Gold & Bonds

Inflation's on the way with real interest rates negative...

A NEW REPORT from Goldman Sachs warns of a "likely return to energy shortages," writes Dan Denning for the Daily Reckoning Australia.

It predicts crude futures will reach $85 by the end of this year and $95 by the end of next year. For what it's worth, crude futures were up 4.1% in New York to $68.71. That's a seven-month high.

Just like old times, isn't it?

Energy is a great long-term investment theme. As we've mentioned before, the collapse in capital spending in 2008 almost guaranteed that any resumption in demand growth would trigger higher prices because of much lower supply growth. Everyone's been focused on inventories and the global recession. But it's supply that you should keep your eye on.

Of course, Goldman is talking its book here, no doubt very long oil and looking to get other players on board. But everyone is talking his book, remember, and in this case, we like the book. It's not dis-similar to our own.

More importantly, we think a carefully selected portfolio of energy shares (conventional, unconventional, and alternative) is big part of making money as an investor over the next five years.

Another part will be Gold Investment, we reckon. Why? Reserve Bank of Australia governor Glenn Stevens said Thursday the RBA would be willing to cut rates again if it needed to. But he also said:

"It would be counterproductive if further reductions in interest rates induced a large number of marginal borrowers into debts they could service only at unusually low interest rates."

Wow! What's gotten into these central bankers lately? First Ben Bernanke puts on his serious face and tells the US Congress that large deficits threaten financial stability. And now we have Mr. Stevens pointing out the dirty little secret of lower rates. They encourage debt that becomes debt bombs.

Shhh...Don't tell anyone else. It would be bad for confidence.

Do you think maybe Dr. Bernanke is just trying to talk his book too? After all, the US Treasury has heaps of debt to sell this year (gross issuance over $3.25 trillion according to Goldman's). If Dr. Bernanke makes adult sounds, it might give people the impression the US is returning to sobriety and fiscal sensibility. And right on cue, ten-year bond yields did in fact fall in Thursday trading in New York. They now stand at 3.54%. After the Fed first said it would be buying US bonds, yields plunged to 2.04% in November of last year. But now the true scope of America's debt bonanza has become apparent to global investors.

We still think bond yields are the prime mover in this market, but not for the reason that you'll read in the paper. Investors aren't selling bonds because the economic recovery is sound and stocks hold better value. You're seeing a bear market in sovereign bonds because many governments are running into a fiscal and demographic brick wall.

Bond yields also hold the key to explaining how a higher Aussie Gold Price is possible given the Aussie Dollar's recent strength against the greenback. With the Aussie chugging along against the USD, it's been an uphill climb for Gold Prices in Australian terms, as well as Sterling and Euros and pretty much everything else not printed by Uncle Sam. But just you wait.

The yield on Aussie ten-year notes was 4.88% in mid-May. It's now 5.67%. That's a 16% rise in three weeks. Granted, it's not the huge spike you've seen in US yields. But it does tell you something. It tells you that the Australian Office of Financial Management has its work cut out for it in selling the $1.4 billion in debt per day needed to finance the country's growing federal deficit.

You borrows the money and you pays the higher interest rates. Or, your central bank – like the Fed – does its part if necessary, creating money from nowhere to buy your debt.

That sort of debt monetisation isn't on the cards in Australia – not yet. For now, there should be plenty of domestic and foreign investors willing to add a little high-yield government debt to their portfolios. But given that real interest rates are already negative, there are plenty of monetary forces already in the mix in Australia that will lead to expansion of the money supply.

That sort of monetary expansion, along with deficit spending and higher yields, is just the sort of thing that's going to power Aussie gold and precious metals prices higher. If it doesn't, we'll eat every single hat here at the Old Hat Factory.