Deflation Investing Strategy: 5 Things You Should Know

Deflation Investing Strategy: 5 Things You Should Know

It’s looking more and more apparent by the day that deflation is returning to the financial markets – and with a vengeance.

Yes sir, deflation is back – it’s out to kick ass and chew bubble gum, and apparently it has just run out of gum!

The reflation trade is being exposed as the fraud we thought it was.  It was just a mirage.  A standard fare retracement that did it’s job exquisitely: making market participants believe that the worst was behind us.

So now that deflation has returned, how should you invest?  Here are the 5 most important things you need to remember when making your investment decisions for the rest of 2010 and beyond:

1. In Deflation, Cash is King

In a deflationary period, the price of EVERYTHING declines – which makes good old cash the place to be.

Since most of us have been investing during times of inflation, albeit mild for some long stretches, we are still accustomed to the thought of “yield” in order to compound interest or just stay ahead of inflation.

In deflation, when asset prices are declining all around you, return ON capital is not nearly as important as return OF capital.  So you have to retrain your investing mind a little bit to realize that a 0.1% return, or even a 0% return, is just fine – because asset values are collapsing all around you!

Although your cash looks to be the same amount in nominal terms, it’s actually greatly increasing in value with every triple-digit plunge on the DOW.  That’s because your cash can buy more!  As asset prices plummet down the toilet all around you.

Quick case study – in early 2008, I changed jobs, and was extremely lucky to have my 401K retirement money tied up in cash as I rolled it over to an IRA.  During that long and drawn out transfer process, I was not earning one cent in yield.

But ultimately I came out way ahead, because the tie up in cash was the best thing that could have happened to me – it saved me from decimating myself with my own trading heroics, as the biggest stock market collapse of our lifetimes was occurring!

2. The US Dollar Will Continue to Rally

So what cash should you be in?  Paradoxically, the US dollar has been the strongest performer during deflationary waves.  And ironically, that may be because it’s not the strongest currency, but rather, the sickest.

When deflation hits, a lot of debt “goes away to money heaven” – here today, it’s gone tomorrow, never to be heard from again.  Since most debt is denominated in US dollars, the supply of available dollars decreases, which actually sends the dollar up.

Gold may be a decent cash equivalent, though I am still wary after experiencing this “safe haven’s” collapse in 2007-2008.  The dollar was the strongest currency then, and I expect it to be again until further notice.

US Dollar Index ChartThe US Dollar has rallied since late 2009 – its trend is UP until further notice.


3. Stocks Will Get Creamed

Stocks are not a good place to be during a deflationary depression (check out the price performance of stocks during the Great Depression).

Conservatively, you can expect stocks to take out their previous March 2009 lows, as was the pattern during the Great Depression.  Stocks didn’t go straight to the basement – they shed value in a serious of waves down, with brief price rally breaks meant to sucker investors back into the market.

Stock Prices Great Depression 1929Stock prices collapsed in amazing fashion during from 1929-1932.


We just saw one helluva bear market rally, which probably means we’re about to see one helluva next wave down.  Conservatively, you can expect a sub-600 S&p, and a sub-6000 DOW.  And maybe much lower.

Last time, not many stocks were spared.  The market tipped it’s hand, and I wouldn’t expect many stocks to do alright this time around either.  Best bet would be to avoid stocks altogether.

4. Precious Metals and Energy Will Get Slammed Worse (Mostly)

Gold prices have been holding up extremely well of late, which may bode well for gold bugs.  Originally I thought gold would get slammed as it did in 07-08, just not as bad this time around.  I may have been too harsh in my predictions for the yellow metal.

Gold Price ChartGold has held up more than admirably over the past few trading sessions.


Other precious metals though are getting creamed – as is energy – due to their industrial uses.  When this demand evaporates, prices go down because there’s just too much supply available.

For example, silver is more volatile than gold, due to it’s industrial demand – that works like leverage – great when prices are going up (if you’re long) – but very bad when prices go down.  I think we’ll see single digit silver again before we see silver north of $25.

Same goes for oil – peak oil or not, if demand hits the road for a year or two, we could see an instant replay of what happened to natural gas.  Where all of a sudden there’s more supply than anyone knows what do do with, and prices collapse.

