This from Sovereign Society:

The time to start building fresh positions in oil, gold, silver and TIPs has arrived. Even distressed real estate should be accumulated if credit can be secured.

Over the next 6-12 months the United States, Europeans, Japanese and Chinese will eventually arrest deflation. And long before that materializes, hard assets will begin a major reversal following months of crippling losses.

Since peaking in July, the entire gamut of inflation assets has collapsed amid a growing threat of deflation or an environment of accelerated price declines. The last deflation in the United States occurred in the 1930s, purging household balance sheets, corporations, states, municipalities and even the government following two New Deals.

Thus far, U.S. CPI or the consumer price index has not turned negative year-over-year. Yet as oil prices continue to lose altitude and other commodities have been crushed, input costs and price pressures continue to decline dramatically since October. The only major component of CPI that continues to post modest year-over-year gains is wages. And with unemployment now rising aggressively this quarter it’s highly likely wage demands will also come to a screeching halt.

Plunging Bond Yields Discount Danger

In the span of just six months, foreign currencies (except the yen), commodities, stocks, non-Treasury debt, real estate and art have all declined sharply in value in the worst panic-related sell-off in decades. More than $10 trillion dollars’ worth of asset value has been lost worldwide in 2008.

What’s working since July? U.S. Treasury bonds and the U.S. dollar as investors scramble for safety and liquidity.

On December 5, 30-day and 60-day T-bills yielded just 0.01% – the lowest since the 1930s while the benchmark 10-year T-bond traded below 2.55% – its lowest yield since Eisenhower was president in 1955. Even 30-year bonds have surged as the yield recently dropped below 3% for the first time in more than four decades.

The market is now pricing a severe recession and – possibly – another Great Depression. Despite a series of formidable regular market interventions by central banks since August 2007, the credit crisis is still alive and kicking. The authorities have not won the battle …at least not yet.

Heightened inter-bank lending rates, soaring credit default swaps for sovereign government debt and plunging Treasury yields all confirm that the primary trend is still deflation.

To be sure, credit markets worldwide have improved markedly since the dark days of early October. Investment-grade corporate debt is rallying, commercial-paper is flowing again and companies are starting to issue debt once more – but only the highest and most liquid of companies. For the most part, banks are still hoarding cash and borrowers can’t obtain credit.

The real economy is now feeling the bite as consumption falls off a cliff, foreclosures soar and the unemployment rate surges higher. These primary trends are deflationary as broad consumption is severely curtailed, with consumers preparing for the worst economy since 1981 and rebuilding devastated household balance sheets.

But at some point over the next 12 months, the market might transition from outright deflation or negative consumer prices to some sort of disinflation or at least an environment of stable prices. That’s when inflation assets should start rallying again.

Inflate or Die: The Name of the Game in 2009

The battle now being waged by global central banks, including the Federal Reserve is an outright attack on deflation. Through the massive expansion of credit, the Fed and her overseas colleagues are on course to print money like there’s no tomorrow to finance bulging fiscal spending plans, bailouts, tax cuts and anything else that helps to alleviate economic stress.

Earlier in November, the Fed announced it would target “quantitative easing” and “monetization,” unorthodox monetary policy tools rarely or never used in the post-WW II era.

Without getting too technical, the term “quantitative easing” means the Fed will act as the buyer of last resort to monetize Treasury debt and other government agency paper in an attempt to bring interest rates down. Quantitative easing aims to flood the financial system with liquidity and absorb excess cash through monetization or purchasing of government securities.

Through monetary policy, the Fed controls short-term lending rates but cannot influence long-term rates that are largely set by the markets; the Fed now hopes it can influence long-term rates through quantitative easing. And since its announcement two weeks ago, long-term fixed mortgage rates have declined sharply.

These and other open market operations directed by the Fed and Treasury will eventually arrest the broad-based deflation engulfing asset prices. It will take time. Inflation is the desired goal and is the preferred evil to deflation, a monetary phenomenon that threatens to destroy or seriously compromise the financial system. Policy-makers have studied the Great Depression, including Fed Chairman Bernanke, and the consequences of failed central bank and government intervention in times of severe economic duress are unthinkable.

Ravenous Monetary Expansion

According to Federal Reserve Board data, the Fed is now embarking on a spectacular expansion of credit unseen in the history of modern financial markets.

The total amount of Federal Reserve bank credit has increased from $800 billion dollars to $2.2 trillion dollars (or from 6% to 15% of gross domestic product) as the central bank expands its various liquidity facilities in an attempt to preserve normal functioning of the financial system.

The Fed’s ongoing operations to arrest falling prices are targeted namely at housing – the epicenter of this financial crisis. It is highly unlikely that the United States economy will bottom until housing prices find a floor. Quantitative easing hopes to stabilize this market.

Buy Gold Now

Relative to other assets in 2008, gold prices have declined far less. The ongoing liquidity squeeze has forced investors to dump assets, including gold to raise dollars. I suspect this short-term phenomenon will end in 2009 once the ongoing panic subsides and credit markets become largely functional again.

Gold should be accumulated now ahead of market stabilization. As the financial system gradually comes back to life over the next several months or sooner, the dollar should commence another period of weakness; there will be little incentive to hold dollars with short-term rates at or close to zero percent. The Fed will be in no hurry to raise lending rates.

Still, the Japanese experience in the 1990s warns investors of the travails of long-term deflation.

