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The world has ventured so far into uncharted territory in its collective response to the global financial crisis that we have no clear precedent at our disposal from which to discern the ultimate result.
But that doesn't mean we are incapable of identifying the likely consequences of all this government largesse created in response to the specter of systemic deleveraging throughout our precarious financial system. The intentions of all key government and central banks engaged in this battle against deflation remain both explicit and crystal-clear: They will continue to undertake whatever extraordinary measures they consider necessary to thwart the deflationary beast lurking in the shadows.
Buying time at an ever-increasing cost
Given the extraordinary scale of interventions already executed, perhaps the most foreboding sign of all is just how little they appear to have accomplished, aside from buying a little time. At the realized rate, moreover, this has been some seriously costly time!
The U.S. Federal Reserve has already completed two debt-monetization campaigns, one "Twist," and a dizzying array of bank rescue facilities and liquidity injections. Yet even after all those historic interventions, a hyperaccommodative zero-bound interest rate, and a massive economic stimulus package, the U.S. economy has unfortunately failed to reach the kind of "escape velocity" that might encourage authorities to ease up on the accelerator. Further intervention will inevitably follow. Indeed, because governments and the moneyed interests fear a deflationary spiral above any other scenario, I believe we find ourselves mired in an unseemly vicious circle that gold expert Jim Sinclair has deftly labeled "QE to infinity." The debt issuance, central bank balance sheet expansion, and corresponding currency debasement that still looms on the horizon even after all that has been done to date speaks to the unspeakable scale of the underlying crisis.
After much initial reluctance, Europe has opened the monetary spigots with some gigantic emergency measures of its own. But there, too, each successive response seems only to apply a little salve to a wound that never heals. Noting the tremendously disappointing market response to Europe's $125 billion bailout of Spanish banks announced on June 9, The Economist concedes: "it's a plaster, not a cure." And as Europe's prolonged malaise weighs upon the world economy, the International Monetary Fund has urged both Japan and England to consider additional stimulus in their respective nations. I have long bemoaned the dynamic of competitive currency devaluation that has taken shape as this crisis matures, and now the world stage appears to be set for some sort of coordinated or roughly simultaneous easing initiative by four of the world's major money centers. These are truly remarkable times, and I understand it can be very daunting for investors to make sense of it all and devise their strategy accordingly. Fortunately, a voice from the past can now be heard once again to help Fools navigate their way through the current and forthcoming stages of fiat currency devaluation as a predictable consequence of worldwide efforts to avoid a great depression of staggering proportion.
Understanding the familiar dynamics in play
Recognizing the remarkable relevance of the material to our present predicament, New York fund manager Roger Lipton has resurrected a true classic by publishing a brand-new edition of Harry Browne's 1970 book: How You Can Profit From the Coming Devaluation. In this book, Browne correctly predicted the U.S. dollar devaluation and subsequent inflationary cycle of the 1970s, and he succeeded in presenting the predictable boom-and-bust cycles of inflationary monetary policy in an easily absorbed manner. It's a quick read, and well worth the time. James Grant, noted financial historian and editor of Grant's Interest Rate Observer, wrote the foreword for the new edition. Grant writes: "I commend this volume to every investor and to one particular central banker: For your sake and ours, Ben Bernanke, please read every word."
The work contains too many gems to share here, but permit me to include just a few. I enjoyed Browne's definition of a recession as "the liquidation period following an inflationary cycle." Browne continues: "The government invokes inflation as a way of appearing to create prosperity; as a way of financing, on a subtle basis, its own programs. Once under way, the inflationary program must be sustained to ward off the recession that will inevitably follow." I find this an elegant means of understanding the circumstances that set the scene for our current predicament. You see, when Browne published his book, the dollar was pegged at a gold price of $35 per ounce, whereas today an ounce of gold fetches more than $1,600! That epic degree of dollar devaluation vis-a-vis gold offers a window onto the mother of all inflationary cycles -- an extended period of apparent prosperity that was really nothing of the sort because it left us precisely where we find ourselves today: between a rock and an unimaginably hard place. Browne cautioned back in 1970: "And so the binge continues, guaranteeing an even worse readjustment period ahead. The longer the cycle lasts, the bigger the inflation, the greater number of miscalculations to be liquidated, the worse the recession to come."
How to profit from the ongoing devaluation
Browne conducts a useful exercise in his book by exploring the likely performance of various asset classes through each of the potential scenarios resulting from the bust of an inflationary cycle. For each type of investment, Browne scores its desirability within the context of continued inflation, recession, depression, runaway inflation, and devaluation. Not surprisingly, gold and silver emerged from this exercise with a golden outlook for gains through most of the scenarios considered. For those interested in adapting their investment strategies to the specter of continued fiat currency devaluation, the one unavoidable conclusion is that gold and silver have an immutable role to play.
The way I see it, we're still in the early stages of this global financial crisis and the related devaluation of paper currencies. I consider my long-standing target of $2,000 gold such a simple threshold to reach that I expect it will appear laughably conservative in hindsight. In fact, for those paying close attention to the supply side of the equation, $2,250 gold is coming into clearer view. In silver, I believe the upside could be greater still, and I have positioned my own portfolio accordingly. I consider some bullion exposure critical, and for that I recommend Central Fund of Canada as a one-stop shop for reliably unencumbered gold and silver. Accordingly, my bullish CAPScall on Central Fund of Canada has remained in place since November 2006!
Mining stocks have proven a tough nut to crack thus far in this precious-metal bull market, as a combination of rising costs and way too much poor execution have contributed to a shocking degree of underperformance by the miners relative to the underlying metal prices. But I remain steadfast in my expectation for meaningful outperformance by the miners going forward, with the top-quality producers likely to yield some legendary returns from their currently impaired state. While major producer Goldcorp (NYSE: GG ) offers a low-risk starting point, I gravitate toward smaller-cap operators that appear to be in the midst of a major turnaround. I just visited Brigus Gold's (NYSE: BRD ) Black Fox mine in Ontario, and that company's long-awaited turnaround is finally taking shape. On the silver side, though the well-known Silver Wheaton (NYSE: SLW ) will certainly remain a core holding, I'm excited by the remarkable growth prospects of quality miners Aurcana, Endeavour Silver (NYSE: EXK ) , and First Majestic Silver (NYSE: AG ) .
We need not be hapless victims to the currency devaluation that's heaped upon our shoulders by governments and central banks engaged in an all-out global war against deflation. By making a bit of room for gold and silver exposure within their investment portfolios, Fools would do well to heed the seasoned advice of Harry Browne and profit from the coming devaluation.
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