By The Mogambo Guru

03/14/11 Tampa, Florida – Charts from contraryinvestor.com show that, as of right now, there is going to be almost $1.8 trillion in US Treasury debt maturing this year, and all of it will need to be “rolled over” by issuing new debt.

Perhaps it is also instructive that they also note that “Just shy of 50% of UST debt ‘rolls’ within three years.”

What this means, in practical terms, of course, is that We’re Freaking Doomed (WFD). “Why?” you ask. “Because,” I helpfully explain, “rising rates of inflation mean higher rates of interest that borrowers, especially deadbeat bankrupted governments, must pay when they try to rollover such massive amounts of debt!”

And what were interest rates three years ago when half of all Treasury debt, now rolling over, was first issued? I don’t know exactly, but the graph of “US Treasury Bond Interest Rate History” at observationsandnotes.blogspot.com shows that interest rates were higher in 2008, and lower now in the range economists call “squat,” meaning that rates have nowhere to go but up.

Well, perhaps you would be interested to know that the interest rate on these bonds is lower than at any time since the ’50s, and is just inches away from the all-time, record-low of 2% set in 1940.

Or perhaps you would be staggered, clutching your heart and screaming, “Nooooooo!” when you learn that the average interest rate over the years was somewhere just under 6% ever since the low of 2% set in 1940, which means that interest rates would have to double – double! – from here just to get back to the average interest rate paid on bonds since 1971!

And why was 1971 the big inflection point where interest rates went nuts? Because that was when volatility in interest rates really started Going Freaking Nuts (GFN) because, not by coincidence, Nixon severed the last threads of connection between the dollar and gold.

And there is a personal reason, too for picking that date. Before 1971, I was a fresh-faced kid, his whole bright future ahead of him, but who decided to make one idiotic, disastrous decision after another until I ended up here, decades later, a bitter little man wearing a bullet-proof vest and a tinfoil hat, hiding in the closet under the stairs and typing out hate-mail to the Federal Reserve (“Dear Federal Reserve morons, I hate you! Signed, Hateful in Florida”) and the Congress (“Dear Congress morons, I hate you! Signed, Hateful in Florida”).

And even before that, back to 1900, interest rates were low, and swings in interest rates were much more muted, too, because the dollar was mostly on the gold standard, which are two of the beauties of the gold standard, as we are seeing by just standing up and going over and looking out at a world on the verge of panic and ruination thanks to the Federal Reserve creating So Freaking Much Money (SFMM) for So Freaking Long (SFL).

And when the people of the world do panic, they will run to gold and silver, and their prices will soar, making this investing stuff so easy that you just gotta say, with every bit of earnestness you can muster, “Whee!”

The Mogambo Guru
for The Daily Reckoning

Read more: US Treasury Bond Interest Rates: Nowhere to Go But Up http://dailyreckoning.com/us-treasury-bond-interest-rates-nowhere-to-go-but-up/#ixzz1GncfoU5A

First and foremost, the parameters have changed in just a few short years. Government debt has increased substantially in the last few years. This debt and the debt of the last 10 years has been serviced at very low interest rates. In fact, its been serviced at historically low interest rates. When interest rates were higher in the 1990s, the overall debt load was significantly lower. John Hussman explains:

Moreover, in order to adequately evaluate the existing deficit, it is essential to recognize that this figure reflects interest costs that are dramatically less than we can expect as a long-term norm. Consider the chart below. The blue line represents interest on the gross Federal debt at the average of prevailing 10-year Treasury yields and 3-month Treasury yields. Presently, this figure is comfortably low, thanks to the depressed level of interest rates. In contrast, the red line shows what the interest service would be at a 5.2% interest rate, which is the post-war norm.

For debt service costs to skyrocket, interest rates only need to rise marginally. Think about it like this. There is $14 Trillion in debt. In theory, every 1% rise in interest rates could equate to an extra $140 Billion in interest service costs. Tax revenue in FY 2010 was $2.38 Trillion. Clearly, a continued rise in rates will have a highly inflationary impact. As we’ve said before, the Fed will have to monetize more as a result of higher rates and the Fed will have to monetize to keep rates low.

Furthermore, rising rates will certainly have an impact on an economy that is only three years into a de-leveraging cycle. When rates started to rise in the early 1940s, consumers and businesses already endured more than a decade of de-leveraging. Rising rates in 2003-2007 didn’t hurt the expansion because consumers were euphoric about housing and willing to borrow. Yet, this time around we are only a few years into the de-leveraging cycle and tons of mortgage rate resets are dead ahead.

Simply put, rising rates are a death sentence for an over-indebted nation. It cripples the economy’s ability to grow out of its debt burden. Moreover, it leads to default or hyperinflation, which basically means a doomed currency. Now, we do have a massively huge bond market so I am not suggesting rates are going to spike over a few weeks or a few months. This is something that will happen slowly but the market is already taking notice.

After rising over $200 in sustained fashion, Gold corrected via a “running” correction. This type of correction occurs when a market is very strong and it precedes another impulsive advance. Because of the recent correction, Gold isn’t so overbought. Also the COT data shows a reduction in both open interest and speculative long positions.  

Gold is in position to accelerate to new highs and then higher highs during the first half of 2011. Gold and Silver have already had a great run, but the best may be straight ahead. In our premium service, we are constantly working to find our subscribers the best stocks to profit the trends that lie ahead of us. If this interests you then we suggest you consider a free 14-day trial to our premium service.

Good Luck!

Jordan Roy-Byrne, CMT
Jordan@TheDailyGold.com

How to Profit as Wall Street Insiders Push Oil Higher Find out how high oil will go in this free report. We Value Your Privacy

According to the U.S. Treasury Department‘s Bureau of Public Debt, the U.S. national debt stood at $ 12,684,570,896,780.80 as of March 30. That’s not a typo… we’re talking about more than $12.684 trillion – or roughly $41,200 for every man, woman and child in this country.

