Crisis Reaction

Alf Field
25 Feb, 2008

My article entitled "Into The Abyss" (published 5 January 2008) described the crisis in the financial markets as "The Mother of All Crises" or "A Perfect Storm" crisis. Subsequent events have closely followed the forecast in that article.

The Investment Strategy section in "Into The Abyss" included the following quote:

"The odds strongly suggest that the world is facing the largest ever transfer of wealth from financial (paper) assets to tangible assets, otherwise known as "store of value" assets. This is the most likely strategy that investors will adopt to cushion themselves in the attempt to survive the disaster that seems certain to lie dead ahead."

The article went on to describe the Inverted Asset Pyramid in the following terms:

"Imagine an inverted pyramid consisting of layers of various investment asset classes where the least secure (and most prolific assets) are in the very wide top layers. The inverted pyramid then narrows down through layers of increasingly more secure assets to the small point at the base which consists of the most secure (and least prolific) assets. The theory is that in times of financial crisis investors will cause their investments to devolve downwards through the different asset layers in the inverted pyramid as they search for greater security. This move to assets representing greater security is already happening in the current crisis.

"The asset in the most secure category at the tip of the inverted pyramid is gold. Platinum and silver bullion lie directly above gold. Precious metals have performed the function of protecting wealth throughout the ages. In the layer above the precious metals are base metals, uranium and the minor metals. Above them are the companies that mine and hold large deposits of metals. The least secure assets in the envisioned environment, which form the broad layers at the top of the inverted investment pyramid, will be financial and paper money assets."

The crisis is now several months old and it is appropriate to examine how different asset classes have performed in this environment.

It was late in 2008 that investors began to take the crisis seriously. Prior to that point it was felt that the crisis was localised and containable within the US residential real estate market. By late December there was a broad understanding that the crisis was much bigger in scope and that it extended well beyond the borders of the USA. There was also a growing realisation that the crisis would not be brief and could extend for some years with unknown and unknowable consequences.

Thus the last two months represent the first period during which investors have been able to react with greater knowledge to the current predicament facing financial markets. The following table sets out the performance of a number of different assets during this two month period.

Performance of different assets over the past 2 Months:

One swallow does not make a summer. Nor does two months worth of price data make a trend change.

Nevertheless, the strong price gains in precious metals, base metals and in agricultural commodities at a time when financial assets have been producing large losses strongly suggests that the Inverted Pyramid concept is performing rather well.

The spectacular gains in palladium and platinum need to be discounted for the fact that 70% of the world's production of these metals comes from South Africa where local problems with a shortage of electricity supply has caused some of the major mines to halt or seriously reduce production.

As awareness of the problems outlined in "Into The Abyss" gathers momentum, so the move into increasingly secure assets will continue. This means that the trend in prices reflected in the above table will not only continue but will probably accelerate.

It should be stressed that the gains reflected in metals and agricultural commodities have occurred in just two months.

Toss a 65% plus increase in the contract iron ore prices and an expectation of even higher oil prices into the equation and the result must be grave concern about future inflation.

25 Feb, 2008
Alf Field

321gold Ltd