Gold has fallen 13% since March and is warning deflation is coming.  If the price falls under $1,500, declining asset prices will be definite. It will exist for at least a year as the financial system cleans itself of excess debt.  This is needed because the financial system is the most leveraged it has every been, thanks to historically low interest rates.  There is positive to this however, it is needed to begin a new period of organic economic growth.  Just make sure you are prepared for it.

We believe inflation is on its last legs and this could be the beginning of the third major deflationary period in the last 100 years. The first one, the Great Depression, began on the last Friday in August 1929. North America’s economy was devastated.  A drought exacerbated the situation. The following three years destroyed the DJIA.  It fell 89.9% by the time it hit the bottom in May 1932 and did not hit its August 1929 high until the spring of 1954.

The second period began in 1978 when interest rates started a 3.5-year climb. At the peak a Canada Savings Bond was 21% for a one-year term. A bank 5-year GIC paid l7.5%.  The five-year mortgage was a painful 21.5%. This caused many personal and corporate bankruptcies.  When this bubble burst, falling interest rates began a long-term trend down that ended last year. This played a large part in creating today’s wealth.

There have been noticeable ups and downs, like 1989, but it mostly affected the stock markets, not the economy. On October 19, 1987, the Dow Jones Industrial Average experienced its largest one-day drop in its history, falling 508 points (22.6%). The market got spooked by higher interest rates which climbed for two years to 9.83%.  Thankfully they had room to drop rates and the index recovered.   That market did nothing to the world economy because they had room to drop rates, which they did until a minor jump in 2010.

Today, all asset classes will fall in value. It is a given.  Interest rates alone dictate this.  Those that produce zero-income like most commodities, cryptos, NFTs and many stocks will be hit more.  Interest rates are already hurting the housing market.  This market is dictated by income and interest rates.  Banks cannot lend as much principal when interest rates increase because the payment is based solely on the income that finances the mortgage.  So, when the interest expense climbs, lenders are forced to lend less principal since interest consumes more of the payment financed by the borrower’s income.  This is not only true for principal residences but for investment properties as well.    

Over half of homes sales are due to death and divorce. This means we will always be at the mercy of the market and prices can also go down.     Throw in scared investors and the outlook looks horrible for a few years, at least.    The losses will easily be in the hundreds of billions of dollars in Canada alone. Add in the excess consumer, government, and corporate debt in existence, it means slow economic growth and less discretionary spending for at least the next couple of years.

The stock markets are forward indicators and they have already priced in a recession.  There are noticeable up trends like today, but it will be short-lived.  At 13.57-times earnings, the TSX is currently bouncing around its average price earnings ratios since WWII, which is roughly 13 to 16 times earnings. The index is down from 19.9-times-earnings last year.  The DJIA is currently trading at a still expensive 19.9-time earnings, but is down from 24.2-times-earnings last year.   Companies are cutting expenses (including jobs), paying debt as fast as possible and hoarding cash.  The consumer is doing the opposite.   We predict the Toronto stock market will decline maybe 10% and most others between 15-and-25 percent.

Bottom line is what we have been saying for months; cash is king.  This will be true for the next few years. Stick with 40% cash and equivalents in the portfolio with the remaining money in companies with a positive cashflow and a history of increasing dividends. Today, one can earn a reliable dividend yield between 4 to 6%.  Anything above this and the risk levels begin to climb exponentially. 

You should avoid buying real estate as an investment for the next few years.   If the gold price continues to fall it will tell you how bad things can be. Speculation is out.  It will be a trip to the poorhouse. Capital preservation is in. Common-sense is our guide for many months to come.