David Galland's  Instablog

For pretty much everyone, no matter where they are located in the economic strata, few if any questions are more germane to making plans for the future than whether the US and other major global economies are in recovery.

Getting the answer to that question right is of special importance to investors and businesses.

Stating the obvious, if the broader economy really is in recovery, then investors would be well served by investing in the equities of solid companies positioned to take advantage. Similarly, those very same solid companies would be rewarded by increasing their productive capacity through investments in the plants and people necessary to meeting growing demand.

On the same side of the ledger, bond investors would want to begin shorting up their durations or leaving the bubbly bond market altogether, in anticipation that the flood of funds into fixed income would reverse, sending rates higher (and bond prices lower).

Conversely, if the recovery is a head fake, then an entirely different course of action is called for. For instance, one would want to adopt a cautious attitude about common stocks. And because of the nature of the crisis - crushing levels of sovereign debt - one would want to take advantage of pullbacks in precious metals to buy more, along with other so-called "tangibles." That way they would have some measure of protection against the inflation that fiat-currency powers make all but a certainty.

In addition, reducing personal and business spending in order to conserve rainy-day cash would be advised.

And what about US bonds in the no-recovery scenario? A sound case can be made for including them in a portfolio as that puts you in lockstep with the government's desperate need to keep interest rates down - or, better yet, have them fall further still. Given the highly politicized nature of our economy, that seems reasonable - and anyone who has been long bonds over the last few years has done very well, indeed.

While you'll have to make your own call on bonds, my own enthusiasm is curbed by looking at the charts of the upwards-spiking interest rates on the bonds of Spain, Greece, Italy, and so forth. When Mr. Market ultimately becomes disenchanted with the fiscal excesses of the sovereign deadbeats, he can express his ire most energetically. When the current bond bubble here in the US ultimately bursts, as it must, it's going to be a bloodbath.

Of course, there is much, much more at stake to coming to the correct answer on the recovery, or lack thereof, than that.

For instance, poor economies make for poor reelection odds for political incumbents. And when it comes to maintaining a civil society, the lack of jobs inherent in poor economies often leads to a breakdown in civility. On that note, overall unemployment in Spain is now running at depression levels of almost 25%, and youth unemployment at close to 50%. How long do you think it will be before the citizens of this prominent member of the PIIGS will refuse being led to the slaughter and start taking out their anger on the swine (governmental and private) seen as bearing some responsibility for the malaise?

Meanwhile, back here in the United States, the commander-in-chief is striding around the deck of the ship of state trying to look like the right man for the job in the upcoming election, despite the gaping hole of unemployment just under the economic water line. His future prospects are very much entangled with this question of recovery.

So, what's it going to be? Recovery… no recovery… or worse, maybe even a crash?

We all have a lot riding on getting the answer right.

The Quest for Confidence

Ultimately, the purpose of searching for the truth about the recovery isn't about either fear or greed. It's about confidence.

If you really knew what's coming, then the right moves to make become obvious. You could then make those moves with the calmness of spirit that comes from certain knowledge and get on with your life. While others struggle or miss an opportunity by betting on the wrong future, you'd have set up your affairs to survive and prosper.

Of course, given that we are talking about a complex system - the economy - total certainty is never completely possible. But for reasons I'll share, the nature of the current crisis paradoxically allows for more certainty than would normally be the case.

And so I want to share my conclusion about how I believe things will unfold from here, followed with some support for that conclusion.

While, as readers of any duration are well aware, we at Casey Research foresaw the current crisis years in advance and have remained firm in our conviction that the recovery is a charade… based on my own readings, and after spending the last two weeks in the company of a couple dozen very plugged-in economists, top-performing money managers, and top financial analysts, my conclusion is thus:

The world's largest economies, including the US, Europe, Japan, and China are speeding for the equivalent of a brick wall. In short, I believe that before this crisis is over, we will experience the Greater Depression my dear friend and business partner Doug Casey has long anticipated.

