The Inflation Survival Guide

Editor's Note: Every day at DailyWealth, we hear messages like this one:

I'm worried about all this government spending producing rampant inflation... and ruining my savings.

And we've responded. Over the years, we've published dozens of ideas for fortifying your wealth against potential government inflation. But none of our contributors has thought more about this idea – or done more work on it – than Porter Stansberry.

For the past four years, Porter has been tracking what he calls "the End of America."

In short, Porter believes the debts assumed by the Western democracies will overwhelm their economies. This will lead to the end of the U.S. dollar's role as the world's reserve currency... And it will have a profound impact on Americans' standard of living.

For as long as he's been writing about the End of America, he's been showing his readers how to protect themselves.

So we've gathered a handful of his best essays on the topic. Each one shows you a simple, practical step you can take to preserve and grow your wealth in an inflationary environment. In these pages, you'll find…

If your No. 1 investment worry is how to stop government spending from destroying the value of your savings, this handbook is a must-read.

Best regards,

Brian Hunt
Editor in Chief, DailyWealth

Why You Must Buy Gold – or Even Better, Silver – Now

Many investors believe gold is a hedge against inflation. And that's true... but that's not the real secret of gold...

The real purpose of gold is to hedge against government hubris.

I won't get into a political analysis today – you get enough of that in the paper and on TV. But surely you can see that around the world, the role of government is at the top of a huge period of expansion...

Around the world, governments have promised their citizens a level of economic security in the form of pensions and health benefits they cannot possibly afford.

Today, not very many people understand the fallacy of these actions... or their inevitable collapse. But... over time... more and more people will begin to doubt the solvency of their governments and the practicality of their schemes.

If the government can't pay its bills... why am I saving its dollars? If I can't depend on the government to protect me and my family, how will I pay for protection... for health care... for energy... ?

When people have tangible evidence that something has gone badly wrong with the economy, they begin to hedge against it. They hoard real assets. Rich people hoard gold and silver.

Hedging is like buying life insurance. You don't buy life insurance as an investment, except maybe as a tax strategy... but that goes beyond this metaphor. In general terms, you buy insurance so that if something terrible happens, your family will have something to live on.

Likewise, you should have some exposure to gold and silver in your portfolio. And no, it's not too late to buy some...

What you want in a hedge is a lot different than what you want in an investment. With an investment, you need something that is stable, hopefully provides a yield, and isn't going to drive you crazy with volatility.

Silver is none of these things. But it is a perfect hedge because when things go wrong economically – when there's a crisis – the price of silver goes bananas.

Why? Because of the gold-to-silver ratio.

Historically, the price of gold has been around 16 times the price of silver. So in spring 2013, for example, based on the long-term historical average ratio, with the price of gold around $1,590, the price of silver should've been around $99. It wasn't, of course. It was around $29.

In this case, then, the silver ratio is more like 54. What explains the difference between hundreds of years of history and today? Simple – demand for silver as money. During periods of history when silver has been used as a currency, it has almost always been valued around 1/16th the price of gold.

When silver has been "demonetized," supplies soar as people sell silver for gold and currency. On the other hand, during periods of monetary crisis, the price of silver tends to increase far more than the price of gold as demand for silver is once again created by monetary needs.

This influences the silver-to-gold ratio heavily in silver's favor. For example, the ratio returned to its historic range (16) during World War I. It happened again in the early 1970s, when Nixon abandoned the gold standard. It also happened most famously in 1979-1980, when gold briefly soared to $800 an ounce and it seemed as if America was really entering a severe money crisis.

Silver is the best hedge against a money crisis because its price will increase many more times than gold as the gold-to-silver ratio reverts to its historic average. Silver will once again be worth 1/16th the price of gold.

Back in 2006, with gold trading for around $650 an ounce, I set a target at $2,000 an ounce. We're getting there. A $2,000 gold price divided by the historic silver ratio of 16 sees the price of silver at $125 per ounce. 

Given this perspective, I hope you see why silver's move from around $15 an ounce to around $30 in the last three years is only the very early signs of a money crisis. It's going much, much higher.

Even if you think I'm nuts, it's still a good idea to hedge your portfolio from the currency risks I believe are very real. You can do so easily and safely by taking a position in silver today.

A Safe Land Investment That Can Protect You from the Dollar Crisis

In the last four years, precious metals have soared.