By the time you read this, however, that number will be even larger: That’s because the level of public debt is growing at an average of about $4.02 billion per day – and has been since September 2007.

Americans have become so used to hearing about the national debt, and so used to the huge numbers associated with it, that they’ve essentially become immune to the whole topic and just accept it as a fact of life. In doing so, unfortunately, they miss a very important point: In order for the federal government to borrow this money, someone has to be willing to lend it.

This really hasn’t been an issue in years past because our government has financed the bulk of our national debt by regularly auctioning new Treasury securities of varying maturities ­- from as little as 90 days to as much as 30 years, generally speaking – to the public, which includes institutions such as banks and mutual-fund companies, private investors and, most notably, foreign governments and central banks.

As of the end of March, Treasury securities buyers held almost two-thirds of the total U.S. national debt, or roughly $8.2 trillion. That equates to about 56% of the U.S. economy’s annual output, as measured by gross domestic product (GDP). The remainder of the national debt – about $4.48 trillion – is money the government owes itself as part of reserve funds for various programs, such as Social Security.

Although the massive national debt is troublesome, as is the continued deficit spending, we could probably live with this situation, assuming the economy continues its recovery. After all, government debt has been a major feature of American life for decades, now.

Unfortunately, the federal government keeps creating new debt, and trying to sell more Treasury securities to finance it, meaning the demand for those securities is falling sharply.

And by all indications, this decline in demand could get worse.

In fact, if you look at recent Treasury sales numbers, it appears that international buyers – led by China and Japan – are drastically reducing their purchases of long-term U.S. bonds, notes and stocks.

According to recently released data, foreign purchases of U.S. Treasury securities declined to a net total (total purchases minus total sales) of just $19.1 billion in January, down 69.8% from $63.3 billion worth of net purchases in December.

China accounted for a huge chunk of that drop, selling $5.8 billion more in U.S. debt securities than it purchased, which reduced Beijing’s total holdings of U.S. government paper to just under $890 billion. This was the third straight month in which China was a net seller of U.S. debt, extending a downward trend that stretches back to July 2009, when China held almost $940 billion in U.S. Treasuries.

Japan, the second-largest foreign holder of U.S. debt, was also a net seller in January, with Tokyo’s holdings falling to $765.4 billion, a decline of $300 million from the month before.

It’s been more than a year since I first warned that this storm was brewing. Foreign governments were growing disenchanted with Washington’s inability to keep its financial house in order, particularly since that escalated concerns about the safety of the U.S. dollar. On top of that, overseas central banks are exceptionally concerned about the U.S. Fed’s insistence on maintaining artificially low interest rates – a more-recent development that’s nevertheless exacerbating fears about the health of the U.S. greenback.

Those fears are finally coming to a head. Now, barring some quick policy actions in Washington, our foreign creditors may well take matters into their own hands – possibly even staging a “buyers’ strike” against new U.S. Treasury offerings – ostensibly in an effort to force the Fed to raise U.S. interest rates.

In what would stand as a dramatic example of the classic supply/demand equation, the sharp drop in foreign demand for U.S. government debt in the face of the inevitable steady increase in supply could cause bond prices to plummet.

Couple that with the inverse relationship in the pricing of Treasury securities, and we would see bond yields zoom in order to attract sufficient buyers. Millions of investors would get crushed.

Historically, China has moved with practiced caution in this area. But as the fallout from the global financial crisis continues to play out, my sense is that as China’s domestic markets gain power (and exports become less important) Beijing could react both quickly and decisively if it feels threatened, or even just insulted, as was clearly demonstrated in the recent showdown with Google Inc. (Nasdaq: GOOG).

Unfortunately, at least where China is concerned, there seems to be something of an ill wind blowing in Washington, with gusts that at times appear both threatening and insulting.

For some time now, the United States has been trying to get China to let its currency, the yuan, appreciate against the dollar, a move that would help stem a growing upward trend in the U.S. current accounts deficit – in simple terms, the amount by which the wealth (in all forms) that’s flowing out of this country exceeds the wealth that’s coming in.

For the last two years, China, in order to support its own balance of trade, has resisted holding the yuan steady against the dollar. By devaluing the yuan, China makes its exports seem cheaper to foreign consumers, which generates larger trade surpluses and brings in more cash to bolster the $2.4 trillion in foreign reserves the country already holds. China accounts for 31% of the world’s foreign reserves, according to recent published reports.

As a result, Washington will decide later this month whether to declare China a ” currency manipulator” – a seldom-used designation that would allow the United States to impose a variety of trade restrictions, including new tariffs, import quotas and the like. In my opinion – shared by many others who closely follow China-U.S. relations – that would undoubtedly provoke a trade war, in which both sides would ultimately lose.

More potentially damaging, however, would be a decision in anger by China to retaliate by completely halting new purchases of U.S. Treasury securities – a move that would severely hamper Washington’s ability to borrow money to fund ongoing government operations and future deficits. This year alone, Washington will need to issue a record $1.6 trillion in new debt just to fund the shortfall between tax receipts and projected spending.

Indeed, it’s highly likely that the big cutback in China’s U.S. Treasury purchases we’ve seen during the past three months is meant as a warning of Beijing’s willingness to play hardball. It’s also a sign of China’s growing unhappiness with Washington’s spendthrift ways and the way in which the U.S. government has undermined the value of its own currency.

It’s a warning Washington would be ill advised to ignore.

The United States would be better served to allow interest rates to rise to realistic levels, while also shifting the domestic focus from artificial “stimulus” to reduction of the federal deficit. Such a strategy would undoubtedly cause significant near-term pain. But it would put the U.S. economy on course for sustained, healthy growth, while simultaneously bolstering the nation’s relationship with its foreign creditors.

