“Interest rates on Treasury securities, which have been exceptionally low since the recession are projected to increase in the next few years as the economy strengthens and to end up at levels that are close to their historical averages (adjusted for inflation).” – Budget Outlook for 2014, Congressional Budget Office.

Had the Congressional Budget Office done the math, as outlined in the table above, it might not have appeared so nonchalant about the prospect of Treasury paying the historical average interest rate on the massive federal debt.

The historical average interest rate paid by the Treasury Department from 1990 – 2013 calculates to 5% and to 7% from 1971 – 2013.  The current average interest rate paid by Treasury across the range of maturities is 2.4%.  At 5% Treasury would more than double its interest payments from $416 billion annually to $867 billion.  At 7%, Treasury interest rate payments would balloon to $1.2 trillion nearly triple the current interest payment annually.

Tax revenues amount to $2.8 trillion.  As a result interest would take up 31% of revenues at the 5% average rate, and 43% at the 7% average rate.  In short, the federal government might be seen by the rating services in either instance as ultra-high risk, or possibly even technically bankrupt. As it stands the St. Louis Fed puts the sovereign debt to GDP ratio for the United States at 103.3%. Anything over a 100% ratio is considered over-indebted.

Keep in mind that the federal government will have added nearly $1 trillion (or more) to the national debt when fiscal year 2014 comes to a close end of September, and no one sincerely believes that the borrowing is going to come to a standstill, or even that it is going to be cut significantly.

The federal government in short is ensnared in a debt and interest rate trap of its own making from which it will be difficult to extricate itself.  Pundits and market analysts alike might believe that the Fed is going to raise interest rates at some point in the future, but the reality of higher interest rates might bring far worse consequences than can be achieved by simply staying the course.  Some small, even token, rate hike is tolerable, but a return to historical norms could reap consequences in the general economy far beyond the direct effect on the federal government’s fiscal status.

It is a matter of convenience, perhaps even good politics, to be discreet about the relationship between the Treasury’s debt, its associated interest rate burden and the Fed’s ability to raise rates.  Sooner or later, though, the Federal Reserve and the Treasury Department will be faced with the hidden and unavoidable consequences of raising interest rates to the historical norms, and the interest rate trap will becomes apparent to the financial markets, including gold. The Federal Reserve is already reacting to the problem by deliberately keeping interest rates down. Blaming that policy on the employment problem, though, might someday soon become a slight of hand played to an increasingly skeptical audience.

The implications for gold

The Everyman edition of Edward Gibbon’s History of the Decline and Fall of the Roman Empire comprises some six volumes and nearly 4000 pages.  Rome was not built in a day and, as Gibbon’s work reveals, it was not lost in a day.  What we are challenged to recognize with respect to U.S. monetary policy today is not an event, but a process. The decline of the dollar since the United States went off the gold standard in 1971 has not come in a handful of sudden, cataclysmic events like formal devaluations, but gradually and consistently, over a period of four decades coinciding with the steady decline of the dollar. That process is likely to continue.

Gold has had long periods where it gained in value during those four decades, periods when it lost value, and periods when the price was stagnant.  The over-riding trend, though, has been to the upside. In fact the long-term linkage between the rising U.S. national debt and a rising gold price is one of the most enduring features of the contemporary fiat money economy president Richard Nixon launched in 1971. (See chart)

Since the early 2000s, when gold’s most recent bull market began, periods of stagnation like the one we are in now have reaped the highest rewards for the patient buyer. The lesson here is one as old as the gold market itself:  The time to buy is when the market is quiet. As an old friend and client used to say (he recently passed away) when the market was stuck in the $300 range:  It is not a question of if but when. He lived to see his prediction come true and his estate reaped a small fortune from his gold coin holdings.

The continuing inability of the U.S. federal government to come to grips with its fiscal problems largely explains the enduring, some would say stubborn, presence of gold coins and bullion in millions of investment portfolios around the world – including those of central banks, hedge funds and sovereign wealth funds. Until such time as fiscal rectitude takes hold in the halls of Congress — an unlikely proposition any time soon – current gold owners are likely to hold tight and new gold owners are likely to continue joining their ranks.  In the end, contemporary gold owners by and large do not own gold to become wealthy, but to protect the wealth they already have.

