Few in the investment business believe the biggest threat to the global economy is deflation.  We share that belief and are confident it will begin within the next year. It will begin in the stock, housing, and bond markets. All three are at or near record highs.  This has never occurred before and if all three correct there will be a historic amount of wealth lost.

What will occur shortly after that? Unemployment will rise. Personal and commercial bankruptcies will also. Prices of consumer goods will drop due to less demand created from shrinking disposable incomes – which may occur no matter what due to rising taxes. And, more importantly, lending will tighten because there will be less income and savings to balance the amount of leverage in real-estate. Rising mortgage rates will exacerbate the situation.

When the asset deflation begins it is surprising how fast investors will step aside and wait for what they believe will be the bottom. Deflation can be slow moving at first but once it passes an unknown point the drop in prices will accelerate.  Bankruptcies then become more common as debt outstanding becomes greater than equity, which in turn drives prices even lower as people try and unload. 

Interest rates fell for 40 years pushing asset prices higher.  The most obvious example is in real-estate. When interest rates decline it allows for consumers to borrow more principal because interest consumes less of the mortgage payment.  This results in higher prices. This equity has turned to be the basis of our economy and the bulk of household wealth.  Unfortunately, interest rates will be going higher for years to come meaning leverage has run out of fuel from here on in. We can see a prime lending rate of 4% within 2 years.

Everyone believes that we will we soon experience record inflation. It has already occurred.  Food prices are at record highs. The cost of fuel is increasing.  Rents have never been higher (although they are now falling in many regions) and home prices are inflated to levels higher than any other country based on incomes. Like rents, prices have only one direction to go - that is down.

One of the best guides for inflation and deflation is the price of gold.  This year there has been 9 days of the price falling around $20 with one down $30.  Over the next 4 to 5 trading days the price would recover only to fall $20 in one day (on March 30^th it dropped almost $50). Investors should take this as a warning deflation is coming so be prepared.  I expect the price to fall to the $1,500 area.  If the price does not hold then $1,200 will be reached and indicate deflation.  A price of $1,500 will be a signal of slow growth, which would be a plus today.

Canada has one large weight on its shoulders that few countries have - a useless one-person government who has and will continue to make a mess of the country.  Over the past 6 years Justin has forced business to redirect over $600b of investment to outside our borders.  He has destroyed over 100,000 high paying jobs throughout the energy sector – one of Canada’s biggest industry and source of billions in tax dollars. Justin has turned Canada into the only country in the world that refuses to take advantage of its biggest assets – natural resources.  He is the laughingstock of the political world.

Canada can escape the worse of deflation if we get rid of Bill C-69.  This bill places so many restrictions and rules on developing major infrastructure that companies do a quick cost analysis and say, “see you later, we can do this far cheaper elsewhere.”  This alone has cost the government hundreds of billions of dollars in future tax revenue. Bill C-48 is another bill that deters investment. This one restricts tankers from much of the West Coast. Hypocritically, those same tankers can sail up and down the St. Lawrence River.   Both bills inhibit economic growth in Canada.

How does one prepare for deflation?  You want as little debt as possible.  This is because debt remains the same during a time when asset prices decline and wipes out equity. You also want your investments to be very liquid. An investment with low liquidity will fall in value further because there are larger buy-sell price spreads.   Investors should also build up a cash reserve (at least 30% of one’s portfolio).   If we are wrong, you still will win because you will have money in the bank and no debt.