If you see a similar scenario as inevitable, consider investments such as the ProFunds Rising Rates Opportunity Investment Fund (RRPIX), which is positioned to post substantial gains as interest rates rise.

You could also consider creating a hedging program of your own, using such exchange-traded-fund (ETF) investments as the SPDR Gold Trust (NYSE: GLD), or the United States Oil Fund LP (NYSE: USO). Those two ETFs closely track the world’s two most actively traded “currency alternatives” – gold and oil.

Many governments around the world see this same trend unfolding. Those nations have already started establishing non-currency “reserves” as a hedge against this contingency, and are making serious investments in gold, oil, minerals and other commodities. With the long-term economic growth projected for China, India and other emerging economies, commodity prices are destined to rise in price anyway, which makes those commodities a sound investment, as well as a viable hedge.

It’s a trend that U.S. investors would do well to note.

[Editor's Note: Money Morning Chief Investment Strategist Keith Fitz-Gerald is a perfect 22 for 22 with the recommendations made for his Geiger Index advisory service. It's a stunning record, but to those who know Fitz-Gerald well, it's actually not a surprise. A veteran trader, skilled analyst and noted market tactician, Fitz-Gerald is known for being able to see through the confusing haze of today's quickly changing markets to visualize and understand what the future really holds. This ability to predict looming changes is a key reason Fitz-Gerald is also able to divine the profit opportunities those changes will create. It's also a big reason he's been able to maintain a perfect track record with The Geiger Index. If you would like more information about the Geiger service, please click here.]

We also wanted to prepare our readers and clients for the next leg of the gold bull market as it will prove to be extremely volatile. Gold bull markets are unique in that buying becomes driven by both fear and greed. Gold is quickly moving into the hands of those who are unwilling to gamble on fiat currencies or bonds as a store a value. The new owners of gold are unconcerned with its lack of yield but instead are focused on its historic ability to preserve wealth and its unquestionable value. Given the difficulty we have valuing paper money, it becomes extremely difficult to come up with a reasoned price target for gold. Today’s gold market is significantly different from the gold market of the 1970s for two reasons: 1) Central Banks are more likely to be buyers of gold today and 2) They clearly have little ability to dramatically raise interest rates with the massive increases in government issued debt. Thus, it is easy to envision a similar twenty-five fold increase in the gold price that was seen between 1970 and 1980, which would result in a gold price today above $6,000 per ounce. We expect the often quoted “1980 inflation adjusted high” of approximately $2,200 to be achieved in short order. These targets may well prove to be irrelevant, however, as the quality of our lives will be more greatly impacted by the continued evolution of our money and how the general public chooses to value it, or not.

The so-called “exit strategy” has yet to enter the picture.

U.S. Federal Reserve policymakers yesterday (Wednesday) announced that the benchmark Federal Funds rate would remain in its record-low range of 0.00% to 0.25% for an “extended period.” And policymakers also said that the nation’s central bank would continue with its plan to wind down its purchases of agency debt and mortgage-backed securities.

The term “exit strategy” is a financial euphemism for boosting interest rates. By keeping short-term interest rates at what many experts say are artificially low levels, the Fed is betting that inflation will remain subdued in the short and medium-term and that the beleaguered U.S. housing market will be able to stage its recovery without crutches.

The policymaking Federal Open Market Committee (FOMC) “continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” the Board of Governors said in a statement.

But while most members of the committee agreed with the decision, Thomas M. Hoenig, president of Federal Reserve Bank of Kansas City, dissented. Hoenig believed that “economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted,” the Fed statement said.

Hoenig and other critics worry that the Fed’s expansive monetary policy will allow inflation to creep back into the economy. The concern is valid, considering prices are gaining upward momentum along with the U.S. economic rebound.

The Consumer Price Index (CPI) rose 2.7% last month from a year earlier. That’s the largest gain since 2007. Producer prices, meanwhile, rose for the third straight month in December, increasing by 0.2 % and recording their largest year-over-year gain since October 2008.

Like Hoenig, Money Morning Contributing Editor Martin Hutchinson believes the Fed has gone too far and fears that high inflation and a weaker dollar are all but unavoidable.

“The Federal Reserve’s loose monetary policy has put the dollar under duress. The central bank has pumped more than $2 trillion into the U.S. economy since the financial crisis began over two years ago,” Hutchinson wrote in a recent column. “As a result, the dollar tumbled about 20% against the euro in the past year. The Dollar Index – which measures the greenback against the euro and five other currencies – fell to a 15-month low earlier this month.”

The Fed might have considered at least changing its language to telegraph an eventual tightening of monetary policy. However, if Hoenig and others are wrong about inflationary pressures building, raising rates too soon could crush the fragile recovery.

“The Fed wants to sit still until the smoke clears,” Lyle Gramley, a former Fed governor who’s now a senior economic adviser to Potomac Research Group, told Bloomberg News. “To change the ‘extended period’ language would send a signal to markets that a tightening is not far off, and I don’t think the Fed wants to do that.”

Gramley doesn’t expect a rate increase for at least six months, while others don’t believe the Fed will change course until at least November. But by then it will be too late, Hutchinson says.

“With interest rates, the bottom line is that Bernanke is likely to keep them at a low level for far longer than he should,” he said. “When he eventually does start to raise them, he’ll do so only grudgingly, at first, even as inflation races away.”

Indeed, the Fed will have to keep a close eye on inflation, but it also will have to watch for turbulence in the housing sector. The FOMC statement said that the Fed is still in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the policymaking arm of the Fed is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter, March 31.

After a disastrous collapse, the housing market has shown some signs of stability. Home sales surged 28% from September to November. And the Standard & Poor’s/Case-Shiller 20-city home price index released Tuesday inched up 0.2%, achieving a seasonally adjusted reading of 145.49.

