The U.S. MUST continue to attract foreign capital. It has no savings. Its people continue to live beyond their immediate means, trusting the stock market to provide. Thus, the U.S. MUST continue to be a magnet for foreign capital. With prospects for capital gains dwindling - see the recent performance of the U.S. stock and bond markets - the prospect for at least a solid rate of return in a SAFE investment must be maintained. That means HIGHER interest rates.
(Posted here on May 12)
The U.S. now HAS higher interest rates, on commercial debt of all kinds. The Fed saw to that on May 16 when they boosted the Fed Funds and Discount rates to 6.50% and 6.00% respectively. That was very quickly followed by commercial banks, who pushed their prime rates up to 9.50%. This is the closest they have come to "double digit" prime rates for almost a decade
But where the U.S. does NOT have higher interest rates is at both the long and the short end of the Treasury yield curve. Privateer Subscribers, if you have not yet done so, check out the Treasury bond yield curve graphs. On May 26, the 30 year Treasury bond closed yielding 6.06% and the 3-month T Bill closed yielding 5.82%. Both rates are substantially below the current Fed Funds rate, and more than 400 basis points below commercial prime rates.
Now, re-read the quote reproduced above from two weeks ago. "The U.S. MUST continue to attract foreign capital." How is it going to do that with the yield on what is universally regarded as "cash" (T-Bills) so low, and with the Dollar itself starting to come under real strain?
All over the world, people have been "conditioned" (that's the word) to expect BIG gains from their investments. This conditioning reached its apogee in the recent dot com boom. The boom affected every major market in the world, with HUGE rises in tech stocks of all descriptions - right up until March this year. In the U.S., investors have been expecting - and getting - annual gains of 20% for five years now. But in 1999, the Nasdaq gave them almost 86% - and then rose another 25% in the first three months of 2000.
Of course, since March, the tech stock boom has collapsed in even more spectacular fashion than it rose.
Investors all over the world have now had about two months to realise that the "punch bowl" has been well and truly whisked away. Most of them, especially in the U.S. but elsewhere in the world too, have not yet realised it, or to be more precise, they are refusing to even consider it. But as always happens in this situation, a small but growing number of investors are acknowledging a bear market, and are looking around for alternatives. These people are not looking for capital gain, they are looking for capital preservation.
To take the U.S. in this example, the search went from the "new economy" (the Nasdaq) to the "old economy (the Dow). But now that the Dow is showing distinct signs of weakness too, capital is gravitating in increasing amounts to the bond markets - both commercial and government bonds. Commercial bonds pay much higher yields, but they are much riskier. Government bonds are "safer" but they pay much lower yields. And for those who want to go into the "cash" end of the bond market, the yields are VERY low - 68 basis points under the Fed Funds rate to be exact.
Gold? No one is going into Gold, not in the U.S. anyway. Very few, even of those who understand the situation to some extent, are willing to park capital in an investment class which has been showing almost continuous LOSSES for nearly as long as the stock markets showed continuous gains. Couple that with the fact that Gold has not improved at all in $US terms (in fact, it has weakened) in the past two months while stocks were burning down, and it is not hard to understand why Gold is not attracting many buyers.
Very few want to admit that the days of easy capital gains may be over. Getting rich quick is a delightful prospect. But most of those who got rich quick on paper borrowed heavily to do it. Now, the paper riches have evaporated, but the debts have not. They need servicing, and the servicing costs are rising while the return on offer for the "safest" type of investment is not. For Americans, that's an uncomfortable situation, to say the least.
For non-Americans, the attraction of U.S. investments - of ALL varieties - is steadily lessening. Stocks are performing badly EVERYWHERE. U.S. debt paper yields on the government side are not keeping pace with market rates. Commercial debt paper offers attractive yields, but more and more of that is seen to be a risk premium. And the Dollar itself has definitely stopped rising, and is now starting to show unmistakable signs that it might be beginning to FALL. The global capital magnet is beginning to lose its pulling power.
Gold is DOWN in the face of all this. It has weakened in $US terms this week and has weakened much more in terms of major Asian and especially European currencies. The big fall on Gold took place on May 25, and was reliably reported to be exclusively the work of U.S. institutional short selling. Take a look at the volumes for that day on the charts above.
There is no proof that the VERY low rates on 3-month Treasury paper is partly due to Fed intervention. There is no proof that the big jump in Gold short selling this week is a concerted effort to harness the Gold price. Given the global financial situation of the present, though, and we have no reasonable doubt that both are the case. We have no way of knowing how long this can last. We do know that the vested interest in having it last as long as possible is huge.
But in the final analysis, the present level of Gold against the U.S. Dollar cannot be maintained indefinitely, especially if the Dollar continues to fall in coming weeks. It is much too early to call the Gold close of $US 270.70 on May 25 a "bottom". All we can say is that it was certainly a selling climax, and that the Dollar fell - precipitously - the very next day. Watch this space. We may not wait till next weekend to update this commentary.