Nov 28, 2010

Big Gains Ahead as Interest Rates Rise

By Andrew Mickey, Q1 Publishing

Everything has changed.

Two days ago Black Friday. It’s a day when Americans shop and the financial media dispatches as many reporters to stands outside malls and big box store describing and describe the size and types of crowds, what they’re buying, and speculate on how much they bought. They interview of one or two shoppers posed as if they’re representative of the crowd.

It’s an annual tradition. This year, however, it was a much different story.

Leading the financial post-Thanksgiving headlines was a much less pleasant theme – debt.

The revolving crisis in Europe has snagged Ireland this time. But as the market has realized late night negotiations will inevitably lead to a bailout. And then it will Portugal’s turn to be followed by Spain and Italy.

The one common factor among all of this is that interest rates are going up. The deteriorating creditworthiness of countries around the world has forced lenders to demand higher rates of return for the increased risks. And with interest rates on government debt as the baseline, the inevitable rise will ripple through the rest of the global economy.

As long-time Prosperity Dispatch readers know, interest rates are the most important factor in the financial markets. They drive stocks, commodities, the economy, and bonds directly or indirectly.

Now that they’re on the rise, the financial media is right to be focused on them because rising interest rates will have significantly and negatively impact most investors’ portfolios. But despite all the bad news, history has shown rising interest rates signal very good times ahead for one asset class.

-----------------------Special Offer-----------------------
Don’t Miss the Next Big Gold Discovery

There’s a quiet excitement building around a small company which has recently hit discovered some big gold.

The last time we saw a situation as attractive as this, readers had the chance to walk away 1,121% gains.

Follow this link for all the details.
--------------------------------------------------------------

Interest Rates: The Key to Long-Term Investing Success

To see what’s likely to happen in the next few months and years, all you have to do is look back to the last time interest rates rose for a sustained period – the 1970s.

The decade was dominated by stagflation. There wasn’t much opportunity for investors as rising interest rates sunk bonds and stocks. The 1970s was worse than a lost decade. It was a decade of losses.

The chart below shows what happen to stocks in between 1972 and 1982 as interest rates rose:

Rising interest rates destroyed stocks for the entire decade. The S&P 500 increased 20% while the yield on the 10-year Treasury bond increased from about 6% to 15%.

In real (after inflation) terms, the results were even worse. The value of a dollar declined 56% as tracked by the consumer price index between 1972 and 1982. So the real return on stocks was actually negative 50%.

That’s why the financial markets reaction over the past few weeks is of paramount importance.

In the past few weeks the yield on the 10-year U.S. Treasury bond climbed from 2.40% to a recent high of 2.90% - a relative rise of 20.8%.

The junk bond market has fared even worse. After a post credit crisis renaissance which saw record setting amounts of high-yield debt issues, the bull market has shown its first signs of weakness. The yield on CCC rated debt (official defined as: currently vulnerable and dependent upon favorable business, financial, and economic conditions to meet commitments) has increased from a 52-week low of 10.2% to 13.9% - a relative 36% increase.

Muni bonds have been hit too. The Republican takeover of the House has made a bailout of profligate spending states even more unlikely as more of them near insolvency. Merrill Lynch reports the yield investors expect on short-term muni debt has climbed from 2.4% to 3.2% - a relative increase of 33%.

The sharp rise in rates is ominous. But there is one asset class which, if history is any example, is set to continue its run even in the face of rising interest rates.

Rising Rates: A Symptom of Inflationary Disease

The 1970s were not good for many investors. But it was a boom time for gold investors.

The table below shows a startling correlation between interest rate changes and gold prices:

In 13 of the 14 years tracked both interest rates and average gold prices rose. The only exception was 1981 which came after a year when average gold prices nearly doubled.

This time around we’re seeing a very similar situation. The 10-year Treasury bond yield has increased 30% and gold prices have climbed 55% since treasuries yields bottomed out in December 2008. That move is strikingly similar to 1979 when rates increased 24.3% and gold rose 58.72%.

At the risk of saying “this time is different” though, it really is shaping up to be somewhat different.

There’s no incoming Fed chief with plans of whipping inflation now (in fact, they’re taking steps to do the exact opposite).

The political will to induce a recession which would drive housing prices down to their historical norms, put an end to the stock rally, destroy the bond market, and likely bottom out near the next election, is non-existent.

So if you’re concerned about the recent rise in rates – which you should be – keep in mind there is always an upside and downside to any change. Rising rates are not good for stocks, bonds, or the economy. But they signal conditions are great for gold.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

-----------------------Special Offer-----------------------
The Best $29 Investment You’ll Ever Make

We recently put together our best offer yet. Our investment research will pay for itself within three months or we’ll give you a 100% refund – no questions asked.

Take advantage of this special offer today.
--------------------------------------------------------------