The Japanese, unlike the United States, only started to seriously attack falling prices in the economy in 1998 through massive fiscal spending. In contrast, the U.S. is already throwing everything at the crisis after just 17 months.

I expect the United States to print its way out of misery and, over time, and conquer deflation. But the cost will be humungous and at the expense of the dollar, U.S. financial hegemony and calls for a new monetary system anchored by gold.

It’s literally “inflate or die” for global central banks. Inflation will win.

Source:  Inflation on “Sale” as Deflation Dominates Global Markets

We’re “officially” in a recession and the panicky markets are bracing for deflation. But what most investors don’t realize is that inflation – not deflation – is the real threat that they face.

For more than a year now, I’ve been telling readers and attendees at financial conferences around the world that the United States has been in a recession since last November.

I was wrong.

But only by a month: According to the National Bureau of Economic Research (NBER) announcement last Monday, we “officially” entered into a recession last December.

Now, I realize that stocks have taken a drubbing in the past few months. And the odds are good that share prices will get beaten down further in the weeks ahead. But that’s actually good news – and for three reasons:

• The NBER, which called the recession — apparently from its suite in the “Better Late Than Never” Department — is not known for being timely. In fact, its timing is so consistently bad that this latest recession pronouncement might actually be viewed as the light near the end of the tunnel. Indeed, of the four recessions since 1980, the NBER announced that we were in a recession in a (somewhat) timely fashion only once. That was in 1981, a full six months after the recession actually started.  But in each of the other three recessions – 1981-1982, 1991 and 2000 – the NBER didn’t officially label the deteriorating economic conditions a “recession” until the downturn was nearly over.

• In three of the past four recessions – 1980, 1991 and 2001 – the Standard & Poor’s 500 Index had already reached its recessionary lows at the time the announcements were made.

• Since 1900, the average length of a U.S. recession is 14.4 months. Assuming that historical relationships hold true, the NBER data, despite the fact that it’s a year late, falls in line with our suggestions of a few weeks ago that a late springtime rally may be in the works.

(Whether we believe that last point is another point entirely for reasons we’ve written extensively about in recent months. So we won’t rehash those today.)

But we will point out something that’s vitally important right now: There has not been a recession in history that wasn’t followed by inflationary pressure. And that, in turn, suggests that investors would be wise to shore up their defenses now while everybody is looking the other way … at deflation.

Why?

The U.S. Federal Reserve is expanding our monetary base by more than $11 billion a day since September to nearly $1.5 trillion, which represents an increase of 79.02% since October 2007.

What they are doing is unprecedented in recorded history.

On an annualized basis, the run rate in just the last few months alone works out to more than 369.92% per year – which means the monetary base is accelerating dramatically (See accompanying chart).

According to the Federal Reserve’s latest H.3 report, dated Nov. 28, bank non-borrowed reserves fell to -$362 billion, more than doubling the -$158 billion reported in September. Meanwhile, the preliminary Nov. 19 two-week figures reflect total borrowings are now $652 billion, up 11.85% over the same time period.

At the same time, total borrowings (TOTBORR) of depository institutions from the Federal Reserve have spiked dramatically, which signals still more money is working its way into the system. Note how smooth the TOTBORR chart has been historically for the last 22 years and how dramatically it’s spiked as a result of the financial crisis. When I say unprecedented, this is the kind of chart I’m referring to.

And we’re not done yet. In addition to all the infusions we’ve already mentioned, Club Fed is poised to inject another trillion dollars to bail out banks, insurance companies, Wall Street, possibly Detroit’s “Big Three” automakers and just about anybody else who “needs” a handout to overcome years of inept management,financial malfeasance – and plain old greed.

That’s why – more than any other single reason – deflationary pressures that might exist in the next six months or so aren’t really the enemy.

Carnegie Mellon University economist Allan H. Meltzer was much more in a recent interview with Forbes, stating that “people who say deflation is a threat are either rumormongers or ignorant.”

Added Meltzer:  “They need to take a refresher course in economics.”

As much as we’d like to dismiss Meltzer’s comments, we can’t. At least not entirely, because interest rate swaps are currently pricing in deflationary expectations.  And that speaks to something I’ve pointed out repeatedly: Any time the Fed squares off against the markets, the Fed loses. And it’s clearly fighting a losing battle now.

That’s why the bond markets are indicating deflationary expectations of 1.5% over the next two years and inflation of just over 0.0% over the next five years. Over the next 10- and 20-year periods, the markets are pricing in inflationary expectations below 2.0% respectively.

With an expanding monetary base already screaming inflation, this connotes opportunity.

The best way to capitalize on this in the long term is through Treasury Inflated Protected Securities, or TIPS. Right now they’re comparatively cheap because investors have fled to straight Treasuries, preferring their immediate liquidity. But TIPs are rising nicely and are likely to rise much further and faster with the first whiff of inflation.

Speaking of which, we think there is a 50-50 chance of so-called “core inflation,” which excludes food and energy prices, rising to 4.0%. That doesn’t sound all too bad, but that’s 2.3% more than the recent 1.71% yield on five-year U.S. Treasuries, which means TIPS are a better bet today.

Our favorite, the iShares Lehman TIP (TIP), sports an attractive 8.21% yield and plenty of upside. So it’s not only the good defense we’ve mentioned in the past, but one with plenty of inflation protection built in.

It’s up 14.35% from the low of $84.14 set Oct. 10. That’s something most investors are not focused on right now, but they should be.

Source: Inflation – not Deflation – is the Threat, Now Here’s What to do About it