However, that boost was driven largely by the Fed’s purchase of mortgage-backed securities and the Obama administration’s $8,000 homebuyers tax credit, which was originally set to expire in November. The tax credit has been extended, but the housing sector will undoubtedly take a hit as the Fed winds up its debt purchases.

In fact, there already were signs of turbulence in December, as existing home sales plunged 17% to a 5.45 million annual rate. That made for the biggest decline since the National Association of Realtors (NAR) began keeping records in 1968.

“Housing is so heavily dependent on the Fed right now,” Sung Won Sohn, former chief economist at Wells Fargo & Co. (NYSE: WFC) and now an economics professor at California State University- Channel Islands, told Bloomberg. “The important thing for them is not to rock the boat and leave themselves plenty of flexibility so that in February and March they can alter their position if they need to.”

The Fed’s purchases have helped reduce mortgage rates by a range of a 25 basis points to 75 basis points, Boston Fed President Eric Rosengren told Bloomberg through Thomas Lavelle, a spokesman.

http://moneymorning.com/2010/01/28/federal-reserve-interest-rates/

News and Related Story Links:

Federal Reserve:

Jan. 27 Press Release

Money Morning:

Can Bernanke Tune Out Political Pressure as the FOMC Again Ponders Policy Changes?

Potomac Research Group:

Official Web Site

Money Morning:

Disastrous December Collapse Exposes False Start to Housing Market Rebound

Bloomberg:

Fed May Take Risk MBS Program End Won’t Hurt Housing

ZERO CORNER, DEBT COSTS & ISOLATION

by Jim Willie CB December 16, 2009

home: Golden Jackass website

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Jim Willie CB, editor of the “HAT TRICK LETTER”

Think isolation. Think monetization. Think trapped. Think Catch-22, no remotely viable option. Think motive for propaganda. Think end of the road in a gigantic USTreasury bubble, in the process of discredit. Think last resort of monetization, due to the absence of bidders at USTreasury auctions. Think pressure like a vise. The USGovt is in a great big bind and chooses not to discuss it. As European nations ponder the plight of sovereign debt default, the United States compares an order of magnitude worse from deeper insolvency. A default closer to home is considered unthinkable. So was a broad mortgage market breakdown. So was an endless housing decline. So was an insolvent broken banking system. So were consecutive $1 trillion federal deficits. All were forecasted here.

BOND BOYCOTT LED BY CHINA

Call a spade a spade! The Chinese, trade partner turned adversary, have been in boycott of USTreasury Bonds for a year. While still a significant creditor for USGovt debt, it also stands as the primary adversary in the movement to displace the USDollar from its global reserve currency, a veritable throne of privilege. Arabs and Chinese are mentioned consistently as the most important creditors for official USGovt debt. Something of note happened in 2006 and 2007. The Japanese stopped adding to their USTreasury Bond holdings. The slack was taken by China. Now something has happened again. China has stopped purchasing the USTreasury debt securities. The United States has been set up for acute risk in funding its debt. The response is clearly to be a greater dependence upon the printing press, as the USGovt will be forced to finance its debt through monetization, perhaps almost exclusively. This is the closest one might ever see of a major industrialized nation engaging in behavior best described as Weimar-like. And US economists reward its chief monetary mechanic with a national award! We witness the ultimate in moral hazard, even its celebration.

The war of words continues with China. The leaders and officials in Beijing have delivered salvo after salvo against the weakened US fortress for months. They direct volleys the deficit flank, the currency flank, the tariff flank, the reform flank, and others. They have led the rebellion to remove the USDollar from exclusive usage in international trade settlements. They have endorsed the phase-out demise of the Petro-Dollar. The deputy governor of the Peoples Bank of China had some stern words recently. Zhu Min from the PBOC said, “The United States cannot force foreign governments to increase their holdings of Treasuries. Double the holdings? It is definitely impossible. The US current account deficit is falling as resident savings increase. So its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world. The world does not have so much money to buy more US Treasuries. [It is] getting harder for governments to buy United States Treasuries because the US’s shrinking Current Account gap is reducing the supply of dollars overseas.”

This is a double whammy. Foreigners have less US$ funds to buy when USTreasury supply is exploding, due to smaller US trade gaps and smaller foreign trade surpluses. The outlet is USFed monetization to purchase the official bond supply using printing press funds, a last resort source of money. Asian economies have their own challenges. Gone is the Japanese trade surplus. China, on the other hand, is openly sick & tired of financing a government debt when the direction has not been set toward progress or reform. Improvement of the USGovt finances seems NOT a priority in the eyes of foreign creditors. Zhu was as plain as possible, that the USGovt should no longer rely on China for funding its bottomless deficits. Conditions are extremely likely to grow worse, with more desperation to finance deficits that in no way are reduced. The Fed has no choice but to turn the monetization machine on hyper-drive. A chart accentuates the problem and exposes the risk, thanks to RBS bank.

China has made two important changes in their USTreasury management. They have converted much long-term debt securities into short-term debt securities. They have also stopped buying short-term USTreasury Bills almost completely. See how China has sharply reduced their short-term USTBill support (US S/T in brown), which fell off a cliff since summer 2009, when it was an annual outlay of almost $200 billion worth, but now is next to zero. Shown are rolling 12-month sums, meaning around May 2009 the previous 12 months totaled around $190 to $200 billion. As of October 2009, their assembly of USTBills has been nil for a year!! Their long-term USTreasury purchases remain steady (in light blue) in the $90 to $100 billion range, again summed over the last 12 months.

