A $7 Trillion 'Moment of Truth' Is Approaching

This critical interest rate is soaring... A $7 trillion 'moment of truth' is approaching... What to do about gold now... A different way to make money on gold...

"Libor" hits a new multiyear high...

The London Interbank Offered Rate (or "Libor") – the rate at which banks are willing to lend money to each other over short periods of time – continues to rise.

Yesterday, three-month U.S. dollar Libor hit a new post-financial crisis high above 0.87%. That's up from just 0.61% at the start of the year – a massive 42% increase – and the highest level since 2008.

The move has largely been driven by new government regulations set to take effect this Friday. As Bloomberg reported on Tuesday...

The new rules require prime money market funds – an important source of short-term funding for banks and companies – to build up liquidity buffers, install redemption gates, and use 'floating' net asset values instead of a fixed $1-per-share price.

While the changes are aimed at reinforcing a $2.7 trillion industry that exacerbated the financial crisis, they are also causing turmoil in money markets as big banks adjust to the new reality of a shrinking pool of available funding.

Some $1 trillion worth of assets have shifted from prime money market funds into government money market funds that invest in safer assets such as short-term U.S. debt, according to Bloomberg estimates. The exodus has driven up Libor rates as banks and other corporate entities compete to replace the lost funding.

Because of the new rules, money is fleeing from money-market funds (which own the relatively riskier short-term debt of banks and corporations) and into funds that own only short-term government debt instead. And because money-market funds suddenly have significantly fewer assets under management, they're buying significantly less short-term bank and corporate debt.

Unfortunately, money-market funds were a critical source of short-term funding for many banks, so they've had to turn to other banks – or "interbank" lending – to make up the difference. And this increased demand for interbank lending has pushed up Libor.

In other words, much of the rise in Libor may be due to simple supply and demand. Many more banks suddenly need to borrow short-term money from other banks, and rates have gone up in response.

But that doesn't mean it isn't important...

First, the new government rules are likely here to stay. They're intended to prevent a repeat of the 2008 financial crisis – when one high-profile money-market fund collapsed after its net asset value fell below $1 per share. But they've "conveniently" been great for the U.S. government, too, as nearly $1 trillion has essentially been forced into the short-term Treasury market. More from Bloomberg...

The shift in demand will be key as government spending on Social Security, Medicare and Medicaid widens the budget shortfall. The public debt burden may swell by almost $10 trillion in the coming decade, according to Congressional Budget Office forecasts, and the U.S. government has already taken advantage of the increase in bill demand to boost issuance.

"The Treasury is probably real happy with the results," said David Glocke, the head of taxable money markets and Treasury bond trading at Vanguard, which manages about $195 billion in money-fund assets. "They can increase the issuance at the short-end of the curve and take advantage of it."

As long as these rules remain in place, this trend is unlikely to reverse... And demand for interbank loans could remain strong. Even if the recent rise in Libor plateaus once the flight from money-market funds ends, rates may still remain elevated compared to historical levels.

Next, not everyone agrees that the move is entirely due to the new regulations. Some analysts believe it's also a sign of tightening credit conditions. They have a point...

Libor has long been seen as a measure of stress in the banking system. When banks are more concerned about the creditworthiness of the other banks they're lending to, they charge more to borrow. Longtime readers may recall that this is exactly what happened during the financial crisis in 2008 when Libor soared to record highs.

If banks are growing more concerned about the health of other banks, Libor may continue to rise even after these money-market moves are finished...

A $7 trillion 'moment of truth' is approaching...

Why does this matter? Because Libor isn't just a critical interest rate for banks... It's also a benchmark rate for nearly $7 trillion of debt, including mortgages, student loans, and high-yield corporate debt and leveraged loans.

Higher Libor rates mean higher costs to service and refinance these debts. And the higher Libor goes, the worse it gets. For example, as we explained in the September 26 Digest...

The first "domino" in a series of benchmarks is the 0.75% level... When that level is breached, a number of junk-rated companies are required to pay more on their floating-rate debt.

About $230 billion worth of debt is benchmarked to the 0.75% mark, according to Bloomberg data. But most of the debt in the $900 billion leveraged loan market is set to a Libor floor of 1%. When the 1% level is breached, the real trouble could begin.

In short, if Libor continues higher in the days and weeks following Friday's deadline, it would be a serious new sign of trouble in the credit markets.

What to do about gold now...

It has been a tough month for gold. Gold and silver have fallen 8% and 15%, respectively, from their summer highs.

Regular Digest readers know that the latest selloff followed a number of "hawkish" headlines from central banks, including talk of a rate hike from the Federal Reserve and rumors of changes to quantitative-easing programs in Europe and Japan.

But as we wrote in the October 5 Digest, none of this changes the "big picture" for precious metals...

Central banks may eventually abandon QE or even negative rates. These policies are clearly not working as intended, and have distorted markets and crushed banks in the process. But to believe central banks will simply give up is naive.

Governments have always preferred to inflate away their debt problems rather than face them head on. That's unlikely to change anytime soon.

Rumors suggest "helicopter money" or another form of direct money-printing may be next, but this much is clear: Precious metals are likely headed much, much higher before it all ends.

We also warned that there could be more downside ahead in the short term. Our colleague Jeff Clark agrees. In yesterday's edition of our free Growth Stock Wire e-letter, Jeff noted that gold had fallen to his downside target, but he warned that the correction could go on a little longer...

When the technical pattern turned bearish last month, we knew we'd see gold fall to at least $1,260 an ounce. Now that we've reached that minimum downside target, is now the time to buy gold? The short answer is... no. Here's why...

