Current Reality:

Virtually all investors large or small, institutional or private, sophisticated or clueless have managed to weather the current tsunami in the financial markets. If they are honest, however, most would admit to having taken at least a haircut and a shave, if not a bath, from late September 2008 to the present.

The most recent period would have left most of us down by perhaps forty percent, or more. If we go back to current cycle highs of over a year ago, the financial destruction has likely been much greater and, depending on which asset class we dined on, the loss differential has been much greater or less than the average. For example, I am a commodities aficionado which means I got clobbered unmercifully.

We have all met our respective personal financial Waterloo unless we were sufficiently prescient to bail out somewhere along the way and parked our precious stash of cash in US Treasuries or money market funds. By virtue of significant recent USD appreciation, that move not only would have preserved our capital, but grown it significantly because of recent substantial dollar appreciation. While interest income on that cash would have been negligible, the recent decision by the US Treasury department to raise and broaden Federal Deposit Insurance Corporation (FDIC) deposit guarantees would have provided a most satisfying sense of security.

Such wise investors are now smugly perched on the financial sidelines carefully examining which beaten up equities and other investment products warrant their valuable and safe cash. Indeed, targeted purchasing of high value, but beaten down, equities at the present time will make these folks much richer down the line, thereby transforming these investors into icons whose opinions will be much sought after.

Most of us either were not that wise or lucky. We have been transformed from persons who evaluated investments based on prospects for capital appreciation and dividends into chastened persons who find our highest priority is now the investment which preserves what remains of our not so carefully husbanded savings. We have lost so much in such a short period that the option of whether to sell out or to wait it out has foreclosed on us. Heck, with the market bottom getting near, there doesn't seem to be much sense in bailing out now, is there?

Rather, we watch CNBC's perpetually positive talking heads and conclude that happy investing days are clearly evident on the financial horizon. On the other hand, if we read widely we see facts are constantly marshaled to support all manner of economic and financial opinion and forecast. Much of it suggests that the largest installment of the economic, if not the financial, Armageddon lies ahead.

So what is an investor, who has been severely chastened, to do now?

The Period Immediately Ahead:

Let's assume that a) the forced selling by leveraged hedge funds and individuals is nearing its end, and b) year end selling for tax loss reasons doesn't have much longer to run either, and c) a lot of cash is on the sidelines parked in Treasuries and money market funds, and d) that the US dollar has recently appreciated dramatically. There is no compelling reason to believe it will rise any higher but more likely dollar fundamentals will reassert themselves shortly, causing the dollar to inevitably resume its downward trend.

In other words, the time seems ripe for a significant bear market rally in equities. Why not? Many agree that the markets have been oversold and much value is present at these price levels. Surely value investors like Warren Buffett have imitators and believers? Early in 2009 we therefore should see significant and sustained increases in the price of a broad cross section of equities.

Will that rally last and signal the end of declining share values? Does a meaningful stock market rally mean the financial markets are signaling that the economy and the recession will be ending before too long? It is a fact that a rising stock market is a leading indicator suggesting future vitality in the economy. However, few believe the next rally in the stock markets signals the end of the current deepening recession. The damage to the real economy has not yet begun in earnest. Until the pain of economic recession is seriously reflected in rising unemployment, lowered GDP and other negative measure of economic illness, there is little prospect that an economic recovery is about to begin.

So what is an investor to do? Value investors should use the current period to buy stocks with great fundamentals, superior management and prospects at current prices. Such stocks should be held rather than traded. This is especially true with equities in the resource sector since they have been beaten down to levels previously unheard of. They are keepers whose quality should be treasured. They will become star performers during the next period of economic resurgence. Having spare cash to purchase these gems and the patience to give them time to perform is all that is required.

The other action to take in the next rise in the equities market is to use it as an opportunity to "ditch your dogs." Most of us got stuck with some of these stinkers as the recent market decline rushed past us to the downside and into the trenches. We stood by motionless and unwilling to allow ourselves to sell them. If we intend to right the wrong of this missed opportunity, we must remain vigilant to take the first opportunity to sell into a rising market.

Cash from the sale of these mainly motionless equities with little future potential, should be kept handy for the first opportunity to acquire under priced high value gems in the right sector. That time will arrive down the road simply because no sustained rise in the markets will take place until near the end of what is likely to be a deep and elongated economic recession.

Because the economy will continue to trend further into negative territory, we should not be too quick to assume an end to this growing recession. Once rooted, an economy caught in a deepening and lengthening recession will not readily return to health. Why is that?

The deeper and longer the succession of bad news, a kind of self reinforcing attitude develops among workers, investors and the general populace. While the media is usually a potent force for optimism in normal times, it can do the opposite in times of turmoil. A constant parade of pictures and voices exhibiting defeat could become the dominant theme. Of course the facts depicting unemployment, shut downs, layoffs, deficits, debt and statistics of all types setting modern records on the downside is seriously depressing for almost everyone.

Factors Directly Affecting Your Investment Decisions:

I sense that late 2009 or early 2010 will mark the trough or bottom of this recession. That is by no means a given, but it also likely portends the economic recession could become an elongated "U" stretching out in time from that point. Most of us will become accustomed to a constant stream of bad news and will have lost any residual sense of optimism. We may well have hunkered down for the long term. Many will have caused themselves to believe that the recession is the new norm...a permanent condition.

Central banks and governments everywhere will have been using the same game plan for dealing with the problems of financial institutions and the general economy. Words and terms like rescue, bailout, assistance, help and stimulus will have become common and vastly overused.

