Up to about one year maturity, the United States now has an interest rate structure lower than that of Japan, though with much higher price inflation. Treasury bill interest rates for 3, 6 and 12 months in the US are 0.02, 0.05 and 0.15%. The same rates in Japan are 0.11, 0.11, and 0.14%.
Japan, however, has had price stability for years. Not so in the US. Even the government admits to a 3.5% price inflation rate, though most observers feel that especially if one is not in the market for a home (meaning the great majority of people), the real inflation rate is much higher than that.
What explains interest rates in the US? Could it all be due to manipulation by the Federal Reserve and the banks it regulates?
I can’t answer that one, but here’s a clue. On the futures board today, the prices of stocks, gold/silver/oil, and Treasury notes are all up.
Something does not compute here, just as essentially zero interest rates at a time of moderately high price inflation rate seems wrong.
This leads to an updated discussion of what investors may consider doing in response to these anomalies.
The collective “wisdom” of the futures markets may be that those who can are fleeing cash. That includes throwing in the towel and saying that a 3% annual payout from the government beats getting almost zero year after year. Thus bonds can be up in price (down in yield) despite traders continuing to bid up the price of gold due to the persistence of negative real interest rates, which year after year takes turns setting records in one fiat currency after another. Recently it set an all-time record in pounds, and I assume the same is occurring today. Meanwhile, banks are “encouraged” to buy T-bills. So are value investors who see no value in long-term bonds or stocks and hide out in cash waiting for relative bargains.
The financial times we are in are in some ways more extreme than after the Great Crash of 1929-32. This may relate directly to and stem from the combination of more gross financial leverage and lower lending standards recently than in the 1920s.
The decade of the 1940s was comparable to our times and is that best comparable example I can find from an interest rate, debt and inflation standpoint. Of course, the comparison is imperfect, but perhaps history is rhyming. In the 1940s, the CPI doubled, meaning prices rose 7% yearly. Yet the Fed successfully held short-term rates to around 1% that decade, with very low long bond rates as well. This yield suppression continued even after the Federal debt soared to about 250% of GDP after WW II deficit spending ended.
Of course, gold prices were fixed then at one ounce per 35 dollars, so one cannot look at the price performance of gold that decade. Also, stocks began the decade at about the same level they had been at as far back as 1906. Stock valuations and dividend yields were vastly more attractive then than now. By the end of the decade, stocks sold at a dividend yield of around 6.5%. Fears of another depression were rampant, and investing in stocks was considered highly risky. Voila! Quite the bull market ensued for 15-20 years from the 1948-9 low. But that massive bull market depended partly on very low starting valuations, a benefit which today’s stock market continues to lack.
Today, belief in owning shares remains widespread, the opposite of the view in 1940 and 1949. Yet one gets shares today that by two different fundamental measures of value are just as overvalued today as they were undervalued then. The only significant exception nowadays I can find involves gold (precious metal, mining) shares, which are cheap relative to the price of bullion based on their trading relationship over the past decade. For some reason, investors who are used to bidding the price of oil producers and refiners up and down based on the minute-by-minute fluctuations of crude oil prices on the futures markets think that gold producers are different from oil producers.
The two major ETFs that allow diversified investment in gold miners (and silver miners) go by the symbols GDX and GDXJ. With gold within 1% or so of its all-time high priced in US dollars, GDX (large caps) is close to 15% off its high. GDXJ (smaller cap producing companies) is about 20% off its high. Miners can provide leverage to a rising bullion price. On the other hand, as a class they may allow for positive total returns even if gold bullion is flat to down in price in the years ahead. If indeed gold is eternal money, then share ownership of a company with proven economically-recoverable gold reserves allows one to own money stored safely in Mother Earth. When oil underground in the 1980s and 1990s got “too cheap”, oil stocks greatly outperformed the price of crude. The same could be true for gold and the stocks of ”real” companies operating in that field.
Bringing money out of the ground. Not such a bad business in my book.
Full disclosure: Long a variety of gold mining stocks and funds.
Dr,
I like individual miners as opposed to a basket of equities such as GDX or GDXJ. Reason being I think there’s a higher chance of upside by customized picking of undervalued miners.
Any thoughts/methods on how to pick relatively undervalued companies?
my opinion on the subject is that people are looking at say, the s&p 500, trading at 13x this year’s earnings, or in that vicinity — so the earings yield (inverse of the P/E) is nearly 8%. huh, looks cheap and attractive relative to cash at near 0% or even a Treasury bond at 3-4%.
i think the equity market actually has it right (for once) this time, as it anticipates much higher than zero inflation, which i believe to be over 5%, and i think the Treasury bond market is out to lunch. i realize this is a bold statement given the breadth and depth of the market, who am i to disagree … but i do.
this doesn’t mean Treasury yields widen anytime soon, or that they will not compress even further. but for my money, 3% for a 10-year Treasury is not acceptable as it does not even keep up with the rate at which prices are increasing. and if you are not a renter or you are a homeowner not looking to move, i believe there is zero argument that current pricing is appropriate, as housing is most of what i see deflating in price.
Sundar: I do own certain individual gold stocks. I would prefer to discuss them with you via my blog, as we try to keep things more thematic here. Please put in a comment on the last post at http://econblogreview.blogspot.com and I will respond.
dd: I agree with you in general. I do not think that current earnings estimates (with the government having pushed $2 T in the last 12 months into the economy more than it extracted in taxes) are an especially good way to value stocks, but of course that’s what makes markets. I am partial to the Smithers approach, the valuation chart of whom I link to frequently. See http://www.smithers.co.uk/page.php?id=34
Also, as I am in Econophile’s stagflation camp, I am wary of equities as inflation hedges, thinking back to 1965-82.
My interest in Treasury bonds is primarily trading them for capital gains, not only the yield. For long-term buy and hold for income and some gradual appreciation I prefer (and own) utility stocks. But I seem to recall that you are an investments professional, so in that case you would likely be familiar with both with the concepts of rolling down the yield curve and the leverage inherent in zero coupon bonds. IF (a big ‘if’) I am correct about more economic weakness in the months ahead than the consensus expects, then I may well have a chance to flip Treasuries and buy back into equities with a profit on the Treasuries and a lower buy-in on the equities.
Sundar, in or very near production, max cash cost $500/oz, no hedging, cash in bank, proven resource with upside, share chart positive. You can do a “gold” company search on http://www.asx.com.au
thanks, Doc. all points well-taken and i agree. fiscal tightening, in the short-term, would knock stock market earnings down in a big way. that really is the main debate for owners of stocks, as i see it.