“There’s a growing gap between what central banks are telling us about inflation versus what people are really experiencing in day-to-day life. There are a lot of reasons for this but I think it’s important to understand that [nation] states are broke, and therefore they are looking at ways to default on their own citizens. And inflation is one of those mechanisms. So it’s not surprising they don’t tell you that’s what they are doing.”

– Philippa Malmgren, former White House official, White House liaison to the Federal Reserve and member of the President’s Working Group on Financial Markets (Plunge Protection Team) ina King World News interview.

September Gold Notes

– Stocks are up about 2% year to date and gold is up about 8%.  So after all is said and done – after all the saucy anti-gold and pro-stocks rhetoric is filtered through the various media – the inarguable reality is that gold has been a better performer than stocks thus far this year. . . .and by a significant margin.

– There is much talk about gold demand being down in China thus far this year, but that development needs to be put into context.  Physical metal, not paper trading, dominates the China gold market. Simply put, today there is not as much physical metal available for China’s import as there was in 2013 when the London-Zurich-Shanghai pipeline was operating at full tilt. Most of that gold was sourced from ETFs and those funds are now once again net buyers of the metal.  With ETF metal now off the table, of course China’s imports are down.  Gold market pundits, both friend and foe, should stop fretting about short-term Chinese demand and focus on the fact that whenever large quantities of the physical are made available the Chinese are all too willing to take it up. Put enough physical metal on the market and you will see China’s imports rise.

– Gold stocks are said to lead the physical metal particularly when a major turnaround is in the offing. Gold stocks this year, using the XAU Index as an indicator, are up 25%.  This bodes well for the metal itself going into the annual kick off to the Fall investment season in September.  As noted earlier, gold metal is up 8% thus far this year – so there is a considerable gap between these two components of the gold market.

– “No wonder there is no joy in the land, even if the Dow Jones Industrial Average is bouncing in and out of record highs. The Obama presidency is nearing the final turn. Savers have been devastated. The market isn’t what it seems. No one wants to lend and no one wants to borrow. Unemployment is still above where it was when Congress gave the Fed a mandate to bring it down. A new Fed chairman has made jobs her signature. But will anyone at Jackson Hole ask whether it is the fiat nature of our money that got us into this hole in the first place?” – A recent New York Sun editorial

– Fiat money is probably here to stay, but its presence is easily addressed in the private investment portfolio through the simple expedient of gold ownership. Recall gold’s price history since fiat money was first introduced in 1971. Then recall its history since 2008 — and the dawn of the crisis which Jackson Holers still find themselves addressing six years later. As the Sun’s editor so incisively states in the same editorial quoted above:“We celebrate, say, the sages of Berkshire Hathaway. Yet the value of a share of Berkshire has plunged to something like 159 ounces of gold from the 269 ounces of gold a share was at, say, the day that George W. Bush acceded to the White House.”(Perhaps that nettlesome fact of economic life is what drives the Sage’s antipathy to yellow metal.) Put yourself above the jury-rigged economics — Jackson Hole or otherwise. Save in gold.

– Richard Russell remains one of my favorite analysts simply because he is about as down-to-earth as they come. In a recent interview at KWN, he warns of a stock market crash saying that “trees don’t grow to the sky.” He advises: “Stay with silver and gold and pray for the good of the nation. I must say that I’m fascinated to see how the US will deal with its surging and compounding debts. What worries me is the continuousness of those two eternals — Inflation and War.” Some more hard won wisdom from a money master: “I have picked silver and gold as my form of capital preservation. Both are trading solidly in fixed ranges, which is fine with me. If the stock market drops 25% and a money manager is down 23%, he considers it a good performance. That’s not the way I see it. If the stock market is down 25%, and gold remains in its trading range, I consider that an excellent outcome.”

– Ernest Hemingway: “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”

                                                                ————————————

Michael J. Kosares is the founder of USAGOLD and the author of “The ABCs of Gold Investing – How To Protect and Build Your Wealth With Gold.” He has over forty years experience in the physical gold business. He is also the editor of Review & Outlook, the firm’s newsletter which is offered free of charge and specializes in issues and opinion of importance to owners of gold coins and bullion. If you would like to register for an e-mail alert when the next issue is published, please visit this link.

