By: Brendan Lee

When I was studying economics during my university days, I learned that the worst economics scenario is not recession, but its stagflation. In a normal recession situation, inflation falls and unemployment rate rises. In a stagflation situation, inflation rises, unemployment also rises.

When the economy is facing recession, the government can implement expansionary monetary policy / fiscal policy to boost the economy. But when the country is facing stagflation, the government is stuck. If expansionary policy is implemented, inflation will rise much higher; and if contractionary policy is implemented, unemployment rate will rise.

In my view, US is currently facing stagflation. The latest annualized headline inflation is now running at 2.8 percent or, annualized, at a whopping 9.5 percent. Worse still, the producer price index for finished consumer goods (to be passed on either as higher consumer costs or reduced corporate profits) is now rising at some 9.3 percent.

The Fed is now in a corner facing the gigantic problems of inflation and a subprime dollar calling for higher rates and the prospect of deep recession, calling for steeply lower rates. Hence there is a possibility that we may not see another interest rate cut in 30th January. And if this happens, market is going to be very disappointed and dragged the stock market even lower.

I believe the most prudent investment strategy is to raise cash for our portfolios in times of uncertainties. I had sold off 34% of my portfolio for the past 2 days. But I’ll be looking to invest those funds back into the market when prices are down another 15% – 20%.

In times of hyperinflation, I believe precious metals and oil will be good investment. Traditionally, 11gold acts as a hedge against inflation; and since interest rate is not expected to rise in times like this, oil price will benefit.

For your information, I had called for a buy on gold ETF while it is trading at US$590 and today gold is trading at US$780. I believe silver will be a very profitable investment in 2008, as silver has been a lagging behind the precious metal family for too long.

Source: Metal Trading