Apocalypse Then!

Seen from precious metals, the debate over inflation vs. deflation is absurd...

FINANCIAL MARKETS WORLDWIDE are acting as though the world is about to implode, writes Puru Saxena in Money Matters.

Over the past four months, the investment community has dumped all assets regardless of their underlying economic fundamentals. We have seen unbelievable wealth destruction on a global scale and trillions of dollars have evaporated and returned to monetary heaven.

The rate of decline has been astonishing. In the past twelve months, the Dow Jones Industrial Average (DJIA) has delivered its worst one-year performance in history!

Yes, the Dow's recent plunge has been even worse than the 1929 decline which preceded the Great Depression of the 1930s. But are we really witnessing the end of the world as we know it?

Regardless of the Armageddon fears prevalent today, I would argue that this slump may turn out to be a fantastic buying opportunity for the patient, long-term investor. The mainstream media, in contrast, seems to be convinced that our planet is headed into a permanent global depression and investor-sentiment certainly reflects this thought process. Yet these same cheerleaders, only a few months ago, were gleefully shouting about the emergence of a new global economy are now forecasting eternal disaster.

Furthermore, investors are liquidating all assets as images of their children living in shanty towns fill their fearful minds. 'Demand destruction' and 'de-leveraging' have replaced 'liquidity' and 'global growth' as the new buzz-words. Stocks are down significantly from the highs, corporate bonds have taken a beating and even commodities (including precious metals such as Gold Bullion) have joined the bear parade. Those who naively bought structured products from private banks, meantime, have seen total losses. So, where do we go from here?

The best way to begin is by reiterating that global markets are now extremely oversold and undervalued, hence attractive. This may sound counter-intuitive, but it is vital to understand that a decline of 40% in US stocks (and even more in some countries) has set the stage for fantastic long-term gains. If my assessment proves to be correct, investors who buy the unimpaired sectors today should make a fortune over the coming decade.

Remember, the best time to buy is when everyone is despondently selling. As John Templeton (founder of Templeton Funds) often said, "bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria."

And you can be sure that the investment community is feeling extremely pessimistic and fearful today.

At present, a lot of 'gloom and doom' and 'deflation' chatter is doing the rounds in the mainstream media. The recent selling panic is frequently being described at the worst crisis since the Great Depression. However, this hype does not imply that the economic outlook is similar to the 1930s. One of the biggest reasons why the Great Depression occurred was due to the failure or inability of the money-supply to expand in line with the need for this money. Furthermore, the failure of roughly 5,000 banks across the United States did not help the situation either as millions of Americans lost their savings – a literal destruction of money!

In the current situation, however, various central banks and governments are throwing trillions of dollars into the monetary system and all bank deposits have been guaranteed. And if need be, the authorities will print money until the world runs out of trees. So, in my view, a prolonged deflationary phase or a global depression is not likely to happen.

The recent sharp declines in the markets can be attributed to the fact that two separate negative events caught the public's attention at roughly the same time – depth of the financial crisis and fears of a US recession. As far as the first issue is concerned, it is my belief that the worst is behind us. For sure, we may hear of sporadic bank busts in the months ahead, but the recent government guarantees prevented a total collapse of the banking system.

For the record, I do not agree with the recent bail-outs because they are immoral and are going to cause huge inflation in the future. However, we all have to deal with reality and for now, it seems that the credit markets are starting to function again. And our research here at Money Matters reveals that currently US$3.5 trillion is sitting on the sidelines, waiting to be invested.

When investors deploy this cash into the markets, it will flow towards sectors which have been unharmed in this financial crisis. And apart from natural resources (where supply and demand imbalances persist) and industrials (which may benefit from massive government-sponsored infrastructure projects), I cannot find any other sector which has strong fundamentals.

Housing faces severe over-supply, autos are struggling, banks will suffer due to over-regulation and consumer discretionary stocks will also fare poorly as the over-stretched public in the West tightens its belts.

The one sector of the economy which remains in excellent condition is commodities. Demand is holding firm, supplies of key resources are still tight and the ongoing credit crisis will only delay many projects which were previously meant to come online. This will create additional supply shortages in the future, thereby leading to much higher prices.

As far as precious metals such as Gold Investment are concerned, it is worth remembering that our world's financial system has been hijacked by money-printers. Whether it is the Federal Reserve, Bank of England or the European Central Bank – they are all creating money 'out of thin air' and inflating the supply of paper currencies. As this rampant inflation continues, what is astonishing though is that so many investors are being hoodwinked into believing that our world faces a genuine deflationary bust.

These days, opinion is divided as to whether we will witness continuing inflation or gut-wrenching deflation. In my view, this discussion is absurd and deflation (or a contraction in the supply of money) is out of the question.

Banks are in the business of lending money and debt creation is essential for their very survival and prosperity. So, you can be sure that the modern-day money lenders will find a new way to further expand the supply of money and debt.

Whilst paper currencies (particularly US and Japanese cash) regained some purchasing power in the past few months due to forced liquidation in the asset markets, there is no chance that they will maintain their value over the medium to long-term. History is littered with numerous paper currencies which became totally worthless and I suspect many of the current ones will also disappear. In fact, a remarkable study confirms that only 23% of paper currencies ever issued have survived the test of time! The vast majority were destroyed due to hyperinflation and are no longer in circulation.

Accordingly, I would urge investors to sit tight with their positions in hard assets (precious metals, energy and agriculture) and add more capital at such depressed levels. Under the best-case scenario, global markets bottomed out over the past two months and even if they did not, at the very least, we should get a multi-month rally in commodities and related stocks.