USAGOLD Review & Outlook is the contemporary, web-based version of our client letter, which traces its beginnings to the early 1990s under the News & Views banner. Its principle objectives have always been to keep our clients informed of important developments in the gold market; condense the available gold-based news and opinion into a brief, readable digest; and counter the traditional anti-gold bias in the mainstream media. That formula has won it a five-figure subscription base (and growing). In addition to our regular newsletters, we occasionally publish in-depth special reports that focus on events and developments of interest to gold owners.

Valued for its insight, accuracy and reliability, this publication is linked and reprinted regularly by a large number of websites both in the United States and around the globe. It also enjoys the goodwill of countless websites, individuals and organizations who contribute regularly to its content. To this group, we owe a deep debt of gratitude.

Disclaimer – Opinions expressed on the USAGOLD.com website do not constitute an offer to buy or sell, or the solicitation of an offer to buy or sell any precious metals product, nor should they be viewed in any way as investment advice or advice to buy, sell or hold. USAGOLD, Inc. recommends the purchase of physical precious metals for asset preservation purposes, not speculation. Utilization of these opinions for speculative purposes is neither suggested nor advised. Commentary is strictly for educational purposes, and as such USAGOLD does not warrant or guarantee the the accuracy, timeliness or completeness of the information found here.

In this article, precious metals market analyst Ted Butler (www.butlerresearch.com) explains his vision of how a silver bubble is going to develop. Contrary to the mainstream view, Mr. Butler believes that the silver peak of 2011, when spot silver intraday touched $49 per ounce on May 1st 2011, was only an intermediary peak. In other words, the real price explosion lies still in front of us. Of particular interest is the role of the ongoing silver price manipulation as a key driver in the creation of a bubble.

click on chart for variety of larger silver charts

What is an asset bubble? An asset bubble occurs when a large number of buyers, normally not usually prone to speculate in an asset, bid the price of that asset much higher than underlying valuations would support, most often fueled by leverage or borrowed money. Typically, towards the terminal phase of the bubble the most compelling reason for continuing to buy the asset is due to the rising price itself, as all caution is thrown to the wind amid the collective belief that prices can only move higher still. Then, when the last possible speculator has purchased the asset, the inevitable occurs and the price of the asset collapses as previous buyers turn into sellers and attempt to get out. Since the formation of the bubble and its inevitable collapse are driven by the collective emotions of greed and fear, it is generally impossible to predict how long an asset bubble will persist and how high the price can climb, as well as the timing and extent of the subsequent collapse.

How do asset bubbles develop? Most often, an asset bubble develops when an undervalued asset which has a compelling investment story and there exists an overall financial environment of sufficient buying power, catches the collective interest of the crowd. For example, by the mid-2000’s and after years of steady appreciation, residential real estate developed into an asset bubble amid the self-fulfilling cycle of continued gains and the availability of easy credit.

As far as great stories go, silver has the best potential story to develop into a bubble. First, there is little argument that it is among the most, if not the most undervalued asset of all by objective relative historical price comparison. In addition, it is at or below its primary cost of production, as evidenced in recent quarterly earnings reports. Remember, most bubbles start out with an asset that is undervalued – on this score silver more than qualifies as being undervalued.

Aside from extreme undervaluation, the silver story is multi-faceted. Silver is both an industrial metal and a primary investment asset, the net effect being that very little newly-produced silver is available for investment, perhaps only 10% of the one billion oz produced yearly (mine plus recycling), or 100 million oz annually. In dollar terms, at current prices that comes to less than $2 billion per year. There are two ways to look at that; the observation that there are countless individuals and investment funds capable of ponying up that entire amount on their own and the fact that $2 billion amounts to less than 30 cents on a per capita basis for the world’s 7 billion inhabitants. Simply put, there is no other asset class which would require less buying to develop into a bubble than silver.