Crude oil collapsed into the $30’s last time, and I suspect it could drop even lower this time around.

5. Financial Institutions Will Fail

Remember when banks going under were a Sunday afternoon tradition rivaling the NFL?  It’s going to happen again, but likely much worse.

So it will be very important to have enough savings on hand to get through possible bank closures.  Don’t count on the FDIC – that’s an institution that’s likely to fail also. (Why? Read why the FDIC will soon need a bailout.)

FDIC LogoDoesn’t this make you feel safe?

Very short term US government bonds will be the safest place to stash your cash.  You can buy them direct online at

Just remember: Don’t chase yield and buy anything beyond 3-month paper, otherwise it could be worthless before it matures 🙂

Deflation Investing Summary

Cash – ironically, US dollars – will be the safest place to store wealth during the next wave of deflation.  Most stocks and most commodities will get creamed.  Many financial institutions are toast.  It’s not going to be pretty.

I wish I had better news for you – but I don’t.  Just because bad stuff is going to go down globally, it doesn’t mean bad stuff has to happen to you personally.

Take the appropriate measures to protect yourself now, and you’ll be way ahead of the game when we eventually make it through to the other side.  You’ll be ready to buy stocks for pennies on the dollar – your dream house for $0.10 on the dollar – you get the idea.

For more tips about how to handle the joy of complete deflationary financial destruction, check out deflation expert Robert Prechter’s Deflation Investing Primer.

We also have a free daily newsletter for contrary minded investors like yourself.  Every weekday, we report on investing and trading stories that are often not found in the mainstream press.  And of course we keep close tabs on deflation and related investing strategies.

You can sign up for our free Contrary Investing Newsletter here.

  • I’ve been reading up on deflationary strategies, everyone who is younger than 40 agrees that cash is king. My question is; in deflationary times won’t holding a fiat currency result in the same devaluation as governments shrink the currency base by devaluing the currency? That is; a $500,000 house has fallen in value to $50,000 but your $1,000,000 in cash has remained $1,000,000 until the government knocks off two zeros and, presto, all of a sudden the house is still $50,000 but your cash is $10,000.

    In REAL deflationary times, not just statistical adjustments, and, over time as currencies collapse, what maintains purchasing power? Isn’t it land and/or gold?

  • Brett

    Excellent question Scott. For our deflation argument to come to fruition, credit must be destroyed faster than the government can print it.

    The deflation hypothesis rests on the belief that this day in age, we have a credit-based economy that far exceeds the actual hard cash in circulation. During the last deflationary leg down, we saw $10-15 trillion destroyed (via falling asset prices, exploding debt, etc) and “only” $2 trillion or so created from thin air. Which was net deflationary.

    As the amount of credit in circulation is still estimated to be over $50 trillion, the theory is that the government can inflate the currency ONLY after most of this credit is destroyed (via most debt going unpaid).

    So the time frame we are talking is really the next 3-5 years. Even the most ardent deflationists believe that we could then see wicked inflation or hyperinflation. Both camps are really debating more about the sequence of events…we’re not making the case for a century of deflation, the government will EVENTUALLY be able to inflate – we’re just making the case that they are currently powerless, and likely will be for the next few years, until most of the outstanding credit it destroyed.

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  • Brian Palmer


    I exited all equities in my 401K back in Nov 09 since I thought the market run up was over done. So now I have my money in a money market fund. Now the question; is a money market fund considered cash?

    Thanks, Brian

  • Brett

    Brian, thanks for your comment. While money market funds are traditionally considered to be cash equivalents, they weren’t 100% during the last bout of deflation, since they can be invested in some unsavory investment sausage.

    Bob Prechter recommends very short term T-Bills, which you can buy at And of course physical cash counts too, but there’s only so much one can stuff under a mattress!

  • For people living in the UK (like me) the equivalent to a T-Bill is a Gilt. I found this web-page about retail investors buying Gilts. You can own Gilts in an ISA too (that is the UK’s 401K).

    The UK/European guaranty is GBP 50,000 or EUR 60,000 per bank so the accepted wisdom is to spread cash across several banks if you have more than that.

