The message in the title above is one I have been proclaiming for some time now. I fully believe we are in a horrendous secular bear market for stocks and for asset prices in general. That longer term trend has, I believe not visible to most people because only recent experience takes on a sense of reality. So for example, there is a complacency in the markets now that did not exist in the winter and spring of 2009. Yet, if you take a look at the longer term picture, you see the pathology of our global economy continuing to play itself out. Unless we can keep from getting caught up in the moment and view what is going on from 32,000 ft. up, the secular direction of events is obscured from our vision. What we try to do in this newsletter as well as my radio show is provide the vision from 32,000 ft. up to help you see the longer term picture.

The ability to look at the markets from a longer-term perspective may sometimes keep us from enjoying short-term trading profits from time to time, but it should help us be on the right side of major trends in the markets. That is why I have spent so much time in this letter and on my radio show with folks who are rich in their understanding of history. Folks like Bob Hoye, Robert Prechter, Dr. Robert McHugh, and Ian Gordon all bring with them an ability to see present market action within the bigger picture and thus not get confused by momentary market moves.

All of the folks noted above and others not mentioned believe we are in a major secular bear market. Most who believe that also see deflation as the dominant direction of markets. That is, they see a contraction of credit being the dominant economic force for months if not years to come, whether or not that results in a reduction in price of individual items. With that contraction, Dr. Robert McHugh is suggesting a potential plunge in the HUI Gold Bugs Index. He believes, as do I, that the nominal price of gold may also decline. However, as I have been saying for a long time, I think this will pave the way for the “buying opportunity of a lifetime” for gold mining shares. I say that, simply because during these credit market implosions, the “real” value of gold rises and that leads to higher profit margins for gold mining operations.

Major credit market contractions bring with them a general collapse in asset prices as well as prices of items in the consumer price index in general. Given our view that the credit contraction has a long way to go, we think asset prices, starting with stocks, are likely to decline dramatically.

The dynamics of a credit contraction are outlined in the inverse pyramid chart shown on your left. This concept was first made popular by the great economist John Exter, who was a personal friend of the great Austrian economist, Ludwig von Mises. To a very great extent, Exter was an “Austrian” economist who mostly agreed with von Mises about economics, although I understand from a family member of Mr. Exter they did not agree on the concept of the inevitability of a credit contraction while central banks were pumping money into the banking system. Exter believed that, at some point in time, when the system became so encumbered with debt, no amount of money pumping could overcome deflationary forces of debt repudiation. In other words, Exter believed attempts to inflate the debt away, as Mr. Bernanke and central bankers around the world are now trying to do, was destined to fail.

The point of the inverted pyramid is this. When the credit system expands through lending, more and more money is put into less liquid and more risky assets, sending prices of items such as small businesses, real estate, gemstones, OTC stocks, and commodities soaring. But when the system hits a limit at which it can no longer expand because there is insufficient income to service the debt, those illiquid items at the top of the system are sold at fire sale prices in order to gain liquidity required to secure the most essential life-preserving items for individuals and corporations.

Believing as I do that we are getting ready for another major credit implosion and with it a major decline in stock prices, I also think items up the inverted pyramid, gold shares either in the “OTC Stocks” or “listed stocks” categories, are likely to get hit hard as well. This has been a constant view of mine which has kept me less bullish in the short term than I have been in the longer term.

You have most likely noted that the item at the bottom of the inverse pyramid is gold.  Gold is there because it is the most liquid and most solid monetary asset in the system, whether recognized by law or not. The item that is recognized by law, fiat money in notes, is immediately above gold. In other words, Exter saw most value flowing down the pyramid into gold when the system contracted, with paper money being the second-most sought-after store of value in a systematic credit contraction.

This is the primary reason why, as Bob Hoye has pointed out, gold’s real value gains during major credit contractions. Gold is the optimum liquid asset and so most of what was held of high value during the credit expansion flows back down the pyramid into gold when those items are sold off.  Paper money also increases, because, as Hoye points out, a gigantic short covering operation takes place with demand for paper money rising with the liquidation of illiquid assets to repay debt.