They're soaring in response to a prediction I've been making since 2008 – that the U.S. government will do everything in its power to prevent a deflation in asset prices. This includes the shameless printing of dollars in order to prop up our rotted banking system... which is the plan.

As a result, gold – the "real money" wealth hedge – climbed from around $700 an ounce to $1,900 an ounce in three years. And while I'm a proponent of owning gold and silver bullion to protect yourself from a dollar crisis, there's another excellent way to get out of paper dollars and into productive, "real" assets.

It's a long-held secret of the world's wealthiest people...

Buy timber.

Timber has long been a hedge for the wealthy against inflation. In addition to providing good risk-adjusted returns, timber has also been a non-correlated asset. In short, when stocks fall, timber usually doesn't. And because you only have to cut down your trees when prices are good (timber doesn't spoil), timberland is generally a low-volatility asset.

The best way for individual investors to buy timber is through the well-established, large timber real estate investment trusts (REITs): Plum Creek (PCL), Rayonier (RYN), and Potlatch (PCH).

Because these companies are structured as REITs, 90% of what they make goes to shareholders in the form of a dividend. As of spring 2013, they all yielded at least 2.8%.

In terms of long-term performance, let's look at two five-year charts for Rayonier. First, we have the price appreciation of RYN (the black line) plotted against the Vanguard REIT exchange-traded fund (VNQ, the blue line). VNQ holds apartment, shopping center, and office REITs.

Notice the "boring" timberland investment has done far better than developed real estate.

​

Now, let's take a look at how RYN has done against the entire S&P 500 over the last five years.

Again, the dumb trees have done better than the smart people. Investors with RYN in their portfolio have done extraordinarily well.

With Fed Chairman Ben Bernanke ready to print as much money as it takes, it's vital that you have a portion of your wealth in crisis hedges... in real assets like productive land, gold, and silver.

Gold is screaming at you to do this right now. Start your crisis hedge program with gold and silver bullion.

And consider timber. As you can see from the charts above, it's a time-tested way to get out of cash and conventional equities and earn higher returns, with much less risk.

The World's Greatest Business in Inflationary Times

There's one asset class that appears tailor-made to thrive in inflationary times...

Make no mistake. I know how horrible the inflation I expect will be for most Americans. But all I can do about it is try to position my readers to keep pace with the inflation that's coming.

And these stocks are one of the best ways I know to do that...

There's a reason many professional investors, including myself, believe insurance is the best business in the world.

Few individual investors understand why this is so...

One of my overriding goals is to give you the knowledge I'd want to have if our roles were reversed. When it comes to insurance and insurance stocks, I can only beg you to pay close attention. I believe if individuals would limit themselves to only investing in insurance companies – and no other sector – they would greatly increase their average annual returns. There's no other sector of the market where I believe that's true.

There's a simple reason for this, which everyone can understand, immediately. It's completely intuitive. But I'm pretty sure your broker has never explained it to you...

Insurance is the only business in the world that routinely enjoys a positive cost of capital. In every other business, companies must pay for capital. They borrow through loans. They raise equity (and most pay dividends). They pay depositors. Everywhere else you look, in every other sector, in every other type of business, the cost of capital is one of the primary business considerations.

But a well-run insurance company will routinely not only get all the capital it needs for free, it will actually be paid to accept it.

The best insurance companies make sure the fees they charge for capital are in excess of the risks they accept by extending insurance. These companies actually make a profit on their underwriting. They earn money by taking the capital of their customers. It's incredible. These firms compound their equity by simply opening their doors every morning. They don't have to do anything else. Nothing else in business is like it.

As legendary investor Warren Buffett explained in his 2011 letter to Berkshire Hathaway shareholders...

Insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers' compensation accidents, payments can stretch over decades. This collect-now, pay-later model leaves us holding large sums – money we call "float" – that will eventually go to others.
Meanwhile, we get to invest this float for Berkshire's benefit... If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit occurs, we enjoy the use of free money – and, better yet, get paid for holding it.

The beauty of insurance is that you can get paid to use capital. That's a fantastic way to become very wealthy. And it's precisely how (along with several great stock picks) Buffett became the world's most successful investor.

The nature of this business gives Berkshire – and other insurance firms who can earn a profit with their underwriting and their investments – a truly mind-boggling advantage. And that's not the only one.

Their other huge advantage – and it's a doozy – is that they don't have to pay taxes on those underwriting gains for many, many years because on paper, they haven't technically earned any of the float until all of the possible claims on the capital have expired. So unlike most companies that have to pay taxes on revenue and profits before investing capital, Berkshire and other insurance companies get to invest all the float, without paying any taxes for years and years and years.

These companies, then, are sensitive to increased economic activity (which leads to more insurance being sold), interest rates (thanks to their float, they are extremely leveraged to the capital markets), and inflation.

Let's assume I'm right, and the value of the U.S. dollar is going to collapse. If that happens, the dollars these insurance companies are collecting in premiums today will be invested with the full purchasing power the dollar has now. But they will only pay out claims over the next 10 or 20 years... when the value of that dollar will have fallen by 50% or more.

This inflation/time arbitrage almost guarantees big profits for the entire industry.

The biggest gains will go to the companies that earn a profit on their underwriting – that is, they collect more in premiums than they pay out in claims. Inflation will make future claims more expensive. (Prices will rise and damages will rise with them.) But inflation will also push up the value of the investments the insurance companies make – especially those firms that make equity investments.

I'm telling my readers to buy insurance stocks because I believe inflation will increase the size of policies sold... increase the return on float... and enable these companies to profit from the time arbitrage of inflation. 

One of the Best Trades of the Next Two Years

The stage is set for a global financial reset...

The central bankers in the U.S. and Europe plan to use inflation to wipe away their bad debts. That is their only hope.

They believe they'll be able to control inflation... that it won't end up getting out of control and destroying the monetary system they've built.

I believe they'll be proven wrong... eventually. But in the meantime, we have a nearly risk-free way to make huge gains in bank stocks.

My thesis is simple.

Despite the ongoing financial problems in Europe, both the European Central Bank and the U.S. Federal Reserve have the ability (thanks to the printing press) to stop any run on the banks.

Their previous actions ("quantitative easing") have committed them to an inflationary policy to save the banks and continue the monetary system as it exists today. And that means the world's largest banks will keep getting bailed out via continuous manipulation of the money supply.

That's what happened in the U.S. in the fall of 2008 and 2009. And that's what has happened in Europe, starting in December 2011. These policies will cause the value of many assets to rise substantially. Inflation is the salve that heals all financial wounds.

Consider Miami Beach...

I bought a waterfront property there in February 2011 for around $400 per square foot. Those properties are now selling for more than $1,000 per square foot. I've already received one unsolicited offer for the property. That's one small example.

Rising housing prices in Miami (one of the worst-hit areas of the mortgage crisis) will flow through to the balance sheets of these banks. It will take time... but it will happen. And as the bad debts turn into performing loans and the value of the collateral rises... some of the huge write-offs that were taken in 2008 and 2009 will be reversed.

The coming inflation will also cause banks' net interest margin to widen. That's what determines how much cash flow and earnings they generate. It's the difference between what they pay to borrow money and what they collect by lending it. As long-term rates rise because of inflation, banks' profitability should increase substantially because the Federal Reserve (and the European Central Bank) has fixed short-term interest rates near zero.

These two factors – rising asset prices and increasing net interest margin – should cause the share prices of many banks to double (at least) through the end of 2013. And because many banks are trading for less than book value, you can capture profits without taking on much risk.

Now believe me... I know what the reaction to this idea will be... Most of my readers will never buy these banks – or any others. Some of you will even stop reading because I've suggested what is, in your eyes, heresy.

How could I recommend buying banks when I've been warning of a collapse in the faith of the U.S. dollar... and in 2011, was telling people to short banks?

I recommended shorting European banks in July 2011, when the European financial crisis threatened to boil over because the European Central Bank (ECB) resisted bailing out the banks as the Fed did here in 2008-2009. I reversed course and covered the short later that year. Then, following the huge ECB bailout of December 21, 2011, I changed my global view on stocks...

If the ECB is going to paper over the giant losses these banks face holding sovereign debt that's likely to default, shareholders face little risk and a much greater likelihood that inflation will propel asset values and earnings. Combined with the actions of the U.S. Federal Reserve (which is underwriting much of the ECB actions via swaps), this sets the stage for a global financial reset.

Please understand this... I am not