Wednesday, March 17, 2010

Gold Responding to Interest Rates

One thing this super recession has taught people, and if nothing else, it could be a great silver lining to some of the pain people have gone through, and that is, interest rates exist for a certain purpose, and they aren't always safe, and there are other factors to consider when deciding whether to invest in something with interest rates, or consider another option.

Just look at municipal bonds as an example. Who would have used the term risk and municipal bonds in the same sentence three years ago? Now though, there are a growing number of financial advisers urging their clients to get out of them, as they are highly toxic at this time, and could be for years, depending on a lot of factors; like the financial health of the city issuing them and the project the money is being raised for.

So many people think when the Federal Reserve finally raises interest rates, people will flock out of gold and other commodities and get the higher returns offered through those types of investments. Most believe that won't happen until the latter part of 2010 at the earliest. The Federal Reserve held things right where they're at today concerning interest rates, and gold responded in a nice upward movement.

Anyway, what are the potential consequences of interest rates going up for holders of gold? The real question will be how much more does the average investor on the street understand the fundamentals of gold as it relates to monetary policy and its effects on the economy. If they at least have a general understanding of that, there won't be much of a move out of gold, although the majority of holders continue to be seasoned or institutional investors. If the average person starts investing in gold, that will be a major factor in the overall impact on gold.

Another key element is the same question, but being directed toward institutional investors. Are they any more in the know than the average, individual investor? In many, if not most cases, they aren't. They are Keynesian's, even if they don't understand what that means, and they will operate based on certain assumptions that probably are no longer viable in the post-recession world, once there is a post-recession that is.

Inflation is going to be held off much longer. Money will eventually be released into the markets, and the pent-up demand is extraordinary, and we could see amazing surges in commodity prices as a result. Look at iron ore this year based on demand, and as far as globally, we're far from what could be called a recovery in any meaningful way.

Another big part of the puzzle is the bond market. Once that collapses, which it almost assuredly will, even more investors will pour money into commodities, especially gold. At that time all bets are off as to how high gold prices will go.

Once that happens, we will then finally enter into a possible gold bubble, but that's not here, and won't be until these other events line up.

Gold won't be going away any time soon as a solid investment and place of safety. I think we're really just getting started, and while exact timing and events could take some interesting turns and twists, we will ultimately arrive, and those positioned in gold will benefit greatly while protecting their wealth and spending power.

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