In case that conclusion fails to communicate my current view sufficiently clearly, I will condense it as follows:

The world's largest economies are screwed.

And I will even set my conclusion to music, in the form of the song Somebody That I Used to Know by Gotye, which seems appropriate because the economy that we used to know won't be back again for many years to come.

Trust me, stating an opinion on the direction of the economy in such unequivocal terms troubles me. For starters, I wish my conclusion could be otherwise because no one likes to be a harbinger of doom. Mostly, however, I have long resisted adopting a set-in-cement position on something as wiggly as the future. In my experience, anyone who absolutely, totally buys into a particular future is almost always proven wrong by time.

Yet, as my quest for certainty unfolded, I could come to no other conclusion than that the world as we know it is headed for an economic catastrophe.

Allow me to explain.

The quest started with our Casey Research Recovery Reality Check Summit, April 27-29, in Weston, Florida. We took our mandate of getting to the bottom of this matter of recovery seriously, including faculty members with a variety of perspectives to see if an overarching conclusion about the recovery could be ascertained.

In addition to our own team of Doug Casey, Bud Conrad, Terry Coxon, Louis James, Marin Katusa and Jeff Clark, included in the faculty were: Lacy Hunt, former economist with the Dallas Fed and the world's most successful bond manager; Jim Rickards, money manager and author of Currency Crisis; John Mauldin, best-selling author of Endgame and the just-released The Little Book of Bull's Eye Investing; John Williams of ShadowStats fame; Porter Stansberry, founder of Stansberry Research; Michael Lewitt, editor of The Credit Strategist; Gordon Chang, China analyst; Harry Dent, author of The Great Crash Ahead (who also debated James Rickards on the question of inflation or deflation); Andy Miller on real estate; Greg Weldon of the Weldon Report; John Hathaway of the Tocqueville Funds; resource market guru Rick Rule of Sprott Asset Management; Caesar Bryan, a senior portfolio manager for the Gabelli Fund group; and David Stockman, the head of the Office of Management and Budget during the Reagan administration.

(Plus, on the taking-action front, there was a special panel on international diversification as well as panels where a dozen or so experts on everything from gold stocks to uranium, to rare earths, to graphite, to technology, to energy gave their best picks.)

In other words, a full program.

Then, immediately following the conclusion of our summit, Olivier Garret, Casey Research CEO and partner, and I climbed on a plane for California and John Mauldin's Strategic Investment Conference.

John's event was geared more for hedge fund and very-high-net-worth investors and, as such, included a more mainstream slate of speakers, but what a slate it was.

For the better part of three days, Olivier and I hunkered down to hear presentations and meet with the likes of: David Rosenberg, the star analyst of Gluskin Sheff; H. "Woody" Brock, an economist with some of the deepest credentials in the business (you can Google any of these guys for bio info); economic historian and best-selling author Niall Ferguson; Marc Faber of the Gloom, Doom and Boom Report; David McWilliams, the popular and very erudite Irish economist; David Harding of Winton Capital Management; Jeffrey Gundlach of DoubleLine Capital; Lacy Hunt again… and my favorite for this conference, Mohamed El-Erian of PIMCO fame.

In other words, for the better part of two weeks, I was immersed in presentations and one-on-one discussions with truly some of the smartest, best-studied people in the world today on economics and investment markets - with the primary topic being whether the so-called recovery is real, and the consequences if it falters.

While the speakers used a variety of methodologies to approach the topic, when all was said, the only conclusion that could be reached was that the world is headed for a very challenging period.

