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Bailout May Undermine Goals of Investors
In effect, the government has nationalized the banking system and announced it will "print" or create all the credit necessary to get the economy going again. Money is fuel for the markets, and confidence is the pump that sends the fuel through the system. We're getting a big dose of both.

By Terry Savage

The president and his advisers have just announced the next step in their financial rescue plan. The market opened higher but has given up some gains, proving little except that volatility extends to both sides of the market -- up as well as down. Monday's dramatic record gain should serve as a warning that it is dangerous to change your investments in the midst of extreme emotion.

Today there is enthusiasm for a plan for the government to buy preferred shares in banks, guarantee short-term bank debt, have the Treasury buy commercial paper, and insure deposits even above the new $250,000 limit so companies with large payroll and other commercial deposit needs won't leave their local banks.

In effect, the government has nationalized the banking system and announced it will "print" or create all the credit necessary to get the economy going again. Money is fuel for the markets, and confidence is the pump that sends the fuel through the system. We're getting a big dose of both.

A major turning point

But for those with a larger perspective, today's announcement by the government borders on the unthinkable. We are living through the most dramatic restructuring of the American promise since the Great Depression. It will be interesting to see how this ends, and I don't have the temerity to predict.

One thing, it seems to me, is obvious. There is a frantic race between money going "down the drain" in our economic bathtub, and money being poured in full blast by the Treasury and the Federal Reserve. And there are long odds of them getting the balance exactly right.

If they err by creating too much money, we'll have inflation down the road. The gold markets are trading in a narrow range, trying to evaluate the possibilities. Behind the scenes (and this is a column I'm working on), gold coins are being hoarded by the public at a pace not seen before, even in the late 1970s.

In fact, back then the public dumped its long-held gold and silver coins, jewelry and family heirlooms, selling to get cash that could be easily invested to earn double-digit interest rates in the 1980s. Today, interest rates are at a very low point, a reflection of the scared money around the world rushing into U.S. dollars, which are perceived to be the safest investment.

How long will the dollar be a safe haven and will excessive money creation result in dollar devaluation (inflation)? Is gold just a relic of the barbaric past, too limited a commodity to reflect a huge global economy? Will a global recession, in spite of today's efforts, drive down commodity and energy prices for a long period of time?

These are the questions beyond the current "rescue mentality." Yes, first we need to get the global economy functioning again. So those questions will be deferred until markets rebound, banks start lending and global trade is renewed. But the long-term trends will have an important impact on your long-term plans!

Hedging your bets

For instance, if inflation is around the corner, you would not want to be invested in long-term, fixed-rate bonds. Inflation always brings with it higher interest rates to compensate for the loss of buying power when your bonds mature. Who would give you $1,000 for your old 20-year, 5% bond if newly issued bonds pay a much higher rate? Bond prices drop when interest rates rise. And those who seek a safe haven in higher-yielding bonds could find themselves facing market-value losses if inflation returns.

Gold is the historic "hedge" against inflation, a reliable store of value since gold can neither be created nor destroyed. But gold is a thinly traded market, a market that can move even more quickly and viciously than the stock market. One way to participate is to buy the exchange traded fund that represents gold bullion, the SPDR Gold Trust. Take a look at its long-term chart, though, to get some perspective.

Mutual funds that buy gold stocks have taken a drop recently, as global investors doubt the value of the precious metal in the midst of a predicted global slowdown. The advantage of gold-mining company shares is they typically pay dividends and are liquid, meaning they're easy to buy and sell. Owning a mutual fund that buys these shares gives you professional management and diversification.

Gold bullion coins, as noted above, have been in great demand. They trade on the price of gold plus a small premium and handling charge. The premiums have expanded lately to as much as 6% over the gold price. (Stick to 1-ounce gold coins, such as American Eagles or Canadian Maple Leafs.) And make sure the coins are safely stored in your safe deposit box. These are strategies I use personally and have owned long before writing this letter.

This is not an "end of the world" scenario for owning gold. If nightmares come true, and pray they won't, where would you run with your gold? This suggestion is merely an "insurance policy" against potential inflation, and the devastation it could wreak on the dollars you are saving. And if we escape that scenario, you'll have some lovely coins to remind you of these troubled times.

The vast majority of your long-term investments should be based on your belief in the future of our American economy, its long-term strength and ability to survive these financial shocks. While the markets may be volatile, our American ingenuity and innate optimism are unshaken. That's the basis for the best long-term investment -- the U.S. stock market. And that's The Savage Truth.

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