Good investments for deflation are based solely on safety. Remember, during deflation, the goal is to preserve one's capital for the bottom: the ultimate buying opportunity. Good investments for deflation will not be focused on return on capital but rather return of capital – there's a big difference.
The conventional analysts' battle cry is "diversification." They recommend having your assets spread across different stocks, stock funds and/or foreign stock markets. Advocates of junk bonds likewise counsel investors that having lots of different debt instruments will reduce risk.
This strategy is bogus. Owning an array of investments is financial suicide during deflation. Stocks, bonds and commodities are not good investments for deflation. They all go down, and the logistics of getting out of them can be a nightmare. There can be weird exceptions to this rule, but all assets usually go down in price during deflation except one: cash.
Good investments for deflation: Cash?
Cash is the only asset that assuredly is a good investment for deflation. One safe "parking place" for capital during a deflationary crash is cash notes — for example, $100 bills, £50 notes or the equivalent in your home currency — in a safe depository that you can always access. That way, you will have money if the bank fails, you will have money if credit collapses, and you will have money if the government defaults on its debt.
Good investments for deflation: Gold and Silver?
As discussed in the section about the deflation gold relationship, gold cannot be considered a sure-fire safe haven during deflation; in fact, the reality is quite the opposite.
However, many people are surprised to find that Robert Prechter advocates buying gold and silver during a deflation anyway. Prechter says:
First, it could be different this time, for some reason I cannot foresee. In a world of fiat currencies, prudence demands hedging against a rush to tangible money.
Second, these metals should perform well on a relative basis compared to most other investments. Unlike so many commodities, they will not fall 90 percent from today's prices, much less to zero, like so many stocks and bonds. These metals are downright inexpensive compared to their top values in 1980. Even if the precious metals continue to decline, they will fall much less in percentage terms than most other assets because they have already fallen so far.
Third, the question of whether there will be further bear market in the metals is important primarily to speculators and quibblers. Gold and silver have declined in dollar value for over two decades, which is between 90 percent and 100 percent of the total time I had expected them to fall. It may not be prudent to try to finesse the final months.
Fourth, the metals should soar once the period of deflation is over. Silver rebounded ferociously after it bottomed in 1932, tripling in just two years, rewarding those who continued to hold it. If deflation again keeps precious metals prices down, the rebound after the bottom should be no less robust. Given the likely political inflationary forces, it could well be much stronger. So by all means, you want to own precious metals prior to the onset of the post-depression recovery.
Fifth and foremost, if you buy gold and silver now, you'll have it. If investors worldwide begin to panic into hard assets, locking up supplies, if governments ban gold sales, if gold and silver prices go through the roof, you won't be stuck entirely in paper currency. You will already own something that everyone else wants.
Disclosure: Author short S&P 500 65%, 35% cash