The COT report published last Friday, which includes data through last Tuesday, showed the "smart money" were still net short 271,000 gold-futures contracts.

That's down from the record 340,000 contracts a few weeks ago. But it's still way above the minimum number of 150,000 that typically suggests gold is nearing an important intermediate-term bottom.

So... gold still has farther to fall.

How much farther could it fall? As you can see in the following chart, Jeff noted that gold is oversold in the short term. It's trading well below both its nine-day exponential moving average (EMA) and its 50-day moving average (DMA)...

He thinks gold could bounce back over the next week or two, but he expects gold to head lower once again before putting in a longer-term bottom.

What should you do with this information? As always, it depends on your situation.

If you're a trader, Jeff says you can try to buy gold today in anticipation of a quick rally up toward its nine-day EMA. But if you're a longer-term investor, Jeff recommends waiting to add to your positions right now...

With the commercial traders still holding a large net-short position, gold looks headed toward the $1,210 support level over the next month or two.

Folks with a longer-term investment horizon should wait for lower prices. If gold dips down toward the $1,210 level over the next several weeks, we can then take another look at the "smart money" position. If the commercial traders are net short fewer than 150,000 contracts, we'll know the metal is nearing a bottom.

Your chance to learn Jeff's gold trading strategy…

Longtime subscribers know Jeff is one of the most successful traders we know. But you may not realize that some of his biggest winners have come from trading the gold market in particular.

If you're like many of our readers, you probably own some physical gold and silver bullion. You might own some mining stocks or other precious metals investments, too. And even after the recent pullback, you're likely doing pretty well this year.

But if you're in a position to speculate, Jeff's gold-trading strategy can help you do even better. It's a way to make double- and triple-digit gains from short-term moves in the gold market. In fact, many of his trades last just a few weeks… or even a few days.

Better yet, Jeff's approach can profit no matter what happens to the price of gold. It can be a great complement to a traditional precious metals portfolio… especially during the inevitable corrections like we're experiencing today.

To learn more about Jeff's gold strategy – including several examples of his actual trade recommendations and returns – simply click here. (Note: This does not lead to a video presentation.)

We made a mistake...

One final note today... Yesterday, we mentioned that Porter is hosting a small group of subscribers next month in London. As we explained, guests will meet Porter on Friday, November 4 at the five-star Claridge's hotel in Mayfair, for a special presentation and VIP dinner. Then on Saturday, November 5, they'll join him to watch a legendary football match between Chelsea and Everton.

But we mistakenly wrote that the cost of the weekend was $5,000. In reality, the cost to attend is just $2,500, which again includes football tickets, transfers, and the VIP dinner. We apologize for any confusion. If you've already claimed a spot, our colleague Jamison Miller will be contacting you shortly.

Otherwise, you can still join this exclusive trip by e-mailing Jamison here, or via our website right here. (Please note, only a few spots remain. If you're interested in attending, we must hear from you soon.)

New 52-week highs (as of 10/11/16): none.

In today's mailbag, a new book recommendation... a worry about gold and stocks... and a question about the best Stansberry Research service for new investors. Send your comments, questions, and concerns to feedback@stansberryresearch.com.

"If you haven't yet read The Mandibles by Lionel Shriver, you should. It's a fictional view of the consequences of our government's fiscal irresponsibility & of printing too much fiat money. Porter will wet his pants laughing at the (hypothetical) conversations between the Keynesian economics and the rational, common sense characters. Krugman has been appointed head of Treasury if that gives you any clue as to the climate which prevails in this 2029 setting. Funny as hell and equally frightening." – Paid-up subscriber Michael C.

"I would like to ask a question about the correlation of the price of gold and silver and the S&P. It is my understanding that these two should trade inversely. Yet they appear to be trading in tandem. Why is it that a 'safe haven' like gold drops with the S&P instead of rising?" – Paid-up subscriber Anthony S.

Brill comment: You're correct... As our colleague Steve Sjuggerud explained earlier this year in an edition of our free DailyWealth e-letter, gold is the ultimate non-correlated asset. This means when other major asset classes are going down, gold tends to go up. But the key word here is tends.

In the markets, as in life, few things are black and white. Correlations between different assets and indicators are rarely perfect or static. Over the short term, they can wax and wane (and can even invert from time to time). So while gold is an excellent way to hedge your portfolio and reduce volatility over the long term, there will be times – like today – when gold trades more in tandem with other assets. But this doesn't mean the reasons to own gold have suddenly changed.

In short, this behavior is normal and expected from time to time... and is nothing to worry about.

" I read your free newsletters. I own a mom and pop business. We don't have a lot of money, but we do have some to invest. $10,000 would be about it currently. Which one of your newsletters would you suggest for me to subscribe to to start? Thank you." – Paid-up subscriber B.C.

Brill comment: You can learn more about our range of services on the Stansberry Research homepage here. We can't tell you which would be the best fit for your particular situation and goals, but we can share some suggestions...

Porter's Stansberry's Investment Advisory, Steve Sjuggerud's True Wealth, and Dr. David "Doc" Eifrig's Retirement Millionaire advisories are all great options for novice investors. Each has produced excellent annualized returns of 12%-14% over the past 10 years... And at just $199 per year, they are affordable for any investor.

You can also find a ton of free information on getting started with investing – including our glossary of important terminology, explanations of some of the biggest, most important ideas and strategies for building wealth, and our recommended reading list – in the Stansberry Research Education Center right here.

Regards,

Justin Brill
Baltimore, Maryland
October 12, 2016