Look more closely at the complex chart above. Notice the very serious dumping of USAgency Mortgage Bond, from a level with running 12-month total near $75 billion in the early summer 2009 to minus $25-35 billion in the last 12 months. Clearly, Beijing leaders have ordered a halt of USTBond purchases. Major entities are selling huge amounts of USAgency Bonds. The Chinese Govt has been selling mortgage backed securities almost as fast as PIMCO. However, they have halted the purchase of USTreasurys. Since May 2009, Chinese USTBond holdings have been flat at $790 billion. The USGovt is more isolated nowadays, left to its printing press device to handle the avalanche of debt. The US financial networks are mum.

Imagine, the US recession does not produce enough trade deficits for foreign sources to recycle, perversely. It sounds crazy. A recession will do that, like one that stubbornly refused to end. Going hand in hand with stronger and more robust economic activity inside the US fenceposts is huge trade deficits, no longer seen. This is yet another ongoing recession signal, since the October trade gap was ONLY $32.94 billion, grossly inadequate for foreigners to purchase USTreasurys. Foreigners have less US$ funds from trade to devote to USTreasury conversion, thereby avoiding the currency lift at home. The experts call the process sterlization, since the new US$ money does not convert, does not push the local currency higher, does not interrupt via a feedback loop the export trade that produced the surplus in the first place. Export of USTreasurys is the nastiest, most sinister, most effective device in creating gigantic unresolvable global financial imbalances.

A TEST TO EXIT FROM 0% RATE POLICY

The USFed decided to keep the official interest rate at 0%. My forecast is either no rate hike for 12 to 18 months, or else a gambit of a 25 basis point hike, but with further hikes halted. A series of rate hikes would cause far more havoc and disruption than the so-called experts anticipate. The chronic 0% rate offered at the US bond ring assures a resumed Dollar Carry Trade, and USDollar decline. This is simple speculation mathematics. The result will continue to maintain the gold bull market. As universally expected, the USFed kept its overnight target at 0-0.25% and pledged to keep rates low for an extended period in its words, again. Their statement contained some rubbish about expressed growing optimism for the USEconomy. They cited an abatement in the labor market deterioration and hope of improvement in the housing market, pure fantasy. Neither has remotely occurred.

More important than such nonsense, the USFed underscored confidence in credit markets. It stands by USFed plans to end most of its emergency lending facilities on February 1st. Removal of the primary true source of liquidity will be a dangerous proposition, but they must fake the billboard messages and give it a trial. It is my belief that the USFed will remove the flow of easy money, aka Quantitative Easing, but only on the fringe. They will cut back on some highly visible monetization of USTreasury and USAgency Mortgage Bonds. But they will not reduce any hidden monetization of the same bonds, a powerful enterprise with magnificent unspoken volume that prevents auction failures.

The USFed is actively running a trial balloon. They are permitting the slow motion rise in the 10-year and 30-year USTBonds. If the 10-year TNX yield rises above 4.0%, which could happen easily, a test will be given. Borrowing costs on car loans and commercial loans would rise in step. But the main event would be the test to the housing market from the mortgage rates sure to rise in step. In parallel, the mortgage bond market would undergo a test. The USFed in my opinion wishes to test its urgently needed but impossible exit strategy. My bet is the test fails. My other bet is they lie about its failure. In time, they will halt the test and admit the USEconomy and US credit market remain too weak to begin a rate hike cycle. In order to prevent a future disaster, they must end the current easing cycle. THE USFED WANTS THE TEST FAILURE TO PROVIDE POLITICAL COVER FOR REMAINING IN A RIDICULOUSLY LOW INTEREST RATE ENVIRONMENT. They might wish to kick the Dollar Carry Trade off its path periodically. They know the extended risks. They know much higher price inflation awaits on the other side of Easy Street. The veto vote goes to the short-term USTreasury Bill market. If conditions were ready for a rate hike, the USTreasury Bills would confirm it across the lower maturities. Notice the 3-month USTBill yield. It cannot even rise to reach the 0.18% plateau seen for the entire spring and summer months. This means no return to normalcy anytime soon. A point of history is worth mentioning. The US Federal Reserve almost never breaks away from the path set by the short-term USTreasury Bill market.

To further point out the futility of policy and the lack of viable options, last week former USFed Greenspan actually claimed the United States was on the path toward a ‘formidable fiscal crisis’ unless its deficit situation is tackled shortly. He should know since it bears his signature. Next turn to comedy. A recent report prepared for the National Bureau of Economic Research suggested the monster USGovt debt be reduced by allowing inflation to rise. The real value of the debt would suffer erosion, the victims being the creditors. The NBER contains some of the best nitwit economists on the planet, a shining example of US economist lunacy and destructive shamanism, an embarrassment to the nation. Let us not even delve into the risks of price hyper-inflation, which would serve as the greatest shock of reality to these utter charlatan clowns as they maintain the pretense of practicing economics. Fast rising prices would be like a large bowl of cold liquidity splashed onto their faces. Laurence Meyer, the fixture in the banker elite circles, actually said last week during an interview that no connection exists between USGovt deficits, USTBond issuance, and price inflation. The man is a bonafide idiot, yet revered and sought for interviews. Why do people listen to these guys? They are inflation apologists and high priests who sit on the helm of a titanic vessel dodging icebergs. How many gave nods of endorsement to grandiose 2009 federal budget surplus forecasts just a few years ago!?!?

USDOLLAR LEAST UGLY FOR NOW

The 0% rate continues to undermine the USDollar, an unchanging situation. The 0% rate continues to feed the gold bull, whose trough was pushed aside but will soon be placed to feed its appetite. The world requires an occasional US$ Index (DX) rally so as to avoid having it march directly into oblivion. The USGovt deficits are the ball & chain attached to the embattled USDollar. The onliest thing making the buck look good is the ugliness of the other major currencies. It is like going to a dance where all the ladies are grossly unattractive, and on the path to becoming discarded hags. After further review, the least unattractive start to look better with the passage of time. Add some liquidity, and the little beasts earn a bid higher. The fully engineered, entirely contrived USDollar rally began with the November Jobs Report, a work of fiction. It continued with the very real troubles facing European and London banks, from debt based both in Dubai and Southern Europe. The horrendous fundamentals for the beaten down buck had attention drawn away, by the wretched situation facing banks that underwrote massive debt to these two new centers of indebted attention. The Euro and British Pound gave way and buckled.

