-- Posted Thursday, 31 March 2011 | | Source: GoldSeek.com
By Dr. Jeffrey Lewis
So often the finance folk engorge themselves with the concept that a low cost-of-carry is the sole reason for metals’ ascent. While cheap money perpetuates the commodity’s investment interest, it will be higher rates – not lower rates – that ultimately send metals higher.
The Attraction of Arbitrage
Currently, the world is engaged in a time value of money arbitrage at a level never before seen. Quantitative experts, hiding beyond Excel spreadsheets and years of database data, and the financiers are finding commodities of all type, especially monetary commodities, to be more lucrative than they ever have. They see opportunity in what they’re used to doing: buying dollars at a low rate and selling them at higher rate large enough to compensate for risk.
This bet may be further multiplied by emotion; with the world’s financiers realizing the impossibility of profits in traditional lending, there is much attraction to be found in the prospect of lending to the silhouette of themselves. Institutional and individual investors, empowered by trading accounts, are the perfect borrower—they’re unlikely to “miss” a payment, and above all else, their assets can be liquidated as soon as the warning lights start flashing red. Compare that to the traditional 30-year home loan which is illiquid and has for the past ten years been horribly unprofitable.
Where do Rising Rates Fit into the Picture?
Whereas the institutional investors may be in metals for the time value of money arbitrage, they’re surely beginning to see why metals can fit into their portfolio. A counter-cyclical play, one that has been profitable for more than 10 years, is a must have for any investor looking to offset credit and interest rate risk. It is, for the purposes of eliminating whole standard deviations of risk in equity and debt risk, a perfect investment.
However, the intersection at which the secular bull market meets an exponential incline won’t be when the US dollar is cheaper in the future than it is today. No, it will occur when the US dollar is more expensive in the future than it is today.
That is to say that most institutional investors use a “risk-free” model that assumes forever repayment of US Treasuries, regardless of the debt loads. In such modeling, it is easy to see how finance often misses the biggest bull runs. Suffice that to serve as a suggestion for why John Paulson, a hedge fund manager, is still the king of gold. He doesn’t play time value of money. No, instead he sees opportunity in protecting his money.
When rates inevitably rise, the “risk-free” yields of short-term T-bills won’t look so risk-free any more. Instead, the Treasury will find the credit markets tight, and the cost of government will quickly rise to a level never before seen in the Western World. When this event happens is anyone’s best guess, but it is certain.
QE3 and Your Holdings
As the Fed ponders QE3, most everyone should be carefully considering their exit strategies. The Fed could sell all its assets, but it would see yields sky-rocket instantly, threatening any recovery. Or it can instead continue to inflate, and thus enjoy this period of inflation-lag a little bit longer.
No matter which path the Fed selects, investors are soon to want a premium for their investment dollars, either to account for a lack of money in the credit markets or too much money (inflation) in the credit markets. When this happens, it simply won’t make sense to own dollars, as the Fed, again, will have to enter the market to push down inflationary rates with even more inflation.
Dr. Jeffrey Lewis
www.silver-coin-investor.com
-- Posted Thursday, 31 March 2011 | Digg This Article
| Source: GoldSeek.com
