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Negative Interest Rates (and Deflation) Make Gold More Attractive

By Gary Alexander February 11, 2015

The complaint of many gold-phobic investors is that “gold doesn’t offer any interest income.”  In 2015, that objection has lost all its merit.  Any gold bug can answer, “Interest income?  Compared to what?” 


In recent weeks, the European Central Bank (ECB), the Swiss National Bank and the Danish central bank have pushed short-term rates below zero. They actually charge you money for the right to put your euros, Swiss francs or Danish krone into one of their member banks.  In one week, January 15-22, there were four such negative rate cuts, and then two more dramatic rate cuts in the first week of February:


  • On Thursday, January 15, 2015, the Swiss National Bank suddenly and shockingly cut the Swiss franc’s 1.20 “peg” to the euro. The Swiss franc appreciated up to 30% at one point that day before consolidating a 15.7% net gain to the euro in the month of January 2015. 
  • Then, on Monday, January 19, Denmark’s central bank announced that they would cut its key deposit rate to -0.2%, down from -0.05%….but that was only the first shoe to drop. 
  • On Thursday, January 22, the ECB announced a dramatic new round of quantitative easing, after which Denmark’s central bank announced that would its key deposit rate further, to -0.35%, or down 0.3% in one week! 


In the first week of February this central bank limbo contest continued, pushing interest rates lower


  • On Wednesday, February 4, Finland issued €1 billion of five-year bonds at a rate of -0.017pc: That makes Finland the first country in the eurozone to issue five-year debt with a negative yield. 
  • Hold the presses! On Friday, February 6, the Danish central bank cut rates yet again to -0.75%.


Negative Interest Rates Push Gold Up Faster than Bonds,

Currencies, other Income Alternatives and other Commodities


As of January 31, the US. Dollar is still King in 2015.  Also, bonds trump stocks and gold trounces oil:




Not only did gold beat bonds and stocks in U.S. dollar terms in January, but gold rose by double-digits in terms of many other major currencies due to the strong U.S. Dollar. In January alone, gold soared nearly 16% in the eurozone, rising from 990 euros at the end of 2014 to 1147 euros per ounce as of January 31.





So, most currencies are declining to the dollar while offering near-zero or negative short-term income.  


Moving out the yield curve to 10-years, as of the end of January 2015, several major nations offered less than 1% on their sovereign 10-year bonds.  Of course, there are some super-high rates in troubled lands, where one’s principal is at risk, like Venezuela (16.8%), Russia (13.5%), Brazil (11.8%) and Greece (10.9%), but when you look at the most stable debtor nations in the world, long rates are abysmally low.


10_year Govt_Bond_Rate


If you put 100,000 euros into a 10-year bond, you will get $350 per year interest and the likelihood of a loss in principal due to eurozone challenges.  If you put the money into Switzerland, you might (or might not) see some currency appreciation, but you will pay a “storage” fee of $50 or more per 100,000 Swiss francs.  Even corporate bonds in Swiss giant firms like Nestle and Roche are negative or nearly zero.


Ten-year rates are not much better in Canada (1.35%), Britain (1.55%) or the USA (1.78%) these days, but 10 years is a long-time to wait, so the “no interest rate argument” against gold makes no sense.  Still, any positive U.S. economic statistic usually causes a sell-off in gold derivatives (futures, options and gold ETFs), on the assumption that a strong U.S. economy will convince the Fed to raise rates later this year.


Why Would the Fed Want to Raise Rates This Year?


Why would the Fed want to raise rates when the dollar is attracting so much capital at these low rates, due to the strong dollar and negative short-term interest rates in most of Europe and Japan?  There is no near-term threat of inflation or an over-heated economy, so why would the Fed want to raise rates? Why would the Fed make our budget deficit worse by raising the interest burden on our $18 trillion in public debt?


In the U.S., the government’s interest costs are around $200 billion a year, based on average Treasury rates of 1.1%, according to the Wall Street Journal.  With the debt rising around $1 trillion each year, any rise in average rates could double debt service in short order.  That’s one reason the Fed will not likely add to the burden prematurely by raising rates while the rest of the developed world offers lower rates.


The Journal summarizes their budget sources by saying: “Interest rates will gradually rise, and when that happens, the interest costs of the U.S. government are set to soar, from just over $200 billion to nearly $800 billion a year by decade’s end. By 2021, the government will be spending more on interest than on all national defense, according to White House forecasts. And one year later, interest costs will exceed nondefense discretionary spending – essentially every other domestic and international government program funded annually through congressional appropriations. (The largest part of the budget is, and will remain, the mandatory spending programs of Social Security, Medicare and Medicaid. Mandatory spending is over $2 trillion and is set to double to $4 trillion by 2025.),” the Journal concluded.


In conclusion, here’s a summary of recent central bank actions, including rate reductions and gold buying:16 central banks have “eased” in one form or another since mid-2012, according to ZeroHedge, led by theU.S., ECB and China, also including Australia, Canada, Denmark, India, Russia and Switzerland, plus smaller nations like Albania, Egypt, Pakistan, Peru, Romania, Singapore, Turkey and Uzbekistan.


In addition, eight EU nations (Belgium, Cyprus, France, Greece, Italy, Ireland, Portugal and Spain) are close to, or have surpassed a debt-to-GDP ratio of 100% this year.  This means the ECB is unlikely to raise rates, which would put a greater burden on deficit financing, especially if Europe falls into another recession.  Also, their demographic destiny tells us that not enough young workers are joining the labor force to fund the generous retirements of older, retired folks in the welfare-oriented eurozone economies.


Central banks are buying gold, not selling it.  They realize that quantitative easing devalues paper money and gold has a better chance to gain more in 10 years than 10-year government bonds are offering.  Central banks are stockpiling more gold. In 2014, central banks bought over 300 metric tons* of gold, with Russia buying about half of the total, over 170 tons.  Russia bought at least 300,000 in gold for its central bank holdings in each of the last 10 months of 2014. Russia now holds 38.8 million ounces (1207 tons), making them fifth in total national holdings, behind the U.S., Germany, Italy and France. 


Basically, the rich, established nations have gold, while the developing nations are busily buying more gold, in order to compete with the stronger nations on a more even playing field.  (The five biggest buyers of central bank gold in 2014 were in the same region: Russia, Iraq, Kazakhstan, Mongolia and Turkey.)


Negative interest rates reflect the current threat of deflation, especially in Europe. Eurozone prices were down 0.6% in the year ending January 31, according to Eurostat. As we have shown here in the past, gold tends to perform relatively better in history during times of deflation than inflation.  That happened in the 1880s and 1930s and it is happening once again today, with gold soaring in the deflationary eurozone.


*A metric ton (or tonne) is equal to one million grams, or 32,150 Troy ounces or about 2,205 pounds.



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Disclaimer: The information in this letter is not intended to be personalized recommendations to buy, hold or sell investments. This should not be considered as personalized trading or investment advice to subscribers. The information, statements, views and opinions included in this publication are based on sources (both internal and external sources) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication. Subscribers should verify all claims and do their own research before investing in any investment referenced in this publication. Investing in securities and other investments, such as options and commodities, bullion and futures is speculative and carries a high degree of risk. Subscribers may lose money trading and investing in such instruments.