The last gold rally was led by the United States. The gold price in Euro terms has hardly corrected or budged. Attention is centered upon the European Union, certain to fracture from Parliamentary disappointment, as its monetary foundation suffers a grand erosion in its coastline to the South. Attention is centered upon the European Monetary Union, whose Euro currency will soon be denied usage across Southern Europe. The next round of the gold rally will be led by Europe. The broad advantages of a grand currency devaluation will soon come front and center. Greece, Spain, and other nations will realize the benefits of debt conversion and reduction on the back of returned currencies in the Drachma and Peseta. Then comes steady currency devaluation to enable a competitive position. The common Euro serves as a straitjacket for the distressed nations in the South of Europe. They are stuck, and will surely default one by one. The Revived Roman Empire once more proves frustrating, as it has for a millennium. The sequence of events is complicated. A heavy weight will sit atop the Euro currency from European credit failures until important significant events are unfolded and a new Core Euro is launched. At first the core version might simply be the old version with carved off burdensome Southern gristle and fat. These currency matters are analyzed in the December Hat Trick Letter.

MOTIVE TO MAINTAIN 0% RATES

An ultimate factor of practicality is often overlooked. Cheap interest rates to service USGovt debt is a huge reason why the official 0% interest rate policy continues. The USFed claims to want to end its ultra-easy monetary policy, but it is pure rhetoric of deceitful nature. A higher USFed rate would not only deliver a heavy hindrance to the USEconomy, but a great aggravation to the federal deficit. The USGovt revenues are down sharply. Notice the Receipts have fallen from $2600 billion to almost $2000 billion in the last two plus years. They have fallen and cannot get up. In fact they contradict any lunatic notion of a jobs picture improvement. The November Jobs Report was a pure fiction. Thanks to the Casey Research folks for a great chart.

The heady White House staff estimates the current fiscal year debt service to be $202 billion. That amount is actually less than the 2008 debt service cost, even though the official 2009 federal deficit shot into low stratospheric orbit at $1420 billion. Despite much higher debt in 2009, the service cost to the USGovt debt went down, something of an advantage. In fiscal 2009, the average USGovt interest rate on new borrowings was under 1.0%, the lowest ever recorded. They want that to change??? Hardly!!! TRowe Price estimated that if USGovt debt service costs remained constant into year 2009, the cost would have been $423 billion, higher by $221 billion, or almost 110%. Bill Buckler of the Privateer calls 2009 the ‘Interest Free Year’ very appropriately. The USFed cannot cut rates any lower, unless they go negative. Furthermore, the USFed has used its mouths to make words to the effect that it will stop adding toxic bonds to its balance sheet by March 2010. The USGovt and USFed have enormous motive to keep their borrowing costs down, and to continue the discount to borrowing costs.

My doubts are very high for any end to monetization of USTreasury and USAgency Bonds or for any halt to USFed massive expansions to its balance sheet. If the USGovt and USFed stop buying US$-based official bonds, these debt securities must fight on their own in the bond market for proper valuation. That means higher yields and lower price, since supply is bloated and supply aint stopping!!

FINAL NOTE ON DEBT DOWNGRADES

The debt ratings agencies have been busy in the last few weeks. They do NOT wish for a repeated episode to demonstrate global extreme incompetence, or to suffer further charges of collusion. Their opponents, the many corporate bond losers in the wake of 2008, have begun a parade of lawsuits. Perhaps the discovery phase will produce some ripe evidence from the hallowed bowels of Wall Street. Nah! Claims of national security will block that path. Perhaps religious grounds will be cited, as Goldman Sachs is doing God’s work. The prospects of sovereign debt downgrades have led to wide debate about the likelihood of a string of sovereign debt defaults. Such defaults are written in stone, in my view. The main question is whether the Big Three ratings agencies will be ahead of the game in which they purport to be experts, but actually are agents of collusion, objects of coercion, in a system designed with unworkable built-in biases.

Mere discussion by Moodys in recent weeks of a USTreasury debt default is indicative of the lack of creditworthiness. They said a USGovt debt downgrade and a UKGovt debt downgrade are unlikely. They should come out and admit that neither is permitted. Between the lines they declare a debt downgrade is deserved. The USGovt debt burden will climb to 97.5% of GDP next year from 87.4% this year, according to the Organization of Economic Cooperation & Devmt forecast in June. The UKGovt public debt will swell to 89.3% of the economy in 2010 from 75.3% this year, a bigger percentage jump, according to the OECD. Moodys mentioned that all Aaa rated governments are affected by the global financial crisis, with differences in their impact and ability to respond. They must refer to the ability to print money and monetize debt, perhaps even pressure other nations to purchase the debt via their obedient central banks. David Keeble is head of fixed income strategy in London at Calyon, the investment banking unit of the French Credit Agricole. He said, “There has been a huge increase in debt-to-gross-domestic-product ratios as a result of the crisis. It is right that there should be a lot of attention and pressure on these numbers. It is difficult to drive a big wedge between the US and UK in terms of their fiscal outlook. The flexibility that Moodys spoke about is not obvious. It is all a matter of political willpower.” My interpretation is more like extreme political coercion of the debt rating agencies by the USGovt and the UKGovt. The heightened pressure is of a corrupt nature, precisely like the force used to grant triple-A ratings to Wall Street banks that failed any rational justification in 2008 before the bank sector implosion in the autumn months of 2008.

