on some of the numbers on the swaps by Morgan Stanley and JP Morgan. Kirby set me straight.

    Tracking the evolution of the aggregate derivatives held by U.S. banks, it is apparent that trade in end-user products has been ABSOLUTELY OVERWHELMED by volumes in dealer trades – all in a “supposed market” which is 96% constituted by 5 players [the magnificent 5; J.P. Morgan, BofA, Citi, Goldman, Morgan Stanley]

    Historically, the Federal Reserve/U.S. Treasury ONLY had control of the VERY short end of the interest rate curve – specifically the Fed Funds rate [the rate at which banks and investment dealers borrow and lend to each other on an overnight basis]. With the advent and proliferation of interest rate derivatives – specifically Interest Rate Swaps [IRS], the Fed/Treasury gained effective control of the “long end” of the interest rate curve. Thus the Fed / Treasury has been practicing an undeclared form of financial repression for a very long time.
    Pre “neusury” – such a pronouncement would have caused a MAJOR SELL OFF in bonds [higher rates]. Nowadays, the Fed / U.S. Treasury and their ‘captive’ investment banking vassals high-frequency-trade pre-determined outcomes through the Interest Rate Swap complex to show folks like Bill Gross who’s really in charge. The cascade in 10 year yields depicted above just happens to coincide with the first half of 2011 – when, according to the Office of the Comptroller of the Currency, Morgan Stanley just happened to grow their swap book from 27.2 Trillion to 35.2 Trillion in notional – for a cool increase of 8 Trillion in six months at one investment bank.

    Control over the long end of the interest rate curve works as follows: The U.S. Treasury’s Exchange Stabilization Fund [ESF], a secretive arm of the U.S. Treasury unaccountable to Congress, began entering the “FREE MARKET” – deals brokered by the N.Y. Fed – as a receiver of “all in” fixed rates – in terms from 3 to 10 years in duration. Interest rate swaps [IRS] trade at a spread – expressed in basis points – over the yield of the 3, 5, 7 and 10 year government bond yield. Banks are virtually all spread players. When trades occur between spread players – one side of the trade sells the other side of the trade the proscribed amount of U.S. Government bonds. This creates superfluous settlement demand for bonds.

    This is how/why U.S. Government bonds and hence the Dollar can be made to appear “bid-unlimited” – even when economic fundamentals are SCREAMING otherwise. The amount of demand for cash government bonds that can be conjured out-of-thin-air in the derivative interest rate swap complex, which might be best described as “high-frequency-trade” on steroids – measured in hundreds of Trillions in notional – literally OVERWHEMS the cash bond settlement process.

    This means bond yields are set arbitrarily – in accordance with Fed / Treasury policy – NOT IN FREE MARKETS

    This is the real reason why J.P. Morgan Chase and the rest of the magnificent 5 now sport OTC derivatives books of 50 – 80 TRILLION in notional.

    Morgan Stanley [MS] supplies us with the “smoking gun”. MS grew their derivatives book by 14 TRILLION in notional in the first 6 months of 2011 – virtually all in product [swaps] that requires 2-way / mutual credit lines. MS is a company with about 30 billion in market cap.

  • truther

    STAGFLATION !

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