So, this reasoning goes, the greater risk is that asset prices continue to fall. This is the classic debt-deflation point of view. The theory seems to fit the facts of what we are seeing in the marketplace right now.
I don't dismiss these arguments easily ― and there is more to it than what I've given you here. I've spent some time going over the arguments of some of deflation's most persuasive and sophisticated advocates: money manager Van Hoisington, economist David Rosenberg and others.
Still, I think the endgame is for inflation ― which is when paper currencies buy less. Given the choice of holding U.S. dollars or real assets (such as gold or iron ore or land), I'll take real assets.
Over the weekend, Thomas Donlan at Barron's had a good analogy for it all. He asked what you would rather own as store of value, bananas or corn? The obvious answer is corn, because you can store it for months. Corn lasts longer than bananas. Fruit rots. You can also use corn for a lot of different things ― corn flour, animal feed, etc. You can also arrange to sell corn into the future, say, by arranging to deliver corn so many days from today.
Corn can lose value, obviously, as can any real asset. But it is a better choice than holding the bananas.
Donlan likens money to bananas and natural resources to corn. "In the modern economy," he writes, "a barrel of oil is much like a bag of corn… Paper money and bank balances are more like the bag of bananas." When currency rots, we call that inflation.
The problem with the deflation arguments long term, it seems to me, is that you are betting against a government's ability to destroy its own currency. Governments are seldom good at anything, but one thing they are undeniably good at is destroying their own currencies. The dollar has lost 95% or so of its value since 1913. That's a pretty darn good job. Other countries have been even more thorough.
So that would be the way to bet. Deflation may prevail today, but the real question is for how long. My own crystal ball is frustratingly cloudy on the issue. But the great rewards in investing are always with the out-of-consensus view.
The upside from holding Treasuries seems hardly worth the risk of being wrong, for instance. On the other hand, if we are right about currency rot, then we'll make multiples of our money on natural resource top stocks.
The downside on many commodities seems low, because the prices have already corrected. In several instances, as with oil and natural gas and iron ore, we are already below the marginal cost of production for much of the industry. So unless we don't need these things at all anymore, the simple economics of the businesses involved help support a certain price structure.
Worse Than Subprime
And anyway, as far as the case for gold is concerned, I've been arguing that it is less about inflation or deflation than it is about creditworthiness in general. I wrote about this in the May issue of Mayer's Special Situations.
Gold does well during times of credit troubles. It did well in the 1930s, for instance, even though that was largely a deflationary era. Banking troubles made investors turn to gold.
On that front, we've got plenty of banking troubles on the way. A recent Wall Street Journal headline, buried in the middle of the paper, hints at what's to come: "Pick-a-Pay Loans: Worse Than Subprime." The piece begins:
"For the third straight month, option adjustable-rate mortgages are generating proportionately more delinquencies and foreclosures than subprime mortgages, the scourge of the U.S."
These loans include only partial-interest payments. So the loan balances on many of these loans have actually gone up while housing prices tumbled. It's a disaster. As of April 36% of these loans were at least 60 days past due.
These pathetic loans will mean more large losses for banks ― in particular Wells Fargo, J.P. Morgan Chase and others who were active in these markets. Wells Fargo, the WSJ points out, has a mountain of this stuff ― $115 billion of crap.
So as long as we have banking troubles, we have the potential for fear to return in a big way. And that is when gold does well.
In other cultures, too, gold is more naturally a part of the wealth-storing equation than it is in most Western countries. In places such as China, India and the Arab world, people see gold more readily as a store of wealth than the typical American or European. These areas of the world are on the rise, and their gold holdings are also rising.
Beyond this, gold stocks are cheap again. Gold also has a seasonal tendency to be weak in the summer months. So against all this, I'd use the market weakness in the gold price and in gold shares to pick up your favorite gold miners.
Have a good week, and I'll write you again soon.
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