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What do I fear more than a recession?

Posted by admin on January 21, 2008 in Investment Strategy

Inflation- basically, the trend for a dollar to buy you less and less over time. On Friday, I put an order to withdraw some cash from my money market accounts in my RSP in order to be in a position to start buying the Gold ETF (TSX: XGD). This is not a buy and hold strategy but rather, to use Jim Cramer’s phrase, a capital preservation move. Let me explain.

Inflation is caused by many different factors but one of the easiest ways to create inflation is to print more money. The more money you print, the greater the money supply. The greater the money supply, the less our money is worth (it is basic supply and demand). Let me explain it another way. Imagine you bought an art print from a famous artist who promised she would only sell 1,000 copies of the print. This would make the print pretty valuable and, if you sold it, you could buy a lot with the money you received from the sale. However, over time, the artist sells another 1,000 copies then another 1,000 and so on and so forth. After a while, your print isn’t worth as much and selling it won’t give you the same amount of money in your pocket. It is not a perfect analogy but I hope I convey how inflation works if you substituted art prints for money (for those who collected baseball cards in the heyday of the 1990′s, you know what I mean).

What do we read in the news? The central banks injecting money into the banking system. Proposed bailouts in the U.S. in the hundreds of billions. The feds under pressure to lower interest rates. All of these moves or proposed moves require the printing of more money which pushes inflation up.

If you, like me, have a lot of the portfolio in cash what this means is that the value of cash held is being eroded and the erosion of that dollar is speeding up assuming the government starts a massive bailout in an election year (it is estimated the value of money is halved every 30 years).  Since there is nothing really good to buy now (despite how the markets are doing in 2008 the price to earnings ratios still indicate stocks are too expensive), I am trying to protect the value of my money.

Why gold? The price of gold has a very close correlation to the inflation rate. It is seen as a hedge against inflation and the falling U.S. dollar. There are other inflation protection instruments you can buy- mainly real estate and commodities- but I still think the other shoe has yet to drop on real estate and commodity prices are more closely linked to how the economy is doing than inflation. I am also holding gold for a very short period of time (12-18 months) to preserve capital and nothing else.

I do have a high interest bank account but the issue with putting money in there is that, in a falling interest rate environment, I am not sure whether the bank can continue to pay me 4% interest; real inflation, depending on what you read, is between 2-4% which also does not give a lot of breathing room if inflation rises about 4%.

This strategy is particular to my own personal situation. Thus, as usual, do your own due diligence before you decide to buy or sell gold or any other security.

What is everyone doing to protect themselves in this market?