Jeff Clark (Casey Research):

In the short term, a catastrophic deflation is quite possible. But in the long term, extremely high levels of inflation are now inevitable. The situation is very serious. Gold is the best hedge against both of these things. The better part of your financial assets should be in gold, augmented by well-thought-out speculations. Doug Casey, November, 2009.

Doug Casey and the editors at Casey Research are very skeptical that we are experiencing any sort of economic recovery. In our opinion, too many economic indicators are based on faulty data and optimistic assumptions. Our research suggests that a recovery isn’t sustainable yet. And with that, we lack the foundation needed to support the rapidly rising stock markets.

Among the many reasons for our doubt is this standout:

Over the next two years, the so-called Alt-A and Option ARM loans face massive resets. Even with today’s low mortgage interest rates, most of these home loans, currently enjoying ultra-low teaser rates or pick-your-own-monthly-payment schemes, will see their monthly payments adjust higher – far higher. The result: loan losses and write-downs will balloon for banks, and mortgage holders will get hit with another wave of homeowner defaults. We just don’t see any way for the economy and markets to escape the fallout.

Even the Fed’s perpetual public smiley face can’t hide what’s happening. In their own statement last month, they said, “Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.” A clear and present danger remains in the system.

What does this mean for our favorite sector? Following the market lows in March, gold and gold stocks have, with some exceptions, mirrored the market’s moves both up and down. If the markets correct again, whether mild or severe, gold and gold stocks could get taken down as well.

There will come a point when gold stocks separate from the movements of the general markets, and we look forward to that day. But for now they’re still holding hands.

In the meantime, our view of the big-picture outlook hasn’t changed. Rising inflation and a falling dollar are baked in the cake. Price inflation follows monetary inflation, and governments around the globe have pursued an unprecedented and unsustainable policy of inflating the money supply. Monetary inflation + time = price inflation. It’ll come, and when it does, it will wipe out those who are unprepared.

But in the near term, current economic uncertainties mean heightened risk and call for caution. In other words, this isn’t the time to be aggressive with stock purchases.

So, how does one invest in this kind of environment? Is there a way to hedge your exposure against price fluctuations?

Yes! The secret lies in asset allocation.

Achieving good portfolio performance is possible without overexposing yourself to stocks. The strategy involves playing defense as well as offense.

The following tables compare the returns an investor could expect using different asset allocation models under three hypothetical market scenarios, and assumes a starting portfolio of $10,000.

      *All returns exclude commissions and taxes 

      *Cash return for 1 year of 1.55% based on use of money market account; higher rate possible with a CD, but access to your cash is restricted, and it involves fees and penalties for early withdrawal.

You can see that you’re giving up only 6.6% in gains in Scenario #1 by apportioning your portfolio in equal thirds vs. being overweight stocks. But if stocks decline while you’re overweight that category, as shown in Scenario #2, you stand to lose 16.8%.

If you don’t elect a defensively positioned portfolio at this point, and gold stocks indeed get sucked into the vortex of a general market sell-off, you’ll wish you had that extra $2,300 in cash – which buys well over 100 shares of Kinross at today’s price. And when KGC likely doubles in a couple years, as we expect, remorse may be knocking on your door.

By allocating your investments in a more defensive mode, you’re making a small sacrifice for possible profits over the next six months without sacrificing long-term returns.

You can continue to follow the thinking of the editors at Casey Research — and get specific recommendations for solid, secure gold investments — with an inexpensive subscription to Casey’s Gold and Resource Report. It comes with a free report called The Three Best Ways to Invest in Gold, and until December 18, you’ll get a free subscription to Casey’s Energy Opportunities — all for only $39. Click here to find out more.

This from Taipan Daily:

“Widespread property foreclosures have led to bank failures, and further to much unemployment and a disastrous decline in manufacturing and agricultural production.” Sound a tad familiar?

No, it is not another of my dreary “ripped from today’s headlines” quotes. Rather, it is a contemporaneous description of the chain of events that lead to, and resulted from, the Panic of 1819.

And while the storyline may be some 189 years old, the circumstances are eerily familiar. Washington (the place, not the man – our first president had passed away 20 years earlier) had borrowed heavily to finance the War of 1812, severely depleting bank reserves.

