Inflation or Deflation?

10/13/2008 12:30 pm EST

Focus: COMMODITIES

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Aden, editors of The Aden Forecast, say that there are both inflationary and deflationary forces at work, and investors need to be prepared for either.

The stock market took a dramatic turn for the worse this month. It's extremely bearish, and the same is true of all the world stock markets. The Dow Jones Industrial Average is (well) below 10,725, indicating it could eventually decline to as low as the 7,286 level. For now, however, the Dow is very oversold and a near-term rebound rise is likely.

The Federal Reserve is spending money at an astronomical rate. It's creating this money out of thin air by monetizing bad debts and whatever else it has to. Remember, this is on top of all the other ongoing government expenses, and it's extremely inflationary.

If the banks start to lend again, the economy will be on the road to recovery and inflation. But banks are scared and they're being extremely cautious, for good reason. So, if the banks decide not to lend and instead just sit on their cash, then the inflation process will freeze. In other words, the risk of deflation has greatly increased.

At this point, it's best to be prepared for either outcome. That means gold for inflation and cash for deflation, at least until we see how things unfold. The best investments right now are gold, the US dollar, and bonds, which reflect this economic see-saw.

Gold began to rise as a safe haven during the unprecedented financial meltdown. Platinum, palladium, gold shares, oil, copper, resources, and the base metals all fell to new lows while gold climbed as the ultimate store of value.

Silver and gold shares are poised to catch up with gold. And with silver and gold shares so extremely oversold, we could now be seeing a bottom in the making.

The credit crisis had a huge effect on interest rates. Some of the moves were the wildest in years as worried investors fled to the safety of treasury bills and government bonds, driving these rates down sharply. Bonds are looking good. If you have long-term government bonds, keep them. If bonds break clearly above the 2003 high, they'll do very well.

The US dollar is very strong, and (other) currencies are bearish, but that's unlikely to last long. The fundamental factors that drove the dollar down for years are now worse than ever. We're currently holding a large cash position with a bigger portion in US dollars. Once the dollar turns down, we'll sell. The currencies are extremely oversold and due to rise.

Currently, we have 35% of our total recommended portfolio in US dollars and 30% in metals, which we advised raising to buy more gold. That gives us a 65% position in these markets. Unfortunately, we still have 15% in energy and resource stocks, which we're keeping for the time being since they're so extremely oversold. The same is true of our 20% position (in other currencies).

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