Inflation Investing - A Historical Perspective on What To Do

On Friday I was having a discussion with my friend about inflation, speculating about what may happen to stock prices if inflation were to take hold. Both of us are big fans of Marc Faber, so we were discussing the scenario that Faber has been predicting - that if cash is about to become trash thanks to government money printing, you want to get into tangible assets, including stocks, to protect yourself.

But what really happens to stock prices during inflationary times? You could slice and dice the discussion many different ways from an academic perspective...but the more I thought about it, the more interested I became in digging out historical examples.

Then I remembered that Faber himself had a great chapter in his book Tomorrow's Gold that is entitled The Economics of Inflation.

So, I reread the chapter today.

The Paradox of Inflation

Faber discovered that stock markets of countries that are experiencing very high rates of inflation can become very undervalued in real terms, creating tremendous buying opportunities for the astute and courageous investor.

The reason, Faber says, is that currency depreciation, due to "massive capital flight", overcompensates for domestic inflation, creating stock market values that are truly outstanding. When inflation subsides from extreme levels, equities can realize substantial gains in real terms.

Everyone knows the common playbook for investing through inflation is to buy metals and short bonds. But according to the data Faber presents, it can also be a great time to buy stocks for cheap.

And the higher the rate of inflation, or the worse the hyperinflationary scenario, the greater the buying opportunity generally is. Faber takes a look at examples from Argentina 1977-1987, Germany from 1919-1923, Latin America in the 1980s, and Russia after the fall of communism. And all four examples revealed tremendous buying opportunities for stocks - especially if you bought during the height of the inflation.

Interestingly Faber also cites the opposite case - that countries with low rates of inflation tend to have richly valued equity markets. Such as Japan in the late 1980s, or the Western world in the late 1990s. Goldilocks is not so kind to buy and hold investors.

Overall these findings seem to jive with the old investing adage that you should buy when there's "blood in the streets" - and conversely be cautious when the sun is shining.

I'd like to add that Germany's hyperinflation is often blamed for the rise of Hitler and, ultimately, World War II. However Faber says that hyperinflation in Germany actually ended in 1923, with the institution of a new currency. Thereafter, Germany boomed for the rest of the decade, and was quite prosperous up until the depression.

I think history shows that governments can put the breaks on inflation real quick, if they have the stomach and motivation to do so. Germany did it in 1923. Paul Volcker slayed the inflation dragon in the early 1980's.

So it appears that purchasing stocks today in anticipation of inflation or hyperinflation may not yet be the right move. While stock prices would increase in nominal terms, they may become undervalued in real terms - at which point you'd want to be a buyer.

Intel - More Big Results, But Stock Sells Off After

On Tuesday, Intel announced good earnings and an upbeat outlook for the second straight quarter. Initially, the stock popped - only to trade lower for the remainder of the week. INTC currently sits below where it was at when it announced earnings.

INTC popped higher after its earnings report, but the rally stalled.

(Source: Barchart.com)

Perhaps all of this good news was already priced into Intel's stock price? If that's the case, I'd imagine there are many stocks that you could say the same thing about.

Some More Good Reading

• Guru Robert Prechter shares why he believes fundamental analysis is always trumped by technical analysis.

• A scary chart of US consumer credit, which continues to nosedive.

• Colorado's minimum wage is set to - drop?

• Chinese indices have not yet confirmed the new highs in US equities

• Finally, you can now buy physical gold bars in a famed UK department store.

Positions Update - Still Long the Buck

Well I was either early or wrong on the dollar call, and as far as trading goes, that's basically the same thing!

This is why calling a bottom before it's actually put in is indeed a fool's game. And I fell into the trap yet again.

Although I still like this trade, I should have waited for an uptrend. As is, I'll continue to hold the position, and wait for the break up that we're anticipating.

Oops - you want to be short charts like these!

(Source: Barchart.com)

Open positions:

Thanks for reading!

Current Account Value: $24,309.83

Cashed out: $20,000.00
Total value: $44,309.83
Weekly return: -1.9%
2009 YTD return: -52.2% (Yikes!)

Prior yearly returns:
2008: -8%
2007: 175%
2006: 60%
2005: 805%

Initial trading stake: $2,000.00

UK Department Store to Sell Gold Bars "Over the Counter" - Oh My

This gold bull market is starting to get a little overheated...

The Telegraph reports that famed UK luxury department store Harrods, starting today, will be able to purchase the "ultimate luxury accessory" - gold bars.

Chris Hall, head of Harrods Gold Bullion, said: "The financial environment has kindled a new demand for physical gold among private investors in Britain. For many people this is a new and unfamiliar asset class that demands absolute trust. Until now London has had no well-recognised name serving this market."