That conclusion was for the most part derived from three aspects of the many presentations:

1. Hard data. Tallying up all the charts and tables I viewed and heard discussed over the last couple of weeks, if such a thing were possible, would produce a number well in excess of 1,000. While there were some that dealt in forward-looking projections, the vast majority dealt with the here and now, as well as the historical context of how we got here.
2. What wasn't said. For business reasons, many of the big-name money managers couldn't come right out and say that we were heading for a crash, but they all took pains to communicate in not so subtle ways that this was a likely outcome. Tellingly, not a single speaker over the entire two-week period - at either event - came out and said that we could expect a normal business-cycle recovery to continue.
3. The complete lack of practical discussion about how the world can avoid hitting the wall. While the pessimism was palpable, even among the usually perma-bull Wall Street types, at no point did anyone espouse a politically feasible solution to avoid the coming crash. The few who even attempted to point to a solution, at best, mumbled platitudes about the politicians finding the spine to adopt fiscal-austerity measures. One of the speakers - something of a gas bag, it must be admitted - pronounced in all seriousness that the only solution to the economic malaise was for everyone in America to rush out and read his book.

   As an aside, over the course of lunch with that same gas bag, we had a discussion that went something like this:

[Me] "All of the speakers, you included, point to the current trend of higher debts and deficits and say they are untenable, and so the big economies will hit a wall in the not-too-distant future. Yet hardly anyone actually then defines what hitting the wall will look like."

[Him] "Yes, well, things will likely get a bit messy if the politicians can't pull together to address the structural problems in the economy."

"But wouldn't you agree that, given the nature of our democracy, the odds of the politicians taking action before we hit the wall are almost nil?"

"Not at all. If everyone in this country would read my new book, they would understand the situation and rise up to force their elected representatives to take the right action."

"Seriously? The only way to avoid the next leg down is if everyone in the US reads your book? That's it?"

At which point - I kid you not - he picked up his plate and changed tables. (There's a reason I am only rarely allowed out in public.)

But the fact remains that other than perhaps Doug Casey and a small handful of other presenters at our conference, almost no one even attempted to anticipate just what happens when the crisis swells up to its full height and then comes crashing down.

Or, specifically, what the consequences are likely to be when the world's largest economies all hit the wall at more or less the same time. For the record, I have compiled a list of the ten largest economies in the world, and a reasonable assessment of their current situation follows in descending order by size of GDP:

United States - screwed

China - really screwed

Japan - massively screwed

Germany - pretty screwed, especially in that export economies take a big hit in a crisis

France - le screwed!

Brazil - somewhat screwed

United Kingdom - blimey, screwed too

Italy - properly screwed

Russia - hardly screwed at all (lots of resources and next to no government debt)

Canada - pretty screwed, eh?

As concerning as it is to see how many of the world's largest economies are in trouble, the biggest problem of all is that the central bank reserves of virtually every country in the world are stuffed with US government IOUs masquerading as tangible assets.

So, what happens when the world's reserve currency enters collapse and the dollar turns into a hot potato? Don't know, but I'm pretty sure we'll find out in the not-so-distant future.

[If you want your portfolio to be prepared for what's ahead in the not-so-distant future, you'll want to have the insights -including specific stock recommendations - the 31 speakers at the Casey Research Recovery Reality Check Summit gave. And you can have them: the Summit Audio Collection is available in either instantly downloadable MP3 format or CDs.]

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

If history has taught one certain lesson, it is that the less fettered an economy, the better humankind is able to do what it does best: run from trouble and run toward opportunity. In this way mistakes are quickly resolved and progress assured.

Conversely, the deeper the muck of regulation, mandates, taxes, subsidies and other bureaucratic meddling, the slower we humans are in following our natural instincts until the point that progress is slowed or even stopped.

It is said that history doesn't repeat itself, but it often rhymes. In the current circumstances, it appears that enough time has passed that current generations have completely forgotten the critical connection between the ability of humans to freely pursue their aspirations and economic progress.

You can see this ignorance in the popular demand for even more, not less, meddling in the affairs of humankind. Should this trend continue - and for reasons I will touch on momentarily, I firmly believe it will - then the aspirations of the productive minority will soon be dampened by ever higher taxes and other attempts to "level the playing field" and the global economy, already in tatters, will fall off the edge.

