Why Lower Interest Rates are Good for Gold

Get ready for another week dominated by interest rates, folks. The Reserve Bank meets tomorrow and the market thinks another rate cut is a certainty.

And why not? It’s the only thing this country has when it comes to economic policy.

In a bit of trouble…who you gonna call? Glenn Stevens.

That’s why the market continues to hold up despite signs of visible economic weakness. On Friday, Australia’s largest retailer Woolworths [ASX:WOW] issued a profit warning. It’s share price fell nearly 10%, which is an incredible one day decline for such a large company.

Lower interest rates clearly aren’t doing much for Woolies. They’re not forcing management into smarter decisions or magically boosting profits.

But that hasn’t stopped the market believing lower interest rates won’t help everyone else.

Interest rates are good for the market…until they aren’t. That is, while the weak economy isn’t yet having an impact on earnings, the market will push share prices higher and higher. But as soon as earnings projections take a hit, the market will punish the company in question.

So by all means celebrate the short term boost that another (forecast) interest rate rise will bring, but watch out for landmines along the way. The Woolies bomb just went off.

China’s been flying under the radar lately, but you can be sure its economy is struggling too. On Saturday, the People’s Bank of China cut interest rates on the threat of…you guessed it…deflation.

The Financial Times reports:

The People’s Bank of China, the central bank, cut the benchmark one-year lending rate by 25 basis points to 5.35 per cent and the one-year benchmark deposit rate by the same amount to 2.5 per cent on Saturday night, effective from midnight.

As I’ve explained before, cutting interest rates in a nation of savers like China doesn’t have the same effect as cutting in a nation of debtors, like Australia. Lower rates reduce the return on savings and depress consumer confidence to a greater extent than they do here.

But that won’t stop China from easing. When a vast credit bubble pops, interest rates always fall as deflation spreads across the economy. That’s why I expect lower and lower growth for China in the years to come.

Lower and lower interest rates are good for gold, but no one is taking any notice.

You might remember I’ve been talking about gold entering a new bull market in Aussie dollar terms. I made a special presentation about it a few weeks ago. If you missed it, you can watch it here.

So far, the response to my presentation has been underwhelming. Which is unfortunate, as there’s a huge opportunity brewing in this sector but people are disinterested.

I’m not at all bothered by it though. In fact, I’m encouraged by the lacklustre response. This is exactly what happens when bear markets end and a new bull emerges.

That is, people don’t believe it. They’ve heard the turnaround story before. They lost money during the bear market and don’t want to know about it anymore. Besides, there are other stocks that offer better yield, more security…or whatever.

But while investors, and perhaps you, are looking the other way, Aussie gold stocks continue to perform well. Over the weekend, I spent some time writing a special report for Sound Money. Sound Investment. subscribers. A gold stock that I had been monitoring threw off a buy signal on Friday, and I wanted to get the buy alert out to my readers as soon as I could.

It hit their inbox this morning…

If you’re interested in receiving this type of opportunistic alert, and joining my subscribers in getting in on this trend early, you can check out my presentation here.

Once again, I don’t expect much of a response. It’s human nature to shun these early opportunities and stick with the pack. But if you fancy yourself as someone who likes to sniff out a contrarian play, and get in on a trend before the rest of the crowd piles in, then I urge you to take a look.

Let me give you just one example of what’s happening in the gold market right now. Australia’s largest goldminer, Newcrest Mining [ASX:NCM], is up around 30% since the start of the year. I’m not talking about a speccy gold stock here. This is one of the largest gold miners in the world.

While the market shuns commodity stocks and chases yield plays instead, Australia’s biggest gold stock is up 30% in two months! Since bottoming in early November, the stock price is up around 60%.

The casual observer might look at this and think ‘the stock has already taken off…I’m too late’. That might be the case in the very short term. But consider this:

Newcrest is still nearly 70% below its peak price of $44, reached in late 2010.

If we are at the start of a new upward trend for Aussie dollar gold and gold stocks, share prices have a long way to go before they even reach their old highs. Newcrest would have to rise over 200% to meet its old high.

The stock I recommended this morning is about 800% away from reaching its old high. So a 60% or 100% increase from the bottom so far really is nothing.

In short, don’t let flawed thinking get in the way of an opportunity.

And tomorrow, deflation-buster Glenn Stevens could give another boost to Aussie dollar gold by taking yet another step in the destruction of the currency.

Amongst the gloom, there is a silver lining.

Greg Canavan,
for Markets and Money


Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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