THE HAT TRICK LETTER PROFITS IN THE CURRENT CRISIS.

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Have Violin Must Fiddle

By Neil Charnock

goldoz.com.au

Interest rates are up again here in Australia as the RBA hikes our prime rate by 0.25% to 3.75%. One bank has already come out with a 0.45% hit on mortgage borrowers of nearly double that figure. The Federal Treasurer stated that the banks have no justification to take this policy course however I beg to differ – truth is they have to rebuild their balance sheets to cover the bad and doubtful loans on their books – some of which are disguised as performing assets.

Could the RBA be trying to keep a lid on our housing bubble which deflated somewhat before expanding again after the economic stimulus package?  Perhaps they are giving themselves more ammunition come the next round of economic weakness?  By raising rates now they can drop rates further - later on as stimulus.  Then again perhaps it is just a matter of “have violin must fiddle” and they just can’t leave things alone and feel they have to be seen to be doing nothing.

On top of this news today we have the third leader in the Government Opposition since they lost the last election. I have to resist the chance to joke about bringing back the past Treasurer Mr. Costello to rejoin the new leader Mr. Tony Abbott as no.1 and no.2 (Abbott & Costello) because that would be cheap of me. It’s an old joke but this event makes it seem topical again and funnier. I take no political sides as this is not the venue for comment on climate change or politics.

Then we have the fiasco in Dubai and a major debt default – more on this later including comment on bad loans and remaining weakness within the global banking system.  For now I want to talk about the status of Australia as a leading global gold producer.

Worlds Number Two Gold Producing Nation

Global gold output has been falling and the dominance of South Africa as the leading gold producer for over 100 years has declined over the last few years. China overtook the position of number one gold producing nation in 2007 from the USA which had taken the leading status in 2006. China now produces significantly more than any other nation and is a clear leader.

Just as well because their domestic and Foreign Reserve appetite is immense and growing.  Don’t expect them to start flooding the world with their gold as the Chinese establishment has publicly announced that they encourage their citizens to own the king of metals.  If only our Government had that sort of foresight - all credit to the Chinese for this policy.

This year however Australia has claimed the number two spot at least for the first half of 2009 and this is the area of the market that we specialize in here at GoldOz. The ramp up of the Newmont Boddington mine in WA will be responsible for maintaining this rise in world ranking for Australian production.  Boddington commenced mining in July 2009 and produced its first gold / silver concentrate in September this year so the best is yet to come.

The ramp up will take place over 12 months continuing to add to Australia’s production statistics as it heads towards 7 Mt – 9 Mt of gold per quarter. This massive mine took 16 million man hours to construct and has Reserves of over 20 M oz with a projected mine life of more than 24 years.

On November 20^th Newmont announced on the ASX that it has now achieved commercial production and expects full design production at Boddington in 2010. This mine will add substantially to Australia’s gold production rate which reached 112 Mt in the first half of 2009 according to Surbiton Associates director Dr Sandra Close.

The giant  BHP mine, Olympic Dam in SA, has a proposed expansion over 11 years which could take production of gold from 100k oz per annum now to over 700k oz per annum for a total of approximately 20 Mt of gold each year. To put this into perspective consider that our two other largest mines, after Boddington, include Telfer with production in 2009 of 629k oz and the Kalgoorlie Super Pit that produced 606k oz in 2008.

By the end of 2008 the Australian gold industry exploration programs had defined an additional 34.8 million new ounces taking our Economic Demonstrated Resources (EDR) to 6,255 Mt of gold which represented 81% of our Demonstrated Resources. In 2008 terms this ranked Australia equal second with Russia for in-ground resources, each with 11% of global resources.

The Australian Bureau of Statistics reported an exploration spend of $570M for 2008 and WA continued to be the prime exploration target with $329.1M spent in the same period. WA also produced 134 Mt of gold which was about two thirds of total Australian gold production for 2008.

The interesting thing about the global gold industry is that it is global and therefore the Australian listed gold stocks based here have operations spread across every continent. Australian domiciled companies produced significant quantities of gold offshore too and the local industry also derived a benefit from these activities as earnings are repatriated back into Australia.

Australia has an exceptional Global Sovereign Risk rating making it an excellent place to do and invest in business. We are right up at the top of this table of rankings too. There is no better business than gold right now and for the foreseeable future. Our gold miners are enjoying an AUD$1300 gold price (approximate) and nearly all of our producers are profitable at this level.

Some of the producers rank in the lowest cost quartile in world rankings making them extremely profitable at these levels. We have several in the second quartile of cash costs too. These stocks are generally in powerful up-trends as indicated by the chart below on the Emerging Producers.

Because they are coming off the hyper low, over sold, panic levels of late 2008 there is plenty of room for new profits for investors. Gold was below A$1,000 in September 2008 before the crash and reached about this level in November 2008 when the index below was considerably higher.

Despite the current low end of year volumes they are still being accumulated ahead of further expected rises into 2010 and beyond.  The XGD, Large Producers Index and Explorers Index are also in up-trends with loads of upside potential.

Performance wise, many of these stocks are cheap and our ratings table in the restricted Gold Members area of GoldOz shows this in graphic detail.  We see gold continuing to rise and become more prominent due to its role in international banking and due to investor demand.

The Dubai shock last week showed exactly what I have been saying about the banking system.  Who could possibly think that the economic shocks are over and all is well again in the garden.

That $56B was shown as a performing asset on the balance sheets and this was clearly not the case.  Bank balance sheets need time to rebuild and this process will take years. The bad debt provisioning will have to be added to as time goes on and these disasters come into the light of day.  The confidence in the assets (loan books) of the banks has to be under renewed scrutiny again and this is bad for confidence in general – good for gold.