There is no more timely nor acute example of this growing trend than what is currently going on in France. I refer, of course, to the first round of the presidential election process, scheduled for this weekend.

In France, if no candidate attracts no better than 50% of the vote, then the two leading candidates go to a decisive runoff vote, this time around to be held on May 6.

The current president, Nicolas Sarkozy, a conservative in name only, was running at a fairly steady gait toward re-election (thanks to the head start awarded all incumbents), when leading socialist candidate Francois Hollande came out with a proposal to tax anyone with an annual income of over one million euros at a rate of 75%. He also promised to add a tax on all financial transactions and increase taxes on France's biggest companies to 35% - securing bragging rights as levying the world's third-highest corporate taxes, the US being #1. This all on top of a 25% VAT, one of the world's highest. By some calculations, the result of Hollande's new taxes is that effectively 100% of all incomes over one million euros will now be stripped away by the state.

For good measure, Hollande also promised to reverse the recent modest increase in retirement age from 60 to 62 pushed through by Sarkozy. While I am sure it is mere coincidence, I found it noteworthy that Mssr. Hollande's campaign slogan is "Change - Now!"

Remarkably, at least for those with some small understanding of economics, as a result of leaning into the microphone with these proposals Hollande has galloped ahead of all other potential contenders and is now projected to finish nose by nose with Sarkozy.

After which the also-rans will be removed from the race, freeing their supporters to share their affections elsewhere. Given that the leading contender for third place with an estimated 14% of the vote is one Jean-Luc Mélenchon - charitably categorized as "far left", a label that can be applied to most of the other candidates - it is projected that the "conservative" Mssr. Sarkozy will go down in double-digit flames come May 6.

Bringing to mind the prophetic utterance of Louis XV: "Après moi, le déluge."

The deluge in Louis' case manifested as the murderous affair commonly known as the French Revolution. In the case of Mssr. Hollande taking up residence in the Palais de l'Élysée, the deluge is likely to manifest in the form of rising interest rates as investors look to protect against an acceleration in the country's debt to GDP ratio, already projected to hit almost 90% this year, exacerbated by a flight of capital, investors, entrepreneurs and large businesses.

As is the nature of such things, because of the aforementioned predilection of humans to run from trouble, we likely won't have to wait for Mssr. Hollande to be formally enshrined in the gilded halls for the trouble to start - it will begin within days and maybe even minutes of the handicappers concluding that his ascendency is a sure thing.

Given that France is the third-largest economy in the already-troubled Eurozone, one can expect the deluge to spread, with potentially devastating consequences. That the guillotines may soon be rolled out across Europe can be better understood by taking into account that the Eurozone sovereign deadbeats are on the hook for roughly nine trillion euros in debt, some significant percentage of which has to be rolled over to ready buyers over the next couple of years. Adding weight to the problem is that, according to the latest figures out of the IMF, Europe's banks may have to sell off up to 3.8 trillion euros in assets, many of them questionable, between now and the end of next year. At least, if they want to remain solvent.

Across the pond, the United States also has aggressive funding needs, given that the "change" we experienced ourselves in the last presidential election has left the government gasping for about $1.4 trillion in additional funding each year. Then there is Japan, officially the world's largest debtor in terms of debt to GDP, where the easy availability of local funding has dried up, requiring that nation to go to the international markets for funding as well.

The phrase "an awful lot of hogs at the trough" comes to mind.

My point is not just that these governments are broke and are about to get a lot more broke as interest rates rise on their many debts and financings, but rather that the global trend toward a resurgence in public demand for socialism in response to a worsening crisis is a certainty.

How could it be otherwise when for decades now the schooling of children has been delegated to functionaries of the state?

