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Interest Rates (and Gold) Going Up Up Up

Alan Greenspan recently told the world that hedge funds ought not to be expecting the carry trade to last forever. In other words, they'd better unwind their borrow-short, lend-long positions before it's too late. And if there is one thing we know about Alan Greenspan, it is that he cares about his reputation more than anything. Senate minority leader Harry Reid (D-NV) recently labeled the Federal Reserve chairman as "one of the biggest political hacks we have here in Washington". We have already seen Greenspan blame fiscal deficits, high natural gas prices, corporate scandals, terrorism and virtually any other thing he could name for the "jobless" recovery we are currently experiencing. Anything that will give him political cover is fair game.

In addition to signals from Greenspan that interest rates are moving higher, the U.S. Treasury has let the cat out of the bag too. Starting next month, EE Savings Bonds will pay a fixed interest rate instead of floating. If you buy EE savings bonds (which are guaranteed to double in value within 20 years) before May 1st, then your interest rate fluctuates with the 5-year rate. If market rates go up, the bonds will double in less than 20 years. If market rates go down to zero, you are still guaranteed a minimum yield to maturity of 3.5%. Under the new rule, if rates go up, you are still stuck with a bond paying an annual rate of 3.5%. Bottom line: this new rule saves the government (and costs you) money if rates go up.

So with both the Fed and Treasury telegraphing future rate hikes, we bring our attention to the gold price. We often laugh when the bubbleheads on CNBC talk about how rising rates are good for the U.S. Dollar and bad for gold. Never mind that interest rates usually follow the gold price (remember the 1970s) and their upward movement is typically a sign of uncontained inflation (paid an electric bill or filled up a tank of gas lately?) Never mind that rates fell during the 1990s and the dollar went straight up. While interest rates are important and one should be careful not to "fight the Fed", we think the Fed is the one that should be careful not to overestimate its power. Even if the overnight rate is hiked to 5%, we doubt that such policies would change the balance of trade in America's favor. The American consumer is too set in his ways to stop spending and start saving just because interest rates are a little higher. Furthermore, the glut of dollars sitting in Asian central banks is too large to ignore. Eventually, paradigms will shift and the Dollar will be toast, no matter what interest rates do. The best way to protect yourself when the glut of dollars is dumped is to own some gold.

Gold is protection against weak handed governments around the world and their race to debase their currency. Greenspan and his merry band of "yes" men are leading the charge in sacrificing long-term prosperity for fleeting short-term gains. This fundamental fact is proven with each worsening trade deficit and ballooning debt figure. Gold will inevitably suffer setbacks and frustrating periods of consolidation (like the last year). However, we believe it is imperative for fundamental dollar bears to stay the course. The ultimate rewards for gold and gold mining shareholders will be something to behold.

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