There is always the fear of, and the chance of, the need for new rounds of capital injection into the banks while their balance sheets are weakened.

The debt securitization market is gone because nobody in their right mind will stand there and buy debt in this market given the risks involved. To ram home the point – Dubai illustrates this clearly. Besides, this type of activity is more a feature of the late stages of mature bull markets so a debt securitization market is unlikely to reappear for many many years yet.

This will constrain bank earnings and growth and will slow the process of vital balance sheet repair for the banks and corporate sector. Hence minimal jobs growth will occur which will further constrain growth in particular consumer spending led growth supporting manufacturing and retail.

Investment capital is still looking for safe yield and investors are in still in preservation mode despite the growing appetite for riskier assets post crash conditions. This has led to renewed interest in equities as returns are sought.

It has aided the recovery of gold stocks to above pre-crash price levels which is more than can be said for the rest of the market.  Even the gold explorers and developers who have been able to raise significant money have found traction and are rising strongly.

Main stream investment flows will gradually wake up to gold as time marches on and this will lead to further gold and silver demand. This will in turn create greater and greater demand for gold stocks. I have stated in the past few months that we are now entering the media phase where gold actually receives attention.

Here is the genesis of a new bubble forming to be fueled by the US carry trade, continued fear and new investment interest. The outstanding performance of the gold stocks will generate new interest from mainstream investment flows. It will be fueled by real and totally justified demand for producers that are still undervalued relative to their increasing cash flows – margin over total costs.

Profits will increase as this sector sees the results of new plant development, plant upgrades and increased exploration expenditure over these past few years. We are working on an update to our Capital Raising file for Gold Members to show the phenomenal money that has poured into this sector despite tight credit conditions. Resources will grow thanks to all those new exploration holes and this generates excitement for gold stocks as the price of gold rises.

Australian gold stocks will benefit from global and local demand more and more as time progresses and I fully expect this to turn into a bubble over time.  Fear drives investment demand like no other force – including greed.

See (below) how our gold index (XGD) has outperformed the general market (XAO) here in Australia since they re-listed the XGD. The move to incorporate the XGD into the XMM 300 All Metals and Mining index shocked and annoyed me at the time but I welcomed the obvious return when it finally gained enough interest for the ASX to discover their oversight.

The XGD was axed several years into a bull market which really perplexed me but by the time the XGD was again recognized it was ready to take its worst tumble of the bull market to date. As you see the gold index fell sharper and earlier than the XAO however it also recovered earlier now reaching new heights above those pre-crash 2008 highs.

It has disconnected once again and is looking strong. The RSI on the bottom is for the XGD whereas the XAO RSI picture (not shown) is looking poorly now. This indicates that the disconnection between the two indicies will continue to widen in favor of gold.

As we move forward and the slow growth impinges on the general market companies compared to ever growing interest in and profits from the gold producers the picture will change even more.

This will win new interest in the Australian gold sector as hot money and day traders seek out the leading market sector.  So hot money, offshore investment flows from flight to Sovereign safety, active investors and safe haven investment from the savvy will continue to build investment in Australian gold stocks.  The investment funds will be back early next year looking for another good year of yields too.

These demands will be significant however not to the degree that offshore money can move this index. Once the global rush for gold, silver and gold stocks gets really serious then I expect the excellent status of the Australian gold sector to suck investment flows like debris into a twister, like matter into a black hole only this one will expand.

Our gold sector is tiny compared to the rest of the market for now but this will change. Are you ahead of this game – are you in gold and silver and precious metal stocks?

Our bonus time offer for GoldOz Gold Membership subscriptions is over as of end of November (yesterday) however I allowed a late comer in today on the same deal.  Therefore I have decided to be fair and extend this deal until Friday 4^th December for new Gold Membership only.  From then we will just concentrate on new improvements and investment resources at GoldOz as we scale down for the Christmas break.

Good trading / investing.
Regards,
Neil Charnock

goldoz.com.au

GoldOz has developed a basic Member area (news only) and a Gold Members area with substantial investment tools.  GoldOz web site is a growing dynamic resource for investors interested in PGE, silver and gold companies listed in Australia, ASX share quotes, Aussie Gold Index charts, brokers, bullion dealers in addition to the company research + investment tools via our paid Membership services.

Neil Charnock is not a registered investment advisor. He is an experienced private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.

It goes like this…. “As soon as the Fed raises rates, it will pop the Gold bubble and the US$ will bottom”

This is totally ridiculous. First, it is real interest rates that matter. Rates need to be 2-3% above the level of inflation. So right now, even if you say inflation is 0% or 1%, rates would need to go up to 2-3%. Secondly, rising rates usually follow the price of gold. It was true in the 1970s and is probably true when you look at the price of Gold in other countries. Rates rise because people don’t trust paper. Rates have to rise high enough for people to abandon hard assets and trust paper again.

Based on this factual analysis, the Fed will have to hike rates aggressively. They have never raised rates when unemployment has been rising. Even by their own admission, they won’t raise rates anytime in 2010. And why would they begin to hike aggressively when the economy is approaching zero hour and maintains no real growth of any sort?

Also, we didn’t factor in the currency weakness. Most people expect the US$ to lose value. If it loses 5% a year and inflation is 2-3%, then rates really need to be 10% to poke the bull in Gold. What is more likely for this scenario is that the Fed says inflation is 2-3% and they can tolerate it now because a weak US$ and low rates will help the economy. Therefore they’d keep rates under 1%, even though its obvious the economy is hitting zero hour- the point where new debt is not creating any real growth.

This argument is just total nonsense. Again, it is just a sound byte you hear on CNBC from the same analysts who have gotten everything wrong. They throw this out there, along with other BS, without even looking at the facts. The interest rate argument is at the bottom of a list of concerns for Gold investors.