Why Lower Interest Rates are Good for Gold

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Get ready for another week dominated by interest rates, folks. The Reserve Bank meets tomorrow and the market thinks another rate cut is a certainty.

And why not? It’s the only thing this country has when it comes to economic policy.

In a bit of trouble…who you gonna call? Glenn Stevens.

That’s why the market continues to hold up despite signs of visible economic weakness. On Friday, Australia’s largest retailer Woolworths [ASX:WOW] issued a profit warning. It’s share price fell nearly 10%, which is an incredible one day decline for such a large company.

Lower interest rates clearly aren’t doing much for Woolies. They’re not forcing management into smarter decisions or magically boosting profits.

But that hasn’t stopped the market believing lower interest rates won’t help everyone else.

Interest rates are good for the market…until they aren’t. That is, while the weak economy isn’t yet having an impact on earnings, the market will push share prices higher and higher. But as soon as earnings projections take a hit, the market will punish the company in question.

So by all means celebrate the short term boost that another (forecast) interest rate rise will bring, but watch out for landmines along the way. The Woolies bomb just went off.

China’s been flying under the radar lately, but you can be sure its economy is struggling too. On Saturday, the People’s Bank of China cut interest rates on the threat of…you guessed it…deflation.

The Financial Times reports:

The People’s Bank of China, the central bank, cut the benchmark one-year lending rate by 25 basis points to 5.35 per cent and the one-year benchmark deposit rate by the same amount to 2.5 per cent on Saturday night, effective from midnight.

As I’ve explained before, cutting interest rates in a nation of savers like China doesn’t have the same effect as cutting in a nation of debtors, like Australia. Lower rates reduce the return on savings and depress consumer confidence to a greater extent than they do here.

But that won’t stop China from easing. When a vast credit bubble pops, interest rates always fall as deflation spreads across the economy. That’s why I expect lower and lower growth for China in the years to come.

Lower and lower interest rates are good for gold, but no one is taking any notice.

You might remember I’ve been talking about gold entering a new bull market in Aussie dollar terms. I made a special presentation about it a few weeks ago. If you missed it, you can watch it here.

So far, the response to my presentation has been underwhelming. Which is unfortunate, as there’s a huge opportunity brewing in this sector but people are disinterested.

I’m not at all bothered by it though. In fact, I’m encouraged by the lacklustre response. This is exactly what happens when bear markets end and a new bull emerges.

That is, people don’t believe it. They’ve heard the turnaround story before. They lost money during the bear market and don’t want to know about it anymore. Besides, there are other stocks that offer better yield, more security…or whatever.

But while investors, and perhaps you, are looking the other way, Aussie gold stocks continue to perform well. Over the weekend, I spent some time writing a special report for Sound Money. Sound Investment. subscribers. A gold stock that I had been monitoring threw off a buy signal on Friday, and I wanted to get the buy alert out to my readers as soon as I could.

It hit their inbox this morning…

If you’re interested in receiving this type of opportunistic alert, and joining my subscribers in getting in on this trend early, you can check out my presentation here.

Once again, I don’t expect much of a response. It’s human nature to shun these early opportunities and stick with the pack. But if you fancy yourself as someone who likes to sniff out a contrarian play, and get in on a trend before the rest of the crowd piles in, then I urge you to take a look.

Let me give you just one example of what’s happening in the gold market right now. Australia’s largest goldminer, Newcrest Mining [ASX:NCM], is up around 30% since the start of the year. I’m not talking about a speccy gold stock here. This is one of the largest gold miners in the world.

While the market shuns commodity stocks and chases yield plays instead, Australia’s biggest gold stock is up 30% in two months! Since bottoming in early November, the stock price is up around 60%.

The casual observer might look at this and think ‘the stock has already taken off…I’m too late’. That might be the case in the very short term. But consider this:

Newcrest is still nearly 70% below its peak price of $44, reached in late 2010.

If we are at the start of a new upward trend for Aussie dollar gold and gold stocks, share prices have a long way to go before they even reach their old highs. Newcrest would have to rise over 200% to meet its old high.

The stock I recommended this morning is about 800% away from reaching its old high. So a 60% or 100% increase from the bottom so far really is nothing.

In short, don’t let flawed thinking get in the way of an opportunity.

And tomorrow, deflation-buster Glenn Stevens could give another boost to Aussie dollar gold by taking yet another step in the destruction of the currency.

Amongst the gloom, there is a silver lining.

Greg Canavan,
for The Daily Reckoning Australia

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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slewie the pi-rat
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China’s famed Shaolin Temple plans a $297 million complex in Australia that will include a temple, a hotel, a kung fu academy and a golf course.

Rodney Dangerfield and Peter Sellers were born too soon!

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