So they've actually appointed a head of gold bullion? What's next - gold ATM machines?

Hat tip to our friend and frequent guest author David Galland for posting this link in his excellent daily Casey Research newsletter.

Related reading: Using the Wall Street Journal to Gauge Investor Sentiment

How to Buy Physical Gold

How can you buy physical gold?  It's a question that's coming up more and more these days...as demand for gold bullion is going through the roof.

Jeff Clark points out a few resources that you should take a look at, if you're looking to purchase some physical gold.  And it's probably a great time to buy it - it's anyone's guess how much longer we'll see gold under $1,000.

***

Where to Find the Best Deals in Physical Gold
By Jeff Clark, Editor for Casey Research

When gold breached the $1,000/oz mark this February, the mass media were full of reports of unprecedented coin demand and long wait times for bullion buyers. You couldn't open the paper without seeing a piece about the gold rush.

Although the press has now set gold aside for hotter stories, I can tell you demand for gold coins continues at unprecedented levels worldwide, and production is still struggling to keep up. Take a look at these recent reports:

***Sales of the Austrian Philharmonic gold coin soared 544% in the first two months of 2009 (vs. the same period the year before), with production at the country’s mint running quadruple its usual volume.

***The demand for Krugerrands is at its highest level since 1986. The South African refinery recently doubled production of blank gold coins to 20,000 ounces per week.

***China, now the fastest-growing market for gold, saw 2008 sales (measured in dollars) rise by 50% over the year before – and total sales in January 2009 were one billion yuan (US$146 million), 30% more than all of last year.

***The U.S. Mint sold 193,500 one-ounce gold Eagles in the first seven weeks of 2009 – equaling the number shipped in all of 2007 and about matching the first half of 2008.

***Russia's Sberbank says it has “never seen such strong demand for investment coins.”
With this incredible interest in gold, it's worth going over where to go for the best deals in bullion… and what the stated wait times and premiums are. Here are the dealers that have consistently treated their clients (and our readership) well over the years:

Kitco (Kitco.com; 1-877-775-4826). All bullion products are available at Kitco and can be shipped within 24-48 hours of a paid order. Premiums are slightly higher than our other dealers recommended below, but what's particularly attractive at Kitco is that you can get silver for less than 1% over spot... Its pool account is currently charging only 14 cents over spot (premium fluctuates daily), which is a great way to build your silver holdings while waiting for physical premiums to come down.

The Coin Agent (thecoinagent.com; 1-888-494-8889, or email thecoinagent@gmail.com). Wayne Lemonier currently offers immediate delivery on paid orders for all gold coins except the Eagle, which takes two weeks.

Premiums for gold coins are 6% over spot for Maple Leafs, 6.5% for Philharmonics and Krugerrands, and 7% for Eagles (one of the lowest in the industry).

Silver bars are at the lowest premium we know of: A 10-ounce silver bar costs $1.75 per ounce over spot, and 100-ounce bars are only $1.50 per ounce over spot. American silver Eagles are spot + $4.50, and silver Canadian Maples are spot + $4. Shipping and handling for silver is $20 per 100 ounces.

Border Gold (bordergold.com; 888-312-2288, ext. 7). Both gold and silver Maple Leafs are readily available and can ship the day an order is paid. Border told us premiums are slightly higher this year than last because the Royal Canadian Mint raised its prices.

Premiums on gold Maple Leafs are only 5.5%, one of the lowest in the industry. Shipping and insurance is $25 for one or two coins. A one-ounce gold bar is spot + $25; 5-ounce and 10-ounce bars are available in limited quantities at spot + $22 per ounce.

The one-ounce silver Maple Leaf is $4 over spot for up to 99 coins and then $3.25 per coin. Both 10- and 100-ounce silver bars cost $2.50 above spot, with the 100-ounce silver taking a week to deliver.

ASI (assetstrategies.com; 1-800-831-0007). Gold Maple Leafs, Philharmonics, and Krugerrands can be shipped immediately upon a paid order, with American Eagles currently taking about three weeks.

One-ounce gold coins are 7.5% to 8% over spot; Eagles are 8.5% to 9%. One- and 10-ounce gold bars can be had at 6%. One-ounce silver Eagles are $4.30 over spot. A 100-ounce silver bar is $2.20 per ounce, and a one-ounce bar is spot + $2.50. Costs for junk silver vary but average about $2.20 per ounce over spot.

Some of our readers ask… why don't we recommend any of the larger dealers?

