A deflation strategy

Question: What is the best strategy to preserve the value of a RRSP invested in mutual funds (50% bonds, 50% stocks) if deflation takes hold? – P.S.

Answer:

Deflation is an economic condition in which prices decline rather than rise. We have not experienced it in North America since the Great Depression, however Japan has been coping with it on and off for more than a decade. If deflation takes hold here (which is only a remote possibility), many widely-held assets will drop in value, including stocks and real estate. The best strategy to preserve assets during such a period would be to have most of your money in government bonds, gold, and cash – in a deflation, cash will actually increase in value in purchasing power terms.

Interest rates would be even lower than they are today in such conditions, so government bonds wouldn’t provide much of a return. But in deflationary times, preserving what you have becomes top priority. Gold is recommended because it is seen as a universal store of wealth and as a safe haven during a financial crisis.

Having said this, I would not advise you to rush out and convert all your assets tcash, bonds, and gold just yet. If the economy turns around later this year, we could be looking at a very different picture in 2004.

If you would like more insight from a fund management company that takes a very defensive posture because of concerns about the type of scenario you describe, check out the website of Sprott Asset Management at http://www.sprottassetmanagement.com and read their commentaries. The Sprott Canadian Equity Fund was chosen as Fund of the Year in my 2003 Buyer’s Guide to Mutual Funds. – G.P.  (July 2003)