Published: August 5, 2010

Last month, I told you the folks at the U.S. Federal Reserve -- the people who set short-term interest rates in the U.S. -- showed us their cards...

In short, Fed Chairman Ben Bernanke will keep money as "easy" as possible, for as long as possible. And interest rates will remain below 1% for longer than anyone else believes...

This will create new bubbles. Bernanke won't care... They'll just be the collateral damage of his efforts to fix the U.S. economy.

Where will the new bubbles form?

Whenever the Fed cuts short-term interest rates wildly below long-term interest rates, the first place you have to consider speculating is... Hong Kong.

You see, the Hong Kong dollar is pegged to the U.S. dollar. Because of the specific way the Hong Kong dollar is pegged (it's called a "currency board"), Hong Kong is stuck with whatever the U.S. policy is on interest rates.

The thing is, the U.S. interest-rate policy might not always be the right policy for Hong Kong. If Hong Kong and China are soaring, low interest rates in Hong Kong might not make sense. But its currency board is a "straightjacket" for Hong Kong.

Will Hong Kong try to get out of the straightjacket? No. Asked about it earlier this summer, the Hong Kong Monetary Authority responded: "We have no plan to alter the USD/HKD peg as the currency regime has been effective."

All this means is whenever the U.S. Federal Reserve has dramatically cut short-term interest rates lower than long-term interest rates, crazy things have happened in Hong Kong stocks...

I looked over the last 40 years for instances when the spread between short-term interest rates and long-term interest rates was wide -- specifically when one-year Treasury bond rates were more than two percentage points below 10-year Treasury bond rates.

The Fed cut rates to these crazy-low levels four times in history...

The spread got wider than two points in late 1970. If you'd bought when the spread got wide, you'd have made a fortune... The entire Hong Kong stock market rose EIGHTFOLD in 27 months.

The Fed cut rates to crazy levels again in late 1984 and in mid-1991. In both of those cases, if you'd bought when the spread got wide, you'd have made three times your money in Hong Kong stocks -- again in three years or less.

The spread got wide again in mid-2001. The market didn't bottom in that case until 2003, but then it went on to double.
 

In sum, in three out of four cases, you'd have made three times your money or more (as much as eight times your money) in three years or less.

In the last year, the U.S. interest-rate spread has gotten as wide as it's ever been. In April of this year, the spread went to around 3.5 percentage points. A month later, the Hong Kong stock market hit a low for the year and has rallied.

While you could buy the overall Hong Kong stock market, I just told readers of True Wealth that the best value in Hong Kong is in property stocks. Hong Kong property companies aren't like U.S. property companies. They are NOT heavily indebted. Hong Kong's stock market has always been dominated by property-heavy conglomerates.

These Hong Kong developers are in a unique position... They can borrow money at ultra-low U.S.-type interest rates because of their currency system. And they put that money to work in the world's fastest growing economy. But right now, most Hong Kong property developers are trading at a 30% discount to net asset value.

True Wealth readers have already made great gains with a basket of these developers through an exchange-traded fund called the Claymore/AlphaShares China Real Estate Fund (NYSE: TAO).

The stocks in this fund are cheap! According to Bloomberg, the average price-to-earnings ratio of the portfolio is 7.65. I think even bigger gains are on the way.

It might sound crazy that a high-return, low-risk way to take advantage of the Fed's crazy interest rate policy is to buy Hong Kong property developers. But it makes perfect sense -- and history shows huge gains are possible.

-- Steve Sjuggerud
Editor
Daily Wealth

Note: This article originally appeared in Daily Wealth