Deflation is on the March

Inflation is retreating...deflation is on the march. Food prices were increasing at about a 10% annual rate in July. In August, the increase slowed to 7%. The whole world economy is slowing down. And the bubble system - in which exports of borrowed consumer cash from the United States resulted in huge piles of capital overseas - is slowing down.

So far, everything is happening more or less as it should. The credit bubble has burst. The feds are trying to reflate it. But asset prices are sinking anyway...and so is the rate of consumer price inflation.

The Treasury market reflects the shifting fortunes of inflation and deflation too. Yields on the 10-year note fell to 3.4% this week, which means bond prices are going up. The smart money is said to be rushing into Treasuries to protect itself from falling stock prices, bankruptcies, defaults, derivatives, junk debt and other dangers.

Should you follow the smart money? We don't think so. It may be true that Treasuries will do well during this phase. But there is no margin of safety. At 3.5% yield, you are earning at least 200 basis points less than the rate of consumer price inflation. And when this phase ends, bonds will collapse too. When it will happen, we don't know...but sooner or later, it seems inevitable.

No, dear reader...we'll stick with our formula: Sell stocks on rallies. Buy gold on pullbacks. Gold is a good buy right now. Stock up on the yellow metal now - with change you find between the couch cushions.

*** The Dow bounced Tuesday - predictably. Oil fell $4 and change - to $91.

(We must admit...we're feeling rather content with ourselves. We warned that oil would correct to under $100...and so it has.)

Gold, too, has corrected all the way to $742 (more than we expected...but at least our well-earned humility is intact.) And the euro lost a little ground yesterday. It now trades at $1.40.

Bill Bonner
for The Daily Reckoning Australia

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