    If anyone has bought Gilts or has any good ideas (or corrections) about protecting cash in UK/Europe please reply.

    Brett, should I buy index-linked or not? I don’t see the need if the expected outcome is deflation.

  • Brett

    Interesting – thanks for the comment, and the UK shout out!

    Since I am indeed anticipating deflation, at least in the near term, I agree with you….don’t see the need to buy the index linked variety. Just my $0.02.

  • mike

    every canadian without exeptions exchange 5% of it’s cash in american money on june 1st 2010…….only jokin’

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  • John

    I’m from the UK. I don’t understand the benefit of Gilts over other government savings, such as Premium Bonds, or Treasury index linked-accounts. If anyone knows, please explain

  • Sam

    I am from UK.

    The UK guarantee is GBP 50,000. But what if lot of big banks start going belly up at the same time. Will government still give the money?

    Can anybody recommend safe places in the world to live under the depression scenario?

  • Brett

    Doug Casey loves Argentina as an option – so much so he built out a development there. Reason he likes Argentina and other South American countries is that their governments are inept and generally ignored by the populace – so he believes you’ll get left alone for the most part.

  • John

    To Sam:
    The government will not be able to pay up if all banks go at once. They may guarantee the money, but put a limit on withdrawals, e.g. £500 a month. So, if you have £50,000 it will take 8+ years to withdraw it! I’ve nothing to back this up, but offer it as an idea on how the government might handle the situation
    So spread your money around, so you can withdraw small amounts from several places. Government savings (NS&I) is safer than banks, because the government will allow banks to fail before it allows itself to fail. Keep a generous amount of physical cash at home or in a safety deposit box. And a little gold (sovereigns)

  • Sam

    Thanks Brett and John

    What about cash balances with big brokers. Will the dollars be safe with them if dow goes below 1000?

    John where can I get gold sovereigns. Why not keep gold bars?

  • Brett

    Sam, good question, and “probably not” if the DOW tanks into triple digits. You’d want to get your cash balances mostly out, and mostly into safer short term cash equivalents (like physical cash, or very short term T-bills using

  • Shamus

    Treasury Direct requires you to wire money in and out of bank accounts. If you are buying 90 day bills, then you’ll have funds at a bank on four days out of the year. It would be unlucky to have the bank go under on the day Treasury Direct wired money, but since banks may be unsafe, this seems risky. Do you have any ideas?

  • Sam

    Thanks Brett

    Maybe it might be possible to buy shares near the bottom and that way you are entitled to the shares bought and not lose the cash deposited with them?

  • John S.

    Hello. Question about keeping cash. Leaving the cash in a large bank is not good enough bc the FDIC is going down? Then why would the treasury bills pay if all of the banks are down and out?

    If I just have my cash in the bank under the FDIC limit should I worry about the cash?

  • Brett

    Leaving your cash in bank, under FDIC limit, would only be a problem likely if the FDIC actually went down. Unfortunately I believe the FDIC IS going down…so that wouldn’t be my pick.

    Bob Prechter is recommending you diversify your cash holding as best you can. Physical cash is the safest, but then you have to figure out storage. He believes the shortest term T-Bills will get paid, at least now, that the domino there wouldn’t fall until later.

  • Brett

    Possibly that might be the case…the trickiest part of our deflation strategy may be the switch from deflation to inflation protected assets after the deflation carnage has played out!

  • Brett

    Just shooting off the cuff – since the banks usually seem to go down on Sundays/weekends, maybe you’d want to time it midweek. And spread out the days if you can…so if you catch a bad spin of the roulette wheel you don’t lose everything at once.

  • John Gardner

    Quote “John, where can I get gold sovereigns. Why not keep gold bars?”

    Coins are easier to identify/authenticate (and therefore easier to trade). Also, more pleasing to have, or to offer as gifts. I suggest sovereigns because (a) they are historically interesting and known in most countries, (but not so much the USA) and (b) are they are exempt from UK capital gains tax (just in case you buy a lot and the price goes to the moon!) . Best place to get sovereigns is a gold coin shop E.g. there’s one on Charing Cross Rd, near Leicester Tube. Don’t buy from Ebay, bidding makes it pricy, but look them up on Ebay to get a feel for the price. Gold can be tricky with price going up and down, so buy one or two to begin with, and more when you are confident. Don’t go overboard; gold may yet decline in value along with everything else in a depression, but it good to have some as a “core position”. Best time to buy lots MAY be at the bottom of the depression

  • Sam

    Thanks John

    For gold soverigns I understand there is shop called Gold Coin Exchange on Charing Cross road – is that the shop you are referring to?

