Today’s headline could just as easily have been “The Beauty of T-Bonds,” but we’ll get to that in a moment. I just wanted to make sure I had the attention of gold bugs, who have been on my mind lately. They have been a voluble and engaging presence in the Rick’s Picks chat room, concerned mainly with finding that so-far painfully elusive bottom in gold. For my part, I have preached caution on purely technical grounds, since I still have an unachieved target for the Comex December contract at $513, well below current levels.

But there is another reason I would urge caution, and it boils down to a single idea – namely, that in a deflation it’s conceivable that relatively few investors will be looking to safeguard their nest eggs via the purchase of chunks of metal priced at $1,000 an ounce. More to the point, there may be no savings left to deploy in bullion, since deflation will have wiped out most of what we consider “wealth” these days. Just a thought.

(Click on chart to enlarge)

‘No-Brainer Investment’

Yes, I’ve said here before that gold is the “no-brainer investment of our lifetime”. And so it has been, especially for anyone who became interested in the stuff when it was priced at $300 an ounce not very long ago. But if there is a reason to reconsider if not recant my words, it is the current onslaught of deflation in the housing sector. I am baffled as to why, so late in the game, so many otherwise intelligent observers can’t see it coming. But come it will, with the irresistible pull of a black hole. In the end, tens of millions of homes will be unsellable at anywhere near today’s appraised values.

Who will lose in the end? The lenders, would be my guess. Do they really want the keys to tens of millions of homes? Surely not. By and large, mortgages will be renegotiated downward without the nastiness of 30 million bankruptcies, and the legions of Americans who might otherwise have taken to the streets hunting for the perpetrators of the nation’s new bankruptcy code, will be mollified -- more concerned about joblessness than homelessness.

Deflation Math

I have long insisted here that just a small decline in home prices would saddle someone paying off a $300,000 mortgage with a financially fatal burden. In real terms, that burden is equal to the loan rate – say 5.75 percent – plus the rate of inflation. However, if inflation were to turn mildly negative, as it would in a deflation, and property values were to fall at a rate of, say, 5 percent per year – already a reality in many regions of the country -- then the effective real-rate burden on the homeowner would be upwards of ten percent.

Some of my logic- and imagination-impaired detractors have argued that few homeowners know, or care about, the real – as opposed to nominal -- burden of mortgage interest. Just so. But they will soon enough know, and care, about the distinction, I am quite sure. Meanwhile, what should the wise investor be doing? It seems obvious to me: buying Treasury paper. There is no call-risk, no coupon risk, no cash-flow risk – just a secure and blissfully predictable claim on an interest-bearing asset. Granted, today’s Treasury yields of between 4.5 percent and 5 percent may not sound very sexy, especially with 8,000 hedge funds out there still touting yesteryear’s impressive returns. But consider today’s seemingly modest Treasury yields in the light of what I have written above. The question then becomes, What is the real yield on a Ten-Year Note at 4.6 percent if asset values are falling by 3% to 4% a year?

It’s not as though the hedgies can’t do the math, or that they are unaware that the risks of a housing deflation are starting to trickle into the nightly news. And that is why Treasurys are about to blow through the roof, with smart money diving into zeros as though they were…gold. Bottom line: If you want to buy gold (or equity put options) as a hedge against possibilities I have left unimagined, then by all means do so. But consider doing it with a portion of the interest earned on your T-bond portfolio.