Scott Minerd: The Faustian Bargain

To add more credence to the importance of interest rates on the assets of the federal reserve (and the banks) I will point to this article of Scott Minerd: The Faustian Bargain.

He says that it only takes a rise of 1% in interest rates to render the fed insolvent.

"Now, a 100 basis-point increase in interest rates would cause the market value of the Federal Reserve’s assets to fall by about 8% or approximately $200 billion which would leave the Federal Reserve with a capital deficit of $150 billion, rendering it insolvent under Generally Accepted Accounting Principles (GAAP)."

So I wasn't talking BS when I said interest rates are very important for the assets of the federal reserve and the bank's balance sheet. When interest rates rise, bad things happen.

Another thing to point out is that during high inflation (Table 1: purple blocks), bonds are the worst investment as bonds won't act well in inflationary times. Farmland, gold and silver on the other hand are good performers. And as Marc Faber always points out, art and collectibles will do especially well.

Chart 1: Outperformance comparison (art, stocks, farmland, gold, silver, bonds)

Another Correlation: Interest Rates and P/E Ratios of Gold Mines

In the Peter Schiff Show on the 5th of April, Peter talked about how low the P/E ratios of the gold mines are, compared to the interest rate. He said: "the lower the interest rates are, the higher P/E ratios will be".

This correlation is intuitively correct. As the interest rate is low, you won't get any return by putting your money in treasuries or in the bank. So where do you put your money, if not in cash and bonds? You will put your money in the stock market where you get a higher return. That's why stocks will have a higher valuation and consequently a higher price. A higher price will result in a higher P/E ratio. Conversely, when interest rates are high, the P/E ratio will be low.

For example: if the interest rate were 15% like in year 1981, investors will likely put their money in bonds with a 15% return per annum, rather than putting their money in risky stocks.

To show this correlation I will give historical evidence and show why Gold Miners are very cheap.
Go here to check out my analysis.