Which Stock Investment Decisions Will You Make in a Credit Depression?

The Scariest Chart in the World…

Not everyone knows it’s a credit depression yet. But show them the chart below and they’ll start to get the drift. We published it in our most recent issue of Australian Wealth Gameplan. It shows the amount of tradeable US government debt that must be refinanced over the next four years. It also shows that nearly 60% of total US tradeable debt outstanding – or $5.6 trillion – must be refinanced in the next four years.

US Debt Refinancing About to Hit a Wall

US Debt Refinancing About to Hit a Wall
Click here to enlarge

Where is that money going to come from?

And what stock investment decisions will (at the very least) preserve and (ideally) grow your wealth?

When you look at a chart like that, and factor in what’s going on in Europe with its “fiscal integration”, plus think about the OECD numbers, a couple of conclusions become apparent. Those conclusions are: a) government debt is no longer risk free, b) bank failures resulting from bond defaults by governments will feed asset deflation and lower stock prices, c) real money is better than unsound money.

You might disagree with these conclusions. But if you agree with them, it makes your investment decisions easier. Your first and most important decision must answer this question: what asset class is the safest place for my wealth, given the current environment? After you answer that, you can decide when you want to take a position in that asset class, or build on it.

Notice that stock selection is not at the top of the list of decisions you need to be making. If the conclusions above are correct, you’ll own fewer stocks, have more cash, own high-grade corporate debt, and some precious metals investments, which include a combination of bullion, coins, and shares. This is roughly the strategy we’ve recommended in the Permanent Portfolio.

Most balanced Aussie superannuation funds have at least 50% of their assets allocated to shares. That’s during a bear market, by the way. But let’s leave aside the size of the allocation to shares and concentrate on what shares you should be in. Should you go for safety and dividends or capital gains?

Well, as we wrote a few weeks back, we reckon the market will start seeing a shift toward the safe, dividend-paying shares. These are the companies that have durable business models, which don’t include increasing earnings by borrowing money. Before the credit bubble, reinvested dividends were the key factor that made stocks as an asset class a better performer than any other over the last 100 years.

But if you’re not going for relatively safe dividend payers, like the ones Greg Canavan has in the Sound Money. Sound Investments portfolio, what’s worth taking a punt on? Well, in our view it has to be something that justifies the risk of being in shares at all. In other words, it has to be something that can go up a lot.

In 2011, our best investment idea for “stocks that can go up a lot” was in shale gas. The shale gas industry has allowed the US to become a net exporter of fuels for the first time in 62 years. On Friday, the FT reported that China has hit it in big in shale gas too. PetroChina has begun drilling in 20 exploration wells in southern Sichuan province.

China has 1.275 trillion cubic feet of recoverable shale gas, according to the US Energy Information Administration. We quoted that same study in our Revolution in the Desert report earlier this year. Australia’s shale potential is considerable, too. Perhaps that’s why the three shale plays we recommended are up 67%, 82%, and 85% respectively. Those seem like the kind of shares worth owning in a bear market.

Now, if you’re one of those investors who consider investing in shale gas companies to be unethical, and have lost all respect for your editor for being associated with the whole idea, then we have a solution: watch Dr. Alex Cowie’s latest video presentation. He’ll tell you about his top ideas for 2012, and we’re pretty sure shale gas isn’t one of them.

Alex spent the last 12 months shaking the trees all over the world, looking for a particular kind of resource company. He’s been travelling so much we hardly recognise him when he makes a rare office appearance. But from his reports, we can tell you that he’s taken the view that the deflation in financial asset prices needn’t be a death sentence for resource investors.

In fact, there are some key commodities that will directly benefit from the continuation of Europe’s monetary crisis. Please note, if you’re already a Diggers and Drillers reader, you can skip the presentation. You’ve already read about all the companies Alex discusses in his report.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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