Deflation v Inflation

The most frequent question we receive regards inflation.  We think that massive government stimulus packages, bank bailouts, ramped-up fed lending facilities, and other similar plans from governments and central banks in Europe and the U.S. will ultimately cause hyperinflation.  The derivative question is how should one invest with inflation on the horizon.  We should not be overconfident, however, in a world that can change in a moment.  What happens if we have continued deflation in the meantime?  Knowing whether deflation will continue, or when inflation will kick in, is really a question of timing when trying to pick your next winner. 

Clearly we are in a deflationary spiral right now.  Trillions of dollars of net worth have been vaporized across the planet.  Main asset classes like real estate and equities have taken huge losses.  Far from reaching a bottom, the downturn seems to be accelerating.  Japan just roiled global markets with a significant GDP decline.  China has lost 20mm jobs almost overnight.  The U.S. unemployment rate is climbing toward 8% in the short-term, with some predicting double digits soon.  Higher unemployment, lower consumer spending, and falling economic activity are not a recipe for inflation.   The money wiped out in the financial collapse is presently offsetting the various stimulus and money-creating schemes.  At some point, though, all the new liquidity will likely cause major inflationary pressure.  The question is when, not if.

Other than gold bullion, other traditionally inflation-beating sub-sectors have not appreciated so far.  That could be a tell.  It is possible gold is catching a flight to safety bid from those who think we’re close to the end of the world, or more likely, as a safe haven from a global depression and “everything else isn’t working other than cash and if I’m going to be long anything, gold seems as good as it gets right now” type attitude.

Either way, for those wanting to know if we foresee the collapse of the U.S. dollar, or if one should hold more than a small to moderate position in gold, our answer would be NO.  The time may come when one should be prepared and invested for the hyperinflation scenario.  But is that time now?  Probably not.  That is why we favor hoarding cash, small positions in gold, silver, and mining companies, (although it certainly feels like a crowded trade) and waiting and watching for opportunities.  Deflationary forces have the upper hand right now.  Why try to push the stack one way or the other in this environment?  Better safe than sorry.  Holding cash while waiting for new trends to emerge is an excellent strategy in this economy.

Good Luck.