Money, liquidity, reflation, credit will have become the unifying theme...borrowing, lending, granting and creating it. Little attention will have been given to raising taxes simply because that would be considered a giant wet blanket to a global economy showing only tentative signs of recovery.

Instead, money in various forms will be borrowed and then lent at nominal interest, invested or given to any and all to stave off insolvency and to stimulate demand. Interest rates will continue to be set below prevailing inflation rates justified on the grounds that all barriers to its use must be lowered or removed. Moreover, deflation fears will have totally replaced concerns about inflation. Asset prices will continue to drop causing many to see parallels to the Great Depression of the 1930's and the most recent fifteen years of Japan's sputtering economy and financial markets.

These realities will become the primary justification for turning up the flow of money, both borrowed and newly created. Creation of money and its distribution in the forms of bailouts and stimulus will be done with abandon for the simple reason that central bankers and debtors become paralyzed with fear at the prospect of deflation. Politicians and governments generally will cheer them on as if rooting for the home team. Voters will be conned because they will see and hear news which universally endorses this one way bet.

Of course everyone who advocates unlimited money as the solution to all and sundry financial and economic problems will do so with equanimity. Why? Because it will seem as the correct medicine du jour for the most serious of problems, and even better, it will be done with impunity. In their minds there will be absolutely no prospect of inflation on the horizon. Nonsense!!

Do you sense something familiar here? Remember that a primary cause of the current recession was excessive credit and interest rates lower than the prevailing rate of inflation. In other words, the "easy money" which helped to precipitate this crisis, is again being used to fix it. Let us dredge up yet again Yogi Bera's popular phrase, it is "déjà vu all over again."

The inevitable result? Inflation leading to hyperinflation. That predictable consequence is what all investors must be most conscious of. It is the guaranteed end result of flinging money in unlimited quantities at all and sundry heading like lemmings inexorably toward insolvency. Think GM, CitiBank, AIG, Freddie Mac, Fanny Mae and the myriad of other institutions "too big to fail" and who have impressive political advocates and lobbies saying so. Unfortunately, fixing the economy is every bit as much a political process as a financial one.

Governments everywhere are overextended. Accumulated Debt as a percentage of their annual Gross Domestic Product (GDP) is well beyond the sign post warning of imminent financial crisis. Current US Debt is over $11 Trillion, twice the level it was as recently as just eight years ago. The US annual Budgetary Deficit is predicted to be in excess of $1 Trillion for the current year, three times what it was last year. Add in another projected annual deficit of $1 Trillion for what is called the Trade or Current Account Deficit.

However, as terrible as a $12+ Trillion debt is, Unfunded Liabilities are the ever present slow moving tsunami which few politicians dare mention. This is an obligation, a commitment, a promise, a debt, which is not counted in official statistics or in formal budget reports. In private sector accounting it would not be ignored because the rules demand that it be tabulated and publicized. This number pretty much represents all of the future obligations, sometimes called entitlements, to the citizens for such items as Social Security and Medicare. The respected President of the Dallas Branch of the Federal Reserve Board, Richard Fisher, claims that this number now totals $99.2 Trillion! That's $99.2 Trillion, not $9.92 Billion!

Assuming this is a valid estimate of future obligations, it is probable that the United States is insolvent. It would be bankrupt if it was to be formally acknowledged. This issue is crucial because money spent for the purpose of fixing the current crisis in the financial sector and the growing deterioration in the economy, is mainly additional borrowed and newly printed money.

New digital dollars dilute the money that already exists, thereby devaluing all money. In other words, money just does not buy as much as before. Should we be concerned that the preferred fix for the current crisis could make the patient's condition even worse in the future? Of course we should. Monetary inflation is currently taking place with an unprecedented vengeance by means of the FED doubling the amount in its till from $1 Trillion on Sept 24th at the start of this crisis, to $2 Trillion as I write. The Dallas FED suggests it will be $3 Trillion by year end. In 2009 the pace is guaranteed to accelerate.

Not only does the currency become devalued by monetary inflation, but price inflation follows on its heels. While price inflation is what most people think when they think of inflation, the core cause of price inflation is monetary inflation. Monetary inflation is the principal tool being used by the FED and the Treasury department to fight the current economic crisis. Is this a problem? You can place your bets on the fact that it will become our future reality.

All investors must be alert to this monetary inflation and to the sequence of negative consequences which will follow. Smart investing will anticipate a devaluing currency and price inflation over the immediate horizon. Asset price deflation is only the current and temporary reality.

What Does this Mean for my Investment Strategy?

Simple. Considering the creation of unlimited digital dollars is indeed guaranteed to be an ongoing process, inflation leading to hyperinflation is the undeniable consequence. That also means that an increasingly devalued dollar lies ahead.

Inflation and a devalued currency mean that investors should realize that, in times of declining confidence, tangibles are the investments of choice. The list is topped by precious metals both in the form of the metals and mining stocks. Energy, agricultural commodities and other key resources should also top your list. Even the best of beaten down real estate should be given serious consideration.

So if you have cash now, start picking up some of the value gems which have suffered price markdowns of as much as 80 percent. Secondly, use the next bear market rally to dump your dogs. Use the proceeds on pullbacks to buy value equities you have been lusting after. They come in the form of stocks and long term warrants in the resources sector.

If we do this we will have salvaged much of the loss we currently face. We will have also positioned ourselves to experience fantastic capital appreciation and income on those new and improved investments.