What if deflation wins?
While we think the odds are strongly stacked against it, particularly given the government's furious pace of money printing, the prudent investor understands ― and respects ― the time-tested adage, "Nothing is guaranteed." So while our chips sit squarely on the spot marked "inflation," what will happen to gold stocks for 2010 if we're wrong?
The Great Depression Speaks
The most notable example of what happens to gold stocks 2010 in a prolonged deflationary environment is the Great Depression. However, the United States was on a gold standard at the time, so miners had a guaranteed selling price ― which was a good thing for them, because their operating costs were plummeting. So the comparability isn't perfect, but let's see what we can learn.
When the best stocks market crashed in 1929, gold stocks were part of the general wreckage (sound familiar?). The market then rallied and recovered almost 50% of its losses by April 1930, with gold shares again tagging along. It's what happened next that gives us our first clue about deflation's effect.
When the bear market resumed in the summer of 1930, all securities sold off again ― except gold stocks. Gold shares stayed basically flat until early 1931, when they boarded the elevator and headed for the penthouse.
Let's look at how shares of Homestake Mining, the largest gold miner in the U.S. at the time, and Dome Mines, Canada's senior producer, performed during the Great Depression.
And the chart doesn't show that you could have bought both best stocks at half their 1929 price five years earlier, which would have led to gains of around 1,000%. And get this: both companies paid healthy and rising dividends as the depression wore on; Homestake's dividend went from $7 to $15 per share, and Dome's from $1 to $1.80.
Yes, volatility was high in the gold stocks of 2010 throughout the depression, with occasional wild price swings, but after the 1929 crash most of the volatility was to the upside.
The bottom line is that the two largest gold producers ― during a time of soup lines and falling standards of living ― handed investors five and six times their money in four years.
From Homestake's chart, you get a clear picture of what the stock did compared to the market as a whole:
You'll notice the large spike down in both Homestake and the Dow during the 1929 crash...but then look at Homestake's recovery immediately afterward, returning close to its old high. This is eerily similar to our recent pattern: our best stocks of 2010 sold off violently last October but have since doubled or more from their bottoms.
You'll then notice that Homestake took almost two years to exceed its old high, but once it broke out, it was off to the races. The stock doubled four times in five years during a seven-year run to its peak after the '29 crash.
The conclusion? If history is any guide, gold stocks 2010 can hold their own against deflation. And they could profit tremendously if the demand for gold as a safe haven continues to grow.
Gold vs. Deflation
On April 5, 1933, President Roosevelt issued an executive order forcing delivery (confiscation) of gold owned by private citizens to the government in exchange for compensation at the fixed price of $20.67/oz. And less than nine months later, he raised the gold price to $35, effectively diluting the dollar in every wallet 41% overnight and swindling everyone who had turned in his gold.
We don't know exactly what an untethered gold price would have done during the depression, but given its distinction in history as a store of value, it's likely to retain its purchasing power in a deflationary setting regardless of its nominal price. In other words, while the price of gold might not rise, or could even fall, your best protection is still gold.
But with this said, the overriding concern is that in a fiat system, any deflation will be met with an inflationary overreaction (as we're seeing). And the worse the deflation, the more extreme the overreaction will be.
It's for this reason that the editors of BIG GOLD urge you to own physical gold, in your possession and under your control, given its reliability as a store of value in both inflationary and deflationary environments. If you have less than our recommended one-third of your investable assets in some form of gold, check around for places to buy gold coins and bars at good premiums.
The Silver Lining
For those with an inclination toward silver, our research points to clear signs that silver is increasingly being viewed as a store of value and not just as an industrial metal.
Here's a comparison of silver's performance vs. base metals over the past six months (10-1-08 through 3-31-09), which includes last fall's meltdown:
If silver were viewed solely as an industrial metal, the price would be off sharply.
This doesn't mean we think silver or silver stocks can't go temporarily lower from here, but rather that the demand for silver as a store of value metal will be growing.
Bottom line: Whether we're served debilitating deflation or insidious inflation, holding gold (and silver), along with an appropriate allocation of precious metals stocks for 2010, offers us both a fort for protection and a canon for profit.
Buying physical gold and silver as safe-harbor assets is for many investors a no-brainer at this point. But only a few have heard of another prudent gold investment ― one that has gone up more than 50% in 2008, at the exact same time when the overall best stock market bombed. You don't want to miss out on owning this "48 Karat Gold" stock…
Inflation has a hard time of it when the currency is tied to gold and/or silver. That's why the collectivists like to cut those ties whenever they can.
During a deflationary depression things get cheaper in terms of whatever happens to be money. Governments like to fight deflation by making saving (holding onto money) less attractive; that is, they like to inflate. Gold sort of puts the kibosh on that, hence the state's hatred of the stuff.
Now to your letters. Here's one that snuck in just in time for publication…
Gary,
I enjoy the give and take that is flowing through the bar. I have a couple of observations on taxation and capitalism.
First, I think of myself as what is today termed a conservative. I support free enterprise and capitalism, not because I think they are perfect but because they seem to be about the most effective systems that humankind has developed for taking care of the most people and providing the most possible people with higher standards of living. That said we have on obligation to apply them, as individuals and capitalists with some responsibility and recognition that our resources are not unlimited and that people are not to be exploited. We need to be observing the golden rule of treating others as we would like to be treated. As regards our natural resources we have an obligation to use them carefully and wisely and to only use what is really needed, in other words not to waste what we have or to exercise good stewardship.
