As inflation is worldwide the number one enemy for central banks, it has been subject to many controversial discussions about potential downward manipulation. True or false it is very often overlooked how beneficial inflation can be for the policy of central bankers. Inflation or the constant thread of inflation helps Central Banks actually to limit monetary growth and thus acceleration of higher inflation in the future.

The latest statement of the Bank of Japan to „increase money supply until inflation re-emerges" shows how desperate a country can become to ask for a little bit more inflation. This represents a very risky strategy as an unlimited expansion of money supply can lead to an outburst of uncontrolled inflation.

You may think Japan is an extreme case not very likely to represent any other country. Nevertheless, there are already many indications that the US economy is already in an early stage of Japanese style economic development. Very high economic growth, mostly financed by long term (M3 aggregate money) debt followed by extreme misallocation of capital (in Japan the property market and in the US the internet and telecommunication sector ) lead to a decline in corporate profits and subsequent a decline in stock market and corporate bond quality. The consequence of this decline is reduced economic activity which in turn triggers another decline in stock market and interest rates. A classical liquidity trap. Amongst other similarities US and Japanese interests are following (adjusted for a time lag of ten years) nearly the same pattern.

As the US economy now experiences just the early beginnings of a deflationary spiral, the odds are growing from week to week that we will experience strong deflationary forces in the next couple of years. This will put the FED in a very difficult position. Imagine inflation goes down to -2 % per year. What will the FED do then? Is it then possible to maintain interest rates of 4 or more percent? How will the FED explain to the public and to politicians that it will not decrease interest rates because of high monetary growth? Eventually it has to go down to very low rates, maybe even to zero. This will certainly increase money supply to unprecedented levels.

You think this will not happen in US. Think again? During the Great Depression this happened already and the FED rates have been closed to zero for quite a long time span.

The consequences will be today huge as we have nearly free movements of capital worldwide. How many investors would be really willing to invest in a dollar at zero interest rates? The dollar rates would be below gold leasing rates, this would have serious consequences on the gold prices. Worldwide monetary growth rates would be enormous as the low dollar rates would drag worldwide interest rates to record lows.

Now, imagine the US inflation is really manipulated. This would make the deflationary situation much worse. Much more money has to be printed until finally and hopefully inflation re-emerges and the risk for an outburst of inflation is then much higher than with an accurately measured inflation. So, authorities should be very careful what they wish for as an underestimated inflation entails a high risk of very high monetary growth thus leading to very high inflation in the future. Any possible manipulations of the inflation rate will therefore turn investments in precious metals much more attractive.

The scenario of a gold price rise is very often misunderstood. Gold rises exactly when interest rates and inflation are very low thus making the gold price a leading indicator for inflation. This is the time when money is printed and the future inflation risk is the highest. When inflation is already very high it is time to sell gold. Gold always works as a leading indicator for inflation.

As we will now very likely experience a period of very low interest rates and very high M1 monetary growth in the dollar, it is time to buy gold and precious metals. Last year we have warned investors not to go too early into gold and recommended instead palladium (North American Palladium PDL.TO) and natural gas (Courage Energy CEO.TO), which turned out to be a very good investment with over 100 % return. This year we think the current economic and monetary situation represents an excellent opportunity to invest aggressively in gold and silver companies. We are overweighed in Silver Standard Resources SSO.TO and Black Hawk Mining (BHK.TO), which are the more risky bets. Agnico-Eagle Mining (AEM), Goldcorp (GG) and Franco Nevada (FN) are more sure bets. Nevertheless, the last three companies have already a high market capitalization, which limits the future potential gains.

The only event, which could now really hold down a gold mining share rally is government fixing of precious metals, which is a realistic scenario. During the Great Depression (and after a gold rally), the government fixed the price of gold for a very long time. Let us hope this will not happen once again.

I look forward to receiving your comments

Dr. Heinrich Leopold
18 May 2001

hgleopold@yahoo.com

Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.