Apart from newly-produced silver available for investment, the amount of previously produced metal available for investment, or world inventories, is also shockingly low. As a result of a 65 year deficit consumption pattern that ended in 2005, world silver inventories have been depleted by 90% from the levels existing at the start of World War II. Today, only a little over one billion oz of metal in accepted bullion industrial form exists with perhaps another billion oz existing in coins and bars. In dollar terms, that comes to $20 to $40 billion, where most other asset classes (stocks, bonds, real estate and even gold) are measured in the many trillions of dollars. And please, never confuse what exists with what’s available for purchase – only the owners of the small amount of silver that exists will determine at what price it is available.

The conclusion is simple – the asset requiring the least amount of buying to create a bubble is, automatically, the best candidate for developing into the biggest bubble. The fuel for any bubble is total (world) buying power versus the actual amount of an asset available for purchase. Previous, as well as prospective, bubbles in stocks, bonds and real estate grew to many trillions of dollars of total valuation. At $200 an ounce, all the silver in the world (bullion plus coins) would “only” amount to $400 billion, not even a rounding error to the total valuation of stocks, bonds, real estate and, even, gold. In other words, due to silver’s current undervaluation and its shockingly small amount in existence, it has more room to the upside than any other asset class.

But I’m not done. Silver’s unique dual role as a vital industrial material and primary investment asset creates a setup for something happening that has never occurred in any previous bubble. As and when sufficient physical investment buying develops in silver to drive prices significantly higher, the industrial consumers of silver, in everything from electrical and solar applications to medical and chemical applications, will likely be subject to delays in the customary delivery timelines of the metal. As is almost always the case, whenever industrial consumers of a commodity are deprived of timely deliveries, they resort to stockpiling that commodity as a remedy, further exacerbating delivery delays to other users.

Thus, the stage is set for something the world has never experienced previously – an asset bubble accompanied with an industrial shortage. The two greatest upward price forces known to man, an asset bubble and a genuine commodity shortage, appear set to combine in silver. Either one, alone, would have a profound impact on the price, but the combination seems both inevitable and almost impossible to contemplate in terms of how high the price of silver could be driven. And it’s hard to see how intense investment buying wouldn’t trip off industrial user attempted inventory stockpiling or vice versa; it doesn’t matter which comes first.

Tying everything together, there is one and only one explanation for why silver is so undervalued and the asset bubble/industrial shortage hasn’t occurred yet – the ongoing price manipulation on the COMEX. Massive amounts of paper contracts traded between two groups of large speculators (technical funds and commercials), measuring in the hundreds of millions of ounces and completely unrelated to the supply/demand fundamentals have set the price of silver. This COMEX price control is both the curse and the promise in that it not only explains the undervaluation, it will explain why it seems inevitable for an asset bubble/user shortage to develop.

Think of it this way – the asset with the greatest potential for becoming the biggest bubble ever had better have the greatest story ever as well.  And that is what the COMEX silver manipulation is – the key ingredient in the greatest investment potential score ever.  If silver wasn’t manipulated how good would the story be? Absent manipulation, I wouldn’t buy or hold silver because that would mean that free market forces were setting the price all along. In other words, if silver wasn’t manipulated there would be scant reason to buy it in my eyes. If I wasn’t convinced silver was manipulated, I can’t see how I would have ever written this or anything about it in the past or could have become interested in it in the first place.

As painful as recent prices have been to existing holders because of the manipulation, without it there would be little chance for a price explosion at some point. The easiest major potential change in the silver price equation is for the manipulation to end, one way or another. And if history and logic win out, the silver manipulation must end, not the least because of the coming clash between paper and physical silver. Some call it the disconnect between paper derivatives contract on the COMEX and actual physical silver, but in reality the story is that COMEX futures contracts are very much connected to each other via the delivery mechanism.

The connection between paper and physical has been forged because the main COMEX futures speculators are only interested in trading paper futures contracts and not in trading physical metal. Technical funds have no desire to buy and sell real metal for full cash payment when they can deal in paper contracts for only 10% cash down because they are trading, not investing. The problem is that the trading between the technical funds and the commercials has become so large that it dwarfs real world silver supply/demand fundamentals and ends up setting the price of silver in violation of commodity law. I know that this perversion of the price-discovery process has existed for a long time, but it would be wrong to confuse longevity with permanence.

