Just Remember This, A Hiss Is But A Hiss
(You Played It For Her, You Can Play It For Me - Play It Again, Sam.)

William R. Hecht
January 4, 2006

The case for inflation and gold is very strong and is made repeatedly on this site and others. And while I have tremendous respect for the facts and the economics behind this prediction, I think the gold ship will ride on unpredictable crosscurrents as we enter a deflationary recession/depression environment, with rising t-bond prices, falling equities and a falling dollar. With so many variables and so many of them relatively new in significance, the first order of business for me is to simplify the equation by reducing or eliminating variables to find a ruling theme or reason for my forecast.

I did a local radio show for several months last year and in the course of my tenure as host, I interviewed Jim Rogers, Richard Russell, Bob Prechter, Joe Granville, Arch Crawford, Bill Fleckenstein, Mark Leibovit, and others. They almost universally noted the liquidity and credit bubbles. They are all great students of markets and history. On my end, I have listened and watched and wondered and scratched my head at conundrums and housing prices and complacency. Like the rest of us, I have seen the terrific expansion in M3, witnessed the debt issuance and the triple deficits: Federal spending, US Trade, and Savings. I have seen the global bubbles in assets of all kinds and the expansion of credit and derivative markets, and the boom in gold and commodities. I have not felt comfortable articulate a stance on the environment to come. Nothing made sense other than that a reckoning of sorts was overdue. For whatever reason, though, I know what I want to do now for those of my clients who need something simple yet not too drastic. Some elements of my conclusion may be controversial, but here it is.

We have had a global asset bubble in real estate, stocks and some commodities. That bubble will have begun to pop in earnest by the end of '06 and will engender global economic contraction and overcapacity resulting in falling wages and prices, falling interest rates, falling stock prices, and quite probably a falling dollar. There is no reason to believe that the global asset bubble collapse will bring anything different to most world markets than past bubbles brought to other markets in other times and places.

Though I agree that the tremendous liquidity infusion should be inflationary, the Japanese were unable to re-flate their economy for years with super-cheap money. Also, though M3 continues to expand, the efficiency of the monetary system has managed to create more new debt than growth. With an economic contraction and the ensuing credit contraction, the money supply should contract with similar efficiency. In other words, much of what we call "money supply" is merely "debt supply": like any virtuous cycle gone bad, the action/reaction principle implies that much of this debt will disappear at least as quickly as it arrived. Efforts to re-flate the bubble should fail, though efforts to provide liquidity could weaken major world currencies against gold and commodities. This might result in continued strength in metals and commodities, but the crosscurrent of hard-asset sales to repay debt and the reduced economic activity have to exert some downward pressure on these markets as well.

Equity prices would naturally fall, though the impact on various markets can only be gauged in the context of their relative valuation, savings, and debt levels. Still, the increased synchronization of world markets should make all boats fall with the outgoing tide in the beginning. The US market has underperformed and should take the vanguard in a global equity selloff as US markets face the realities of decreasing stimuli, increasing debt burdens, an exhausted consumer, and diminishing standards of living for most Americans. Exporters of natural resources and raw materials should fare least badly.

Treasury prices will rise as interest rates fall. Credit spreads should widen, however.

With this scenario in mind, a very flexible managed global bond fund that maintains high credit quality could provide dollar-based investors with the trifecta: yield, currency gains, and capital gains. You might have to pay for the right manager, though. I know of one that I like.

We will know if I am right "As Time Goes By." It was a somber film and it depicted a tough time But even if history doesn't repeat itself, it can still make a rerun. I want to see Bogart warning them to get on the plane - to get into quality bonds. Warning them that if they don't they'll regret it. . . .

"Maybe not today. Maybe not tomorrow, but soon and for the rest of your life."

William R. Hecht
email: w.hecht@cox.net

321gold Inc