Availability and premium are the primary considerations in selecting a bullion dealer. Some of the larger houses may match the prices of our recommended dealers; however, there’s an intangible issue: the hard sell.

Many of the big dealers push high-margin numismatic coins. So while you may get good prices and delivery on your bullion coin, beware the salesman who begins talking up rare coins. You won’t experience this with our smaller dealers, and it’s this no-hassle service that gets our business. If you start to hear, “Hey, my friend, I have a great deal right now on a rare Swiss coin...,” you might want to reconsider where you shop.

Gold is the safe-haven investment in times of crisis, and more and more investors worldwide realize this. But even though gold has risen more than 140% in the last five years, there is something that can give you even higher returns: we call it Toronto’s Secret Gold Investment.

Gold Dispensing ATM's: Coming Soon (Seriously)

From Reuters:

A German asset management company plans to set up 500 "Gold-to-Go" ATMs in Germany, Switzerland and Austria this year. A gold-dispensing automatic teller machine (ATM) was on display at Frankfurt's main railway station for a one-day marketing test yesterday. A one-gram piece of gold, the size of a child's little fingernail and about as thin, cost US$42.25--a 30% premium to the spot market price.

Hey - on our way out to the bar...I'm tapped, need to make a quick stop at the old A-T-M...

China Admits It's Been Secretly Stockpiling Gold

On Friday, China admitted to something it's long been suspected of - secretly stockpiling gold. 

Of the countries that disclose their gold holdings, China is now ranked fifth in the world, ahead of the Swiss, the former beacon of a solid currency.

Since 2003, China has increased it's gold holdings by 75%.  Over the same time period, the Chinese have been gradually moving their foreign reserves out of US assets.

I can't think of any reason why these trends would reverse themselves anytime soon.  And apparently, neither can traders, as they bid gold back up above $900 on the news.

There's probably a decent chance any gold the IMF sells will never hit the market, as the Chinese may be waiting to gobble it up.

How to Detect Counterfeit Gold Coins

The race is on to acquire gold bullion while the governments of the world unite to print money as fast as they can.  But unfortunately all bullion is not created equal.  You need to take the necessary steps to protect yourself from being duped with counterfeit gold - so please check out this informative piece, courtesy of Casey Research's Doug Hornig, on how you can take the necessary precautions to assure your gold is indeed real.

All That Glitters is NOT Gold – the truth about counterfeit gold

By Doug Hornig, Editor, BIG GOLD

The Chinese Fake It

You probably remember movies about the Old West, wherein a shady-looking character would offer to exchange a gold coin for a horse, and the seller would bite down on the coin to verify its authenticity. That was about all you could do if you lacked proper assaying equipment and had to make a snap judgment: depend on your teeth to tell you whether the metal in your hand was sufficiently soft to be genuine gold.

The bite test is actually a pretty good one since gold, despite being among the heaviest metals, is also very soft. If you chomp down and shatter a tooth, it ain’t gold. But before you go munching on your coin collection, you might want to ask yourself, why bother?

Well, because of the Internet. While the Net has become an indispensable resource and we’d never want to return to the days when basic research meant a long day in the library, it also has the ability to stir up a hornet’s nest of concern at the drop of a stick.

One such hornet release followed the recent publication of a three-part series by Coin World, dealing with the subject of coin counterfeiting in China, where it’s quasi-legal. Instantly, the Web was buzzing with the worries of bloggers and eBay shoppers, and the pontifications of pundits about this dire threat.

Before we got too worked up about it, first thing we did was carefully read the source material. Yes, the Coin World articles raise the issue, and they feature an in-depth interview with one Chinese counterfeiter, although that’s not what he calls himself. He’s a proud artisan who produces replicas.

Of what? As it turns out, it’s primarily copies of ancient Chinese coins, which are sold to tourists. A few fake U.S. silver dollars are put up each week on eBay, but they are required to carry a Replica stamp.

Do all Chinese counterfeiters abide by this regulation? Perhaps not. But eBay has always been a place where caveat emptor rules, so the best policy would probably be simply to avoid coin purchases from China.

Problem Areas

Next, we consulted with our favorite dealer, asking if they come across many fake bullion coins, such as Eagles or Maple Leafs. The answer was no. They’ve only seen a handful during their thirty years in business.

Not that it’s hard to do. With modern 3-D laser imaging, a die can be created that mimics the real thing in perfect detail. The good news is that it’s impractical. The difficulty is that any counterfeit bullion coin would likely have to be gold in order to pass. If it were pure, then the profit margin would be too small to make the deal worthwhile. And if the counterfeiter skimped on the gold content, the coin’s weight would be a dead giveaway.