The fact is that while the COMEX paper market dominance has lorded over the real supply and demand fundamentals, the stage has been set for a physical asset bubble/industrial user panic event. I’ve become convinced that any prospective bubble in silver won’t be driven by the aggressive buying of COMEX futures contracts, but only by physical buying. For one thing, the crooked CME and CFTC would never allow any group of traders to drive silver prices sharply higher by buying unlimited amounts of COMEX futures contracts. If the technical funds do buy big amounts of COMEX silver futures contracts (as was the case from June to mid-July), you can almost be certain that the CME and CFTC knew that those funds would be soon forced to sell on lower prices.

As a result, any bubble in silver must and will develop from physical investment buying. Surely, any industrial user inventory buying panic must involve immediate physical delivery and not a paper futures contract in a time of delivery delays and uncertainty. In fact, it is hard to imagine, as a silver bubble begins to develop, a greater urgency for holding only physical metal to intensify, due to a growing recognition that the COMEX manipulation was responsible for the former low price.

Since I am speaking in terms of a potential historic asset bubble in silver, I am implying that the price of silver will far exceed its true value at some point before correcting sharply. It is before that collapse point, that God-willing, I intend to sell. I am not deluding myself that I will come close except hoping not to be terribly early or late. While I respect anyone’s reasons for buying and holding silver, my mission has always been to help end the manipulation and be done with silver after that was accomplished and reflected in the price.

This article is based on a commentary of Ted Butler’s premium service at www.butlerresearch.com which contains the highest quality of gold and silver market analysis. Ted Butler is specialized in precious metals market analysis for over four decades.

Related articles from Ted Butler:

JP Morgan’s Perfect Silver Manipulation Cannot Last Forever
I Own Silver Because Of The Coming Silver Shortage
A Manipulation Timeline
The Silver Conspiracy

What can we say? We are in the dog days of summer and precious metals miners remain in a consolidation. Last week was a down week but it occurred on lower volume and the stocks didn’t threaten support.

Here is a weekly chart of our top 40 index. Look at how the index is holding up at present and digesting the early summer gains, as compared to the end of last summer and earlier this year. The index hasn’t even retraced more than 38% of the move from 310 to 440. 

The evidence in my opinion is bullish until the market tells us otherwise. Commodities have corrected big, the US$ has rebounded strongly, the COTs are a concern yet gold and silver stocks have held in well. The mining indices haven’t even tested their 50% retracement and remain above their 200-day moving averages. Furthermore, 78% of the stocks in the HUI are trading above their 200-day moving averages. That figure was a bit higher a week ago but other than that its at the highest level since late 2009.

These reasons among others why I am positioned for a breakout. Sit tight and be right until the evidence changes.  

Here are the links for this past week…..

My Interview with Wall Street Window
This was recorded on Tuesday. Thoughts on precious metals, September, what I’m looking for as far as price action and thoughts on the manipulation meme. 

What’s Next for Precious Metals?
Great post from Tiho.   

Dan Norcini: Aggressive Hedge Fund Selling Plagues Silver
Dan shares his thoughts on Silver as well as his contempt for the kind of analysis that the permabulls provide. 

The Bearish Scenario for Gold & Silver
One can look at the bear analogs for Gold & Silver and make a case that the bear has more to go. I don’t agree with that, however, it is always important to keep all reasonable scenarios in mind. 

Argonaut Gold’s Maiden Resource for San Agustin is 1.28M oz Au-eq
I’m expecting San Agustin to become Argonaut’s next mine by late 2015. The Silver resource will provide a good kicker.

Balmoral Drills More High Grade Nickel
Balmoral has been one of the biggest early winners of this fledgling bull market and I think it can continue to move higher. It has two projects with strong takeover potential.  

Consider a subscription to our premium service as I believe we have one of the best services available. We are the only credentialed technical analyst who is the editor of a service. Secondly, we are one of only a few people who run a real money portfolio. That means our goals are 100% aligned with our subscribers. 

Thanks for reading. I wish you all great health and prosperity in 2014 and beyond. 

-Jordan

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