Second, regarding taxation, we need to decide what the purpose of taxation is. A mildly progressive system may not necessarily be bad, but what is its purpose? Are we trying to raise revenue? Are we trying to punish the people who work hard and are successful? Or are we trying to bring everyone down to basically the same level so that the state has all the power? If the issue is generation of revenue then we need to look at the tax cuts that went into place under first Kennedy, then Reagan, then G.W. Bush. Each of these sets of tax cuts generated significantly more revenue, course Congress could not control itself and for every $1 increase in revenue spent $2, so to speak. Never the less, if revenue is the objective then the Administration and Congress should be looking at carefully, even cynically, lowering taxes to maximize revenue. There is a point when the rates will go so low as to cause a lowering of revenue; at that point they could be raised back to optimum point. This whole concept seems to be foreign to our higher level elected officials (I serve on a Town Board), so apparently the intention is not to raise revenue, but to accomplish some other objective.
Thanks for the thoughtful letter. Now to a Shooter who's been a little disappointed lately…
Bartender,
I was a little disappointed to down the latest shot of W & G to find so much attention by so many smart shooters given to Comrade "God I hate conservatives". There will always be those who look at others who have more than they do and chalk it up to an unfair 'system' where invisible forces keep them at bay while their neighbor with the big house, Mercedes, and hot wife has free reign. It is not their lack of ingenuity or hard work that has condemned them, but the others guy's unfair advantage. This attitude is ripe in college dormitories and public housing projects alike. Universities are infiltrated by leftist professors who attack the founding fathers of this country as the homogenous evil 'white men' who disdained diversity and paying taxes, and the Second World War should be remembered less for the defeat of aggressive militaristic forces as much as it should be for the racist internment of Japanese-American s. Oh, and then there are the 'accomplishments' of the spirit of the 60's and the wonders of Affirmative Action. I can go on and on (and all of it from actual classroom examples I was forced to sit through). The point is, a college student indoctrinated by this bunk while simultaneously protected by the womb of a state institution and regular checks from Mom & Dad quite naturally views government along those same lines: a 'protective blanket' that should provide for everyone while keeping things 'fair & equal'. My guess is this confused fellow will sing another tune when he stands on his own feet and earns what he has, only to see a growing piece of his own pie sliced away and thrown into the governmental black hole.
Now, can we please get back to you providing me with the investment roadmap I am so sure I will sorely need?
Fine. Let's take a look at this peak oil thing again…
So, in light of your current issue, the concept of "peak oil" is just so much claptrap. There's enough oil in the form of heavy oil, to last for several hundred years and Kunstler et al are mere calamity howlers. Hah! I thought so all along.
Not so fast, Shooter!
Peak oil hasn't gone anywhere and James, Byron and all the rest never said we'd run out just like that. The point is that what's left will be increasingly difficult to get and require higher energy investments in the first place.
The EROEI (Energy Returned On Energy Invested) or "bang for the buck" is bound to start decreasing. Industrial civilization has to run faster and faster just to stay in place.
Friend and contributor James Howard Kunstler does a great service by exploring the links between peak oil and vanishing wealth. The takeaway lesson is that standards of living are likely to drop for the unwary.
But here in the Whiskey Room we do our best to make sure that those who patronize this bar are very wary. If you have an idea of what's coming, you can prepare and―perhaps perversely―have your standard of living rise while most of your friends and neighbors watch in dim disbelief as theirs fall.
Byron King could help you out with that. He knows where the money will be heading due to the changing energy landscape. Click here to read more.
And finally, this Shooter enjoys the show, but feels there is a lack of helpful detail…
Gentlemen:
I find your writing refreshing and informative but often incomplete.
You do not go into the tax code like you should. Anyone in finance should study the tax code since it is not how much you make but how much you keep.
The current field for making money is not level, particularly for the rich. Under the IRS code, the rich (unlike the wealthy who are more taxed as a percentage of their compensation/income than any other class) if they structure their wealth properly, particularly in offshore Family trust corporations, pay little tax as a percentage of their total compensation. This is because their compensation is largely in the form of capitalization or unearned income rather than earned income (the distinctions are tax distinctions).
Given a family trust corporation, you can (under section 230 and231 of the IRS code) accumulate money for years without bringing it home ( the mainland) and then bring it home under a favorable political environment ( Bush- December 2004- 5.67% levied tax) and be taxed very lightly. Or a "special bill" provided by your House of representative, who you have supported with generous political contributions for years, will have this bill attached to the once a year general revenue bill that the president has to veto in total or affirm in total and it will say that on such and such a time and day, a certain sum of money from a certain corporation located in a certain untaxed foreign jurisdiction will transfer 100 million dollars (of which 50 million is profit) to a certain bank in the US free of all federal, state and local taxation under the Fe deral Supremacy Clause- i.e. NO TAX. AND A NEW HIGHER BASIS POINT WITH THE 100 MILLION BEING TRANSFERED OUT AGAIN BACK TO THE FOREIGN UNTAXED JURISDICTION. You speak of a system of a capitalist system that does not exist especially for the rich.
Do some work in US taxation law and accounting; it will help you and your readership.
The tax code is theft wrapped in bureaucracy wrapped in torture. I would dispense entirely with it if I had my druthers.
There are times when taxes are sensible means of support because they simplify payment for things that all the taxpayers desire. Municipal infrastructure comes to mind.
But usually taxes are just a way to fund things that the market would never allow, like welfare, bread, circuses and wars of aggression. And the ever-increasing and staggering complexity of the tax code is enough to make hardened men want to curl up and weep.
Speaking of which, it's about that time of day. The bar will be shutting down for the afternoon slump. Your editor will be pulling down the blinds, sitting very still and contemplating his sins.
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