Free Money and Real Estate Bubbles, 19th Century Style

To cope, Washington and Wall Street did what they have done so many times since: they simply changed the rules. This time around they suspended specie payments – a complete violation of depositors’ contractual rights.

With the onerous restriction of actually repaying debt with real coin lifted, most every ambitious soul with a pen and a checkbook rushed into the banking business. The sudden increase in the “money” supply encouraged the most insane sort of speculations (real estate being a particular favorite).

Soon, the whole deal was snowballing out of control. When the Second Bank of the United States finally tried to take away the punchbowl, this hollow economy collapsed in on itself… leading to the aforementioned 1819 crash.

A Haunting Refrain

As you can see, today’s dire warnings of market collapse and recession are not quite as unique as we might hope. Rather, they are simply the latest refrain in a long, long (long) ballad.

Cold comfort, perhaps, to know that our forefathers were just as inclined as we toward such feats of over-stimulation, overextension, and excess speculation. Still, there is some comfort to be found reading through our long tale of financial foolishness.

Over the past 210 years or so, we have “enjoyed” 17 recessions, lasting anywhere from a few months to more than two decades. While the worst, the “Long Depression” of 1873-1896, lasted some 23 years, the average duration has been a mere four and a half years.

Damned Modernism

Now don’t go reaching for the bourbon just yet. We’ve put all sorts of systems in place since those bad old days. Many of you like to curse the day in 1913 that saw the birth of the US Federal Reserve, and are wont to describe Fractional Reserve Banking as “the tool of the Devil” (or at least Joe Stalin).

Damned or not, these institutions do exist. One could even argue their arrival on the scene marks the beginning of our “Modern Economy.” If we were to restrict our list of recessions to said “modern” period only, the average breakdown is reduced to just under three years.

Now dial the clock forward again. If one were to begin counting with the day in 1971 that Richard Nixon finished off the remaining tatters of the gold standard, the average duration of recessions is reduced to a year and three quarters.

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Rounding Second and Halfway Home

The history may be a tad twisted, but my point here is straightforward enough. While there is certainly no guarantee that we could not invent a way to extend our little debacle another year or six, the odds are that we are already a third – if not halfway – through “the crisis of 2007-2009.”

Which brings us to what I like to call the “Window of Serenity.” Near-term, things do still look quite dreadful. And long-term, I have no doubt that we are embarked on the path of monetary ruin described so exquisitely by the Austrians.

But if you look in the middle, beginning some 18 months out, one can see where the ramp-up to the next major bubble ought to be taking place. The question is: how do you navigate the choppy waters between here and there?

How to Stay In the Game

Once again, I have to tell you that mere “trading stops” won’t work. If that’s the limit to your methodology, then perhaps you really ought to just sit things out until the next cycle is obviously underway.

But what if you are intrigued by the values that are out there (and I will grant that the survivors of this current trough are apt to double many times over come said ramp-up – especially in its earliest days)?

If that’s the case, then there is only one tactic I know of that will allow the safe accumulation of shares in current circumstances. And that is the careful matching of put option contracts on weak players to share purchases of strong players.

Buying Survivors

For example: Let’s say you wish to invest in a venerable old retailer like Macy’s (NYSE:M), currently trading under $10 for the first time since 1995.

Heck, they’ve been around in one form or another since 1924, and have weathered seven of the recessions on my list. That fact alone reassures you that they ought to still be here in another 18 months.

Now, I’m not saying you’re right or wrong with this trading theorem. But I can tell you how to survive Macy’s going to $5 while you find out.

A Cure For the Pain

Simply buy some put options on a real deadbeat low class player like, say, Kohls (NYSE:KSS). While Macy’s shares were getting cut in half over the past few weeks, select Kohl’s puts gained as much as 200%.

Your gains on Kohls’ pain become your safety line against losses on Macy’s shares. Heck, you could even use your profits to buy more shares.

These are admittedly hard times, friends. Fortunes are being lost daily. But situations like these, when everyone else has their head buried in the sand, are possibly the most potentially lucrative trading set ups you will ever see.

Source: How to Make 200% a Month Handicapping Recessions