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Friday, October 26, 2007

Will the Fed cut rates?

The market certainly seems to think so.

Just look at interest rate futures and you'll see investors are expecting a 25 to 50 basis point cut in the Fed Funds Rate.

Or, more meaningfully, look at the gold market. Gold prices spiked to over $785 an ounce, today.

That's up 17% over the last month and 31% over the last year.

Why does the gold market indicate a cut in the Fed Funds Rate?

Because the Fed does not create growth--they do not possess some magical fairy dust that makes the economy run faster.

The Fed prints money to decrease interest rates. And, when the Fed prints money more quickly than the economy grows, they create inflation.

Gold prices are going up because gold investors believe the Fed will print money, also known as cutting the Fed Funds rate, thus creating inflation.

Gold is going up because investors are guessing the Fed will create inflation by cutting rates.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

3 comments:

Anonymous said...

Seems to me that the Federal Reserve should not cut, at this time, unless it is nothing more than the lapdog of Wall Street. If the members have any integrity, they will stick to their statements at the time of the last cut, and tell the market that they cannot expect an endless series of cuts, just to boost Wall Street. Cuts can wait a month or two. Cuts, now, coming right after the previous 1/2 point cut, will seriously damage the overall economy, because they will collapse the dollar, run up the price of gold and commodities like oil and food, and drive investors out of dollar denominated investments. The dollar's fall must be gradual. If the Fed cuts, it will drive such intense gold & oil buying that there will be a stampede, by international investors, out of dollar denominated investments. The US economy will collapse along with the dollar.

Anonymous said...

Mike, do you see gold as an opportunity at this point or just a fad fueled by investor fears? Oil hit an all time high, even adjusted for inflation this week (another case of fear-fueled economics...ahem). The dollar continues to weaken and it looks as if the March Fed meeting could bring continued rate cuts--potentially bringing back the same conditions that created the sub-prime debacle in the first place. I'm eager to hear your thoughts.

Michael Rivers, CFA said...

I do see gold as a hedge against inflation, but I'm not smart enough to buy the metal itself. My expertise lies in doing bottom-up research on specific companies, and for that reason I've bought a small 2.5% position for my clients in one particular gold mining company that I understand well.

I don't know where the price of gold is going, but I do know that gold is a good hedge against inflation. I also understand that if gold's price rises, gold companies should be able to generate higher and higher profit margins. This has not happened, so far, because gold miners' costs have gone up even faster than the price of gold (especially oil).

If gold prices were to remain high or go higher, and if their costs remain flat or decline (which is a lot of if's), then gold companies should generate hefty profits. That's the bet I've made for my clients (predominantly as a hedge against inflation).

It has been my contention, for over 4 years now, that the housing and credit mania would end badly, and that the Fed would lower rates and print money in reaction. As that happens, and the US continues to run huge trade and fiscal deficits, it would make sense that the dollar would decline and inflation would increase. That is why I've sought a hedge against inflation for my clients.

This is the first and only time I've made an investment based on macro-economic reasoning. I must admit my bottom-up stock picking has generated much better results and will probably continue to do so. I do, however, like to have such a hedge in place as an insurance policy against a scenario I consider fairly likely.

If you have further questions, please feel free to email me at mike@athenacapital.biz.