Sitka Pacific Capital Management, LLC 3 September 2010
During the depression, most of this deleveraging process occurred while the dollar was fixed to gold.Prices fell dramatically as demand for goods and services plunged, and defaults soared. Rooseveltdevalued the dollar in 1933 hoping to change consumer dynamics.This time around, the cost of deleveraging is felt in the value of the dollar and the value of debt on thebalance sheets of banks and other creditors. The government’s activism in countering the recession has tosome extent blunted the impact of deleveraging by transferring some of the cost to the dollar. Other centralbanks have joined in with various stimulus packages and currency debasement processes. This is thereason gold has reached a new record high, not only as measured against the US dollar, but against manyother currencies as well.However, just because the value of the dollar has absorbed some of the cost of deleveraging and declinedagainst gold, this does not necessarily mean inflation is just around the corner. Until the private sectorstops deleveraging, there is very little chance for significant price inflation and surging treasury yields.Perhaps because we have a vivid collective memory of the 1970s, and because we have not experiencedanything close to deflation in more than 75 years, fears of inflation remain strong today. Adding to theanxiety is the perception (which, as we’ll see, is not entirely correct) that investment strategies that havedone well in past inflationary periods are almost the polar opposite of those strategies that have done wellin deflationary periods.During the late 1970s, when prices really started to rise, the value of bonds and the dollar fell precipitously,and real assets like gold went into a parabolic rise. Although they maintained their nominal price level,with the Dow Jones Industrial Average fluctuating below 1000, stocks fell dramatically on aninflation-adjusted basis. Thus, gold did quite well during the inflationary 1970s, while investors in thedollar and bonds were handed huge losses.During the Great Depression, stocks fell 90% from their peak in 1929 to 1932, and remained depressed untilthe late 1940s. Unlike the 1970s, Treasury bonds and high quality corporate bonds did quite well.What is less well known is that whenyou adjust for price changes, some ofthe key differences between assetclasses during these different bearmarkets disappear.This table to the right shows that thereal return of stocks during the 1970sbear market was actually worse thanduring the Great Depression, eventhrough nominal stock prices roseslightly. It also shows that over the past10 years, the real return of stocks hasbeen about the same as these past twobear markets.Another key piece of information shown in the table is that regardless of whether a long-term bear marketperiod is inflationary or deflationary, gold has risen versus stocks. During the deflationary period between1929 and 1948, even while its price remained controlled by the government, gold rose an annualized 5.55%a year relative to the S&P 500. Between 1966 and 1982, in the middle of which the price of gold was allowedto float freely and inflation accelerated, it rose an annualized 14.22% per year relative to stocks.
Annualized Returns of Stocks and Gold during Bear Market Periods
1929-1948 1966-1982 2000-2010(Q2)S&P 500 (nominal) -2.69% +0.98% -2.6%
S&P 500 (real)* -4.40% -5.62% -4.88%
Gold (nominal) +2.86% +15.19% +15.12%Gold (real)* +1.15% +8.59% +12.84%
Gold vs. S&P 500 +5.55% +14.22% +17.72%
*Real = Adjusted with CPI