    Also, how easy would it be to encash soverigns in an emergency after depression?

    Sorry for the questions but I am a total novice in this field and any education is welcome.

  • John

    Yes, that’s the one. It is a small shop; sells all sorts of old coins, silver and banknotes. He usually displays a few sovereigns and half-sovereigns in the cluttered window; I work nearby, and will check his prices, and let you know.

    I don’t think you will have any trouble selling sovereigns in or after a depression; the think you will not be able to control is the price, which will vary according to the prevailing circumstances. Ebay is an easy place to sell, except Ebay takes a whopping 10% cut, plus Paypal fees on top. Gold coin shops are probably an okay place to sell back to. Avoid “cash for gold” dealers; one local to me are offering £80 for sovereigns, less than half their price elsewhere.

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  • Sherry

    I don’t know much…okay, I don’t know anything about investing. I have a 401K where I work and wouldn’t begin to know how to shift and change in preparation for deflation. Anyway, as I understand it, cash is the best way to keep what you have. So, should I cash in my 401 K? Even after paying the penalty, maybe I would be better off?

  • Brett

    Re: your 401K, if you are fearing deflation, you may want to at least make sure you don’t have your allocations heavy in stock indexes. You can keep it in cash or cash equivalents in your 401K.

    The argument against leaving cash in your 401K at all, rather than pulling out and taking the penalty, would be the fear that the government is going to lock up retirement accounts at some point and force you to place the cash in treasuries as they inflate it away. I don’t think we’re there yet, but I think that is the question you need to figure out as to whether or not you cash in your 401K.

    FWIW I have not done this yet myself, I still have retirement holdings in 401K and IRA accounts.

  • Ted

    (this is a little tongue in cheek but) Why don’t you just invest in US nickels? If there is deflation you come out ahead as the nickel will be worth more and if there is inflation: The nickle is 75% copper and 25% nickel. $18 dollars of nickels are about $9 worth of nickel and $9 worth of copper at current scrap prices. If you get $10,000 worth of nickels you will have 200,000 nickels to play with. Inflation will make a nickel worth much more (in scrap metal prices) than five cents but there could be a problem with scraping US currency. I guess you could do the same thing with pre ’82 pennies but they would weigh 3 times as much as the nickels (about one metric ton vs. three) and you will have to sort through a lot of pennies to find the pre 82 ones. Or you could just do what I’m doing, but if I told you then my strategies wouldn’t work. If you read a solution on the internet, it most likely won’t work. If I knew the winning lottery #’s I would be in great shape, if I told them to everyone (internet) we would all lose. Best of luck to all, we need it.

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  • Good article stays relevant and actual. Here is my take on it:

    1) Yes, cash is King. But safe fixed income is better. You are right: return OF is more important than return ON investment.

    2) Maybe the Dollar will rally. It depends versus which currencies. The Yen may get stronger due to its financial position. If other markets maintain a high growth, their currency may strengthen.

    3 & 4) Stocks, metals and commodities will show booms and busts during a deflationary recession. Buy and sell with the trend. Be careful with just going short.

    5) Yes, debt and high leverage are killing for business and individuals during deflation. Those that are leveraged too highly will disappear.

  • Trader10

    This article is a complete rubbish… everything you’ve said is happening the opposite….you are a old economist thinker.
    Gold, silver, soft commodities like grains and food and some cash are and going to be the best investments to hold this time around for either deflation or inflation… Cantral Banks cannot get enough of precious metals now and LME is Chinese now. You must hold tangible assets if you want to survive this time around IMHO.

About Author


Hi, I’m Brett Owens – and I’m a financial junkie. My “problem” started incollege, when I got a little dose of the stock market – man, was I hooked…in no time, I was reading the Wall Street Journal religously.

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