Pondering The Imponderables

We are reasonably certain that the Fed will stay the course after the FOMC meetings tomorrow and Thursday. It would be a big, big surprise if tapering weren't cut another $10 billion in bond buying per month and a semi-surprise if interest rates were to be raised.

Just a few weeks ago, testifying before Congress, Chairwoman Janet Yellen stressed that at 6.1%, the unemployment rate still exceeds the Fed's target of 5.2 to 5.5%. She also noted that high levels of long-term unemployment and weak wage growth are still pressing problems.

Mark Zandi, chief economist at Moody's Analytics, said chronically lagging pay growth, in particular, will stop the Fed from raising rates before 2015. Then, Zandi said, "the unemployment rate will be well below 6 percent, the amount of slack in the labor market will be winding down and we should start to see better wage growth."

Yellen attributed the struggling housing rebound in part to last year's rise in mortgage rates, which occurred after the Fed chairman at the time, Ben Bernake, began discussing possible cuts in bond purchases later in the year. Markets were jolted by the prospect of reducing the purchases - a step the Fed didn't take until December - and sent long-term bond rates up.

Nevertheless, gold prices are soft today, although they did spend some time in positive territory. Investors are simply insecure. Silver recouped a few cents on its recent price decline.

A very large question - a frightening one, really - concerns what will happen when the Fed begins to market the $4.5 Trillion dollars' worth of paper it has on its hands from various rounds of qualitative easing.

If interest rates rise by mid-2015, can the American (and world) economy take the dumping of all that paper, even if it winds out at about the pace it was reeled in. (Let's say $40 billion per month.)

In order to sell that paper, which is already perceived as tainted in a mild way, the interest rates will have to be higher than what bonds normally pay. Institutions that buy such paper will then attempt to re-market the products in various packages. But, let's say they are getting 1.25 to 1.50%. When that paper is passed along, the rate will be at least double, if not 2-1/2 times the time-of-purchase interest level. By the time end buyers get the paper as part of a pension fund, for instance, the interest rate may be 6%, or more.

If the rates aren't high enough at each juncture, people won't buy the bonds.

The interest rates all down the line that institutions are paying out has to be made up elsewhere, and that, my friends, is a huge section of the great wall of worry.

Financial institutions lend money and charge interest. Now, when they borrow or move money, it costs 6%. If they're paying out 6% on one end, they have to take in well more than that 6% when they lend money. They want to make a profit, they want safeguards against bad loans, etc., etc.

The new end-user lending rates could be more than 7% and go as high as 8%. That would have an absolutely chilling effect on the world economy.

Bottom line is that it will be deflationary in the worst way. We know what deflation does to gold, especially, but silver as well. Precious metals bulls like inflation.

In there here and now, another imponderable is the international scene. Escalation in Ukraine seems inevitable. Israel is trying hard to shorten its invasion of Gaza, but that won't end any time soon.

The international tensions are, for the nonce, shoring up gold. But, those hotspots won't boil forever, and at some point, precious metals will have the tensions baked into their prices.

As always, wishing you good trading,