The only alternative would be to gold-plate a coin made out of some other metal. But again, getting the weight right while preserving the correct size would be a challenge.

Which brings us to the areas where counterfeiting can be a real problem. The most significant is rare coins. These can be made with the proper gold (or silver) content, then artificially aged so that only an experienced numismatist could pick them out. Because of the premium they command, rare coins made with real gold would be highly profitable where a bullion coin would not.

This is one of the reasons (disinterested grading is the other) why many collectors will only trade coins graded and slabbed by third-party specialists like Professional Coin Grading Service (PCGS) or Numismatic Guaranty Corp. (NGC).

Ominously, though, some counterfeit coins are turning up inside phony slabs. If you collect rare coins and have any reason to suspect them, it’s pretty easy to sort the real slabs from the fakes. Coin World provides illustrations on just how to do that here. (http://www.coinworldonline.com/articles/ChineseCounterfeit/Diags.aspx)

Gold bars are a different matter. Fakes do show up in the market from time to time, and they’re hard to identify. Generally speaking, counterfeiters don’t bother with the smaller ones, which are stamped, numbered, and sealed. They concentrate, our dealers tell us, on 1-kilogram or larger sizes. These are poured, rather than stamped, and can be easily adulterated or even hollowed out and filled with lead or some other metal. Compounding the problem is a lack of standard weights, even among good delivery gold bars. The “400-ounce” bar, for example, can vary anywhere from 390 ounces to 420.

How to Protect Yourself

As noted, we don’t believe that there is a serious issue with counterfeit bullion coins at the moment. But that doesn’t mean that they don’t exist, nor does it mean that evolving technology might not make them more profitable in the future than they are now.

The best precaution is the simplest: deal with someone you trust. Establish a relationship with a coin dealer who has built a strong reputation, preferably over a matter of decades, such as the dealers we recommend in BIG GOLD. Buy from them, even if you stumble across some mail order supplier who is charging less of a premium.

For small bars, purchase only those that carry the stamp of one of the known, trustworthy refiners, such as PAMP, Credit Suisse, or Johnson Matthey. For bigger orders, ask your dealer if they do assays. Reputable outfits generally assay bars that are a kilogram or larger. If you want a 100-ounce bar, consider buying direct from the Comex, which will also vault it for you. That removes the assay requirement when you buy, but remember that if you take physical delivery of a large bar, you’ll need an assay when you sell. Do not, under any circumstances, buy a larger gold bar on the Internet or from a private seller you don’t personally know.

If you’re still worried about a coin, there are tests you can perform to check it out.

• For gold, you can bite it, although you may not want to mar the surface of the real thing. Silver coins you can drop on the floor and they will ring; alloys won’t. The ring test is less useful with gold, since 24-karat gold doesn’t ring; less than 22 karats does, but so does brass.

• Size and weight are good measures. Make a list of the diameters of genuine coins for comparison purposes. Get a scale calibrated to hundredths of a gram. If a bullion coin weighs light (or, possibly, heavy), it’s bogus. Here’s a handy list of gold coins with all weights, diameters and thicknesses: http://www.onlygold.com/TutorialPages/Coin_specsFulScreenVersion.htm. 

• A good counterfeiter may be able to get all other aspects of an adulterated coin right, but he won’t be able to fake density. Gold has a higher specific gravity than other metals, and you can test for that. Many Internet reference sites will tell you how.

• You could buy a commercial counterfeit detector. They aren’t cheap, but will quickly and easily test for weight, thickness, and diameter.
  

• If you happen to have some nitric acid and are a very careful person, you can drop your coin into a beakerful. Base metals will react, gold won’t.

• Rare coins are more of a challenge. If that’s where your interest lies, look for specimens that have been graded and slabbed. Otherwise, there’s no substitute for experience. Examine coins with a magnifying glass, heft them in your hand. Get to know what the real deal looks and feels like. Read up on the kinds of imperfections that characterize the phonies. Become your own expert.
  

Precious metals are going to be attractive to con artists, just like anything else of real value. But there are some decent safeguards already built into the system. Supplement them with your own knowledge and common sense, and it shouldn’t be difficult to avoid becoming a victim.

Good thing you don’t really have to worry about purchasing fake bullion coins… because it’s the best time to buy gold, and maybe one of the last chances you get to buy at $800+ levels. Read our report on why ultra-low interest rates could make gold rise to $1,500 (and higher) in the near future – and how you can profit: Click here to learn more.

More articles from Doug Hornig:

• Gold Buyers Smash Records
• Goldfinger Brown Rides Again
• Uncharted Waters in Government Bailouts