For evidence, look no further than the screen swipe here. It is a quote from an essay by a college student in the United States on role the government should play:

The writer of those words was a member of a Valencia University economics class. The professor, Jack Chandliss, asked the class to write an essay on what the American dream means to them, and what they want the federal government to do to help them achieve that dream. Out of 180 students participating, only about 10% wanted the government to leave them alone and not tax them too much, but a whopping 80% wanted the government to provide pretty much the whole dream thing wrapped in a tidy bow - including free college tuition and health care, jobs, even the down payment on their future homes, money for retirement and hard cash, taken in the form of taxes from rich people. Please take a moment to watch a worthwhile interview with the professor.

Pretty eye-opening, eh?

The point here is not complex, but it is important.

With the apparatus of state education over many years serving to bamboozle the populace into the hardened belief that government has a positive role to play in virtually all aspects of modern life, it should come to no surprise to anyone that, when push comes to shove, people are now trained to look to government to solve the problems - even when it was the government that created the problems in the first place.

Thus, confronted with the intractable mess they have made, these governments have to keep alive the mythology they have created about their omnipotence. Which is easier said than done, because with things now swirling fairly quickly around the drain, the mob is beginning to lose faith - and even patience.

Which puts these governments in a very tight spot, because the only way they can actually fix things is by doing exactly the opposite of what people have come to expect from their governments, which is always to do more. Put simply, the only hope now is that these governments begin to reduce their roles in their respective economies, and dramatically so. Concurrently, they have to encourage people in their aspirations to greater wealth, by lowering their taxes and unwinding the tangle of regulations they have created over the last half-century.

But if the governments actually tried to take these actions, the brainwashed masses would be positively befuddled then outraged, as it goes against everything they have been taught. Why, it would be like the Pope shuffling his way to the balcony of St. Peter's Basilica and informing the doting faithful that there isn't a god and never has been.

Riots would follow.

So it is that we find ourselves at a particularly interesting juncture in the historical record.

On the one hand you have a majority of the world's population who have been carefully schooled into believing that the institution of government holds the solution to all problems and is the source of succor to all who need it. (Even that subset of the populace who has lost confidence in their current government invariably believes as doctrine that the next and better government can change things for the better and lead the way to the shining castle on the hill.)

In this mix are the politicians and their functionaries, 99.99% of whom believe that, if for no other reason than their re-election prospects, they have to do something to meet the demands of the public.

Of course, under normal circumstances the "something" usually consists of making grand-sounding speeches and otherwise blowing smoke. Today that's just not going to cut it, for the simple reason that the crisis is real, it is spinning out of control, and it's not going to go away unless and until the markets are allowed to breathe again.

Which brings us full circle to the simple truth that the brainwashed public won't stand idly by while the politicians lower taxes and regulations on the profit makers or cut back state pensions and guarantees or otherwise reduce any of the many services the state has taken on itself to provide.

"Between a rock and a hard place" is an inadequate phrase to describe the situation.

Meanwhile, the mob has started to gather, their dark mutterings heard by the politicos who quickly don the red caps themselves, the better to be viewed as one with the people and join in expressing outrage against the capitalists who have been selected as fall guys in this unfolding drama.

When confronted by reporters about the fact that his 75% tax on high-income owners would raise nowhere enough revenue to offset France's towering debt and social obligations, Mssr. Hollande was heard to respond:

"It's not a question of return. It's a question of morality."

When coercion and theft are considered moral, anything is possible, and none of it good.

While I certainly can't say how this is all going to end, I'm pretty sure it's not going to end well.

[Was David's pessimistic view of the future shared by most of the experts who spoke at the just-concluded Casey Research Recovery Reality Check Summit? If you weren't there, you can still learn the answer to that question - an audio collection of every presentation is in progress. You'll hear every speaker… see every graph and chart… learn what the experts are recommending for your investment portfolio to help you survive and thrive during the coming deluge. The Summit Audio Collection will be available on CDs or in instantly available MP3 format - order your copy now.]

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

It seems that the mainstream investment community only takes a break from ignoring gold to berate it: one of gold's most outspoken critics, uber-investor Warren Buffett, did so recently in his latest shareholder letter. The indictments were familiar; gold is an inanimate object "incapable of producing anything," so any investor holding it instead of stocks is acting out of irrational fear.

How can it be that Buffett, perhaps the most successful (and definitely the most well-known) investor of our time, believes that gold has no place in an intelligently allocated investment portfolio?

Perhaps it has something to do with his mentor, Benjamin Graham.

Graham, author of Security Analysis (1934) and The Intelligent Investor (1949), is correctly respected as one of history's most knowledgeable investors. Over a career spanning 1915 to 1956, he refined his investment theories, in time becoming known as the father of value investing. Much of modern portfolio theory is based upon Graham's work.

According to Graham, while no one can tell the future, there are periods when the valuations of stocks and bonds would deviate from fair value by becoming excessively over- or undervalued. To enhance returns and reduce risk, investors should alter their portfolio allocations accordingly. A quick look at a long-term chart supports Graham's theory clearly shows periods when one asset class offered a better value than the other:

(Click on image to enlarge)

But what of the periods when both stocks and bonds stagnated or fell together? For much of the 1970s and again from 2001 through today, any portfolio allocated solely between stocks and bonds would have at best treaded water and at worst drowned in a sea of stagflation. To earn any real return, an investor would have needed to seek alternatives.

It's clear from this next chart that gold was exactly that alternative, a powerful counter-trend investment for periods when both stocks and bonds were overvalued. Yet gold is conspicuously absent from Graham's allocation model.

(Click on image to enlarge)

But this missing asset class is entirely understandable: for most of Graham's adult life and the most important years of his career, ownership of more than a small amount of gold was outlawed. Banned for private ownership by FDR in 1933, it wasn't re-legalized until late 1974. Graham passed away in 1976; he thus never lived through a period in which gold was unmistakably a better investment than either stocks or bonds.

All of which makes us wonder: if Graham had lived to witness the two great bull markets in precious metals during the last 40 years, would he have updated his allocation models to include gold?

We can never know.

We can know, however, that given Graham's outsized influence on investment theory, there is little question that his lack of experience with gold, and therefore its absence from his observations, has had a profound effect on how most investment professionals view the yellow metal. This, in our opinion, goes a long way toward explaining the persistently low esteem in which gold is held by the mainstream investment community. And, as a consequence, its widespread failure to even be considered as an asset class.

A couple of takeaways: first, perhaps now you can stop wondering why your broker, the talking heads in the financial media, and Warren Buffett continue to misunderstand gold as a portfolio holding. More importantly, however, is that in order to have sustained, long-term investment success, one must accept that an intelligent portfolio allocation needs to include not two but three broad categories of investment - stocks, bonds and gold, with the amounts allocated to each guided by relative valuation.

Investors who understand this tenet have an almost unfair advantage over other investors as it allows them to get positioned in gold ahead of the crowd and enjoy the bulk of the ride, while others sit on their hands.

So when you hear commentators ridiculing gold as a barbarous relic, lamenting that they cannot eat it or smugly asserting that it produces nothing, rest contently in knowing that they're operating with a severe handicap in their own portfolio. Meanwhile, we'll prosper, armed with the understanding that gold fulfills a very important and specific purpose in a portfolio, namely as real money that protects net worth during periods marked by excessive government debt and currency debasement such as we are currently experiencing.

Given the powerful influence of Ben Graham and his disciples, his curse on gold will not go quietly into the night. But it should.

David Galland is managing director of Casey Research, which provides independent investment analysis on a subscription basis to a global network of over 180,000 self-directed investors and money managers. Recognizing the emerging bull market in gold early on, in the late 1990s, Casey Research formed a metals and mining division that has grown into a leading provider of actionable gold and resource intelligence. For investors looking to become familiar with the asset category, Casey Research offers a monthly newsletter, BIG GOLD (try it risk free for 90 days), focusing on undervalued opportunities in mid- to large-cap producers, as well as best practices in buying, holding and selling precious metals. Learn now why it's more important than ever to invest in gold and gold-related equities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.