In my last article in my Market Update I recommended taking a position in TBT. Now the world is waking up to the possibility that long term interest rates may have bottomed and reversed. TBT reflects this change as it broke through its 50-day moving average and gaped higher moving quickly toward its 200-day moving average. A break of that level will more than likely confirm that a reversal is taking place. Almost all asset classes have suffered, blind sided by the rise in rates.
 
The reason for the reversal is three-fold. First, inflationary expectations have reversed. We've gone from fears of deflation here and around the world to concerns of inflation in the future. Second, growth rates were approaching zero at the turn of the new year and recession fears here and abroad were rampant. We are presently running around 3% growth rates according to various tracking  models. And third, the purchase of bonds has exhausted itself. Almost everyone - most hedge funds, institutions, and investors ran to bonds for yield and safety. When everyone is on one side of a trade the trade is over.
 
It's difficult to acknowledge a trend reversal that has been in place for thirty-five years, but that's what I told my subscribers last month in my last article when discussing interest rates.  Short term we will likely see a notable move higher. That's what I think we’re seeing now in its infancy. But the case for higher interest rates is really the long term case.
 
It is inflation and debt that will be the movers of interest rates in the years to come. The National Debt has doubled in the last eight years and the tendency next year, no matter which party is in power, will be to spend much more money. Infrastructure and defense spending will likely lead the way.
 
As spending increases, deficits and debt will increase and inflationary concerns will rise with prices. The demand for materials and resources should raise prices in general, more than we've seen since 2014. But the real threat will be a potential inability to service the debt we are determined to run up.
 
No one knows where or when that line will be crossed, but at some point the bond market will begin to fear a default on debt or some political variation of a default. Donald Trump alluded to it when he said casually that "debt holders might have to take a haircut". He has since disavowed any notion of a default, but what will government do if the National Debt increases to twenty-five trillion dollars over the next five or ten years and rates rise as they did in the 1970's?
 
Meanwhile, the dollar will come under attack as a simultaneous concern over a potential default and the use of the "inflation card" to extinguish debt, will lead to greater inflationary fears. The unfunded liabilities that must be paid for, will be the greatest motive to create money out of thin air to pay for services.
 
Real interest rates always outpace inflation in the long run, and so does gold. For this reason my long term investments are divided between resource stocks, mainly gold and silver companies, and TBT, with a bit of physical gold and silver coins for ultimate safety. ( I sold my TBT at 41 after buying it at 29. I am thinking of buying it back here. See my Market Update for specifics.)
 
A lot of people believe that the Fed can control interest rates. The fact is they can only control the short end of the yield curve. The market is in control of most interest rates throughout the world. While it’s true that a central bank can influence long rates, they cannot control them. The market in debt instruments is so large it makes puny the influence of central banks. The Fed knows this -- politicians do not, but they will learn this lesson soon.
 
The lesson was learned once in the 1970s when the Fed monetized the debt created by government to pay for the Veit Nam War and all the welfare programs legislated over the years. Inflation crawled, then galloped during those years. At the beginning of the decade it was in the 2% range; by the end of the decade it had soared to 14%, the dollar was crashing, and interest rates leaped to over 20%! 
 
Can you imagine what would happen to the US government's ability to service the National Debt if interest rates moved anywhere near that kind of level?  The word "Venezuela" comes to mind.
 
So, the importance of making the entitlement system solvent is essential. And the importance of cutting government spending and reducing our deficits to enable us to service it, is essential. And preserving the value of our dollar and preventing inflation and higher interest rates from running out of control is essential. And yet, nothing is on the agenda of any politician to do anything of the kind. In fact benign neglect is on the agenda for most politicians as it has been for years and many more are in favor of greater government spending, i.e. fiscal stimulus. 
 
Where I concede Donald Trump is delivering a growth message on the economy, I think it is just that -- a delivered speech. Who knows what he will really do once President?
 
This is why gold is beginning to wake up and this is why interest rates are beginning to rise. 
 
Neither political party has shown any interest in entitlement reform or balancing the budget. On the contrary, both parties are more interested in increasing infrastructure spending, social spending,  and defense spending. Only a handful of fiscal conservatives remain in office, and they are branded as "the establishment" and ignored in favor of helping this or that constituency. Trump just introduced a new welfare program that will cost an estimated 156 billion dollars a year forever -- all to be paid for by borrowing.
 
So expect interest rates to rise, slowly at first, then dramatically once the markets begin to really worry about possible debt default and hyperinflation. The process may take years but getting on board this new trend reversal is potentially the equivalent of getting on board the bond market rally thirty-five years ago.
 
Paul Nathan
Paulnathan.biz