We have listened in the last few weeks as global central banks, like those in the United States and Canada, have threatened to raise interest rates. Now it appears they are delivering on their promises to actually raise them. Rising concerns center on the old menace of continued negative feedback emanating from higher interest rates and the reality that it will lead to larger interest payments on consumer, business and even government debts around the world. Another reality is that an environment with these larger interest payments is not sustainable.
A legend in the bond business, Bill Gross, has taken a firm stand in warning the world about the consequences of the central bank’s interest rate meddling with the financial system and what it means in the near future for everyone. Gross is the long-time bond king of Pacific Investment Management Corporation (PIMCO). He sees a train wreck waiting for the foundations of the so-called global economic recovery.
What does this mean for the average investor? Now is a good time to diversify your portfolio and a gold IRA seems to be the best hedge against this interest rate hike. Historically gold as proven to be the best protection against these types of economic calamity.
Bill Gross’ Warnings on Higher Interest Rate Repercussions Should Not Be Ignored
When it comes to interest rates and how they affect budget balances, corporations and sovereign governments in particular, Gross is a genuine giant. He cofounded PIMCO and for decades he actively managed the world’s largest bond fund making him a true king in the industry. Even after his departure from PIMCO, which included a very public argument and heated departure, Gross maintains his industry status as he handles the Janus Henderson Global Unconstrained Bond fund with holdings that exceed $2.1 billion.
With the reality being a debt ridden worldwide economy, particularly globally important economies, Gross’ concern is that the rising interest rates will devastate these economies. In fact, he included this topic in his recent monthly investors’ outlook which is closely followed. (Bill Gross Photo Courtesy of Fortune)
Gross stated without exception that the actions of the systemically critical global central banks in tightening fiscal policies concerning their interest rates will at best be catastrophic. Those around the world who are still struggling to gain economic traction in this recovery will be devastated. With the interest rates being increased on borrowers, there will also be a rise in the costs for individually and corporate short-term debt as well. In the following chart you can see how low benchmark global rates remain today in this chart (Chart Courtesy of BNY Mellon Wealth Management):
To support his views, Gross highlights the enormous debt levels of households and corporations just within the United States. Combined U.S. households possess an amazing $14.9 trillion worth of debt. At the same time American corporations and companies have $13.7 trillion in collective debts. This data originates from the United States Federal Reserve. Gross doesn’t even delve into the government side of the equation in his timely warning to you that:
“While governments and the U.S. Treasury can afford the additional expense, levered corporations and individuals in many cases cannot.”
His very grave concern is that with the dramatic rise of interest rates over the next few years in combination with the aforementioned debt realities, all this will lead to the inevitable collapse of bond prices.
U.S. Federal Reserve Due to Raise Interest Rates
Gross is not looking for trouble simply for the sake of looking for trouble. The Federal Reserve, with Janet Yellen in the driver’s seat, continues to brag about their intentions regarding the gradual raising of interest rates. In fact, the global financial markets are anticipating that the Federal Reserve will raise interest rates for the third time this year before Christmas. As this is happening the other major global central banks have started the pull back on their liquidity injection and bond buying programs. In the past these programs have been important for flushing cash through their individual economies and banking systems.
At times it seems that Gross is the lone voice crying in the wilderness. He continues to maintain that, when they ought to tighten up their fiscal policy, the stubborn nature of central bankers coupled with a blind devotion to their set governing rules has, “Distorted capitalism as we once knew it with unknown consequences lurking in the shadows of future years.”
As an example, Gross challenges the widely held theory that it requires higher short-term interest rates than longer-term ones (known as an inverted yield curve per economists) to create an economic recession. Though many will economists will disagree with Gross’ contention, nevertheless he has an interesting and striking perspective on where the central banks of the world have led us all. It is an economic environment and monetary era of unpredictability.
“The reliance on historical models in an era of extraordinary monetary policy should suggest caution. Logically (a concept seemingly foreign to central bank staffs) in a domestic and global economy that is increasingly higher and higher levered, the cost of short-term finance should not have to rise to the level of a 10 year Treasury note to produce recession.” – Bill Gross
Gross’ Warning: Stay Away form Stocks and Bonds
Bonds have made Gross a fortune and established his respected reputation among economists and others. However, in light of the current policies guiding the central banks and with the seemingly inevitable rise in interest rates, Gross is warning investors to stay away from investing in stocks and bonds. As a replacement the Janus fund manager is advocating real estate as an investment asset over the more traditional ones. In spite of the S&P 500 Index increasing by 10.5% to date, he holds to his recommendation.
In the midst of the stock market’s continued impressive rally, Gross is not pulling back from his concerns. He continues to voice the alarm, what seems to be a lone voice at times, that the tighter central bank monetary policy which lies ahead will be devastating. Here is our last warning from Gross:
“Today’s highly levered domestic and global economies which had feasted on the easy monetary policies of recent years can likely not stand anywhere close to the flat yield curves witnessed in prior decades. Central bankers and indeed investors should view additional tightening and ‘normalizing’ of short-term rates with caution.”
Rising Gold Prices Confirm Bill Gross’ Assessment
In light of Gross’ assessment of current and future central bank policies, what message are current gold prices sending? Currently gold prices have passed the symbolically important $1,250 per ounce level. For the individual investor, you should view this as one of the last opportunities to invest in this safety hedge, meaning gold, against the effects of rising interest rates. Now is the time to buy gold. It is both relatively affordable and reasonably easy to obtain physical bullion coins and bars.
The reason that time is of the essence is because once finances and budgets of individuals, corporations and governments begin to unravel it will be too late to protect your retirement funds which are probably heavily laden with stocks and bonds.
The solution is to create a new gold IRA or rollover an existing IRA into a gold-backed one. In general a precious metals IRA will give you the safety net you need with the advent of rising interest rates.
What Really Drives Gold Prices
The price of gold is ultimately not tied directly to interest rates. Like other basic commodities the price is driven by supply and demand in the long run. The stronger component of the two is demand. The level of gold supply changes slowly due to the fact it takes 10 years or more for a newly discovered gold deposit to be converted into a producing mine. Rising interest rates are bullish for gold prices simply because they are bearish for stocks.
When interest rates are raised, it is the stock market that suffers the largest outflow of investment capital as fixed income investments become more attractive. Furthermore, rising interest rates nearly always cause investors to consider rebalancing their investment portfolios and many turn to a precious metals IRA, generally gold.
With stock indexes at or near all-time highs, the stock market is definitely susceptible to a significant downside correction. Whenever the stock market experiences an extreme decline, as mentioned previously, investors tend to run toward gold as an investment alternative. Between 1973 and 1974 was a time of rising interest rates and when the S&P 500 Index fell by more than 40%. The effect on gold prices was an increase of 150%.
Could this same scenario occur again? Gross thinks there’s a strong possibility that it will. Given the historical tendencies of stock market prices and gold prices in their reaction to interest rate increases, gold may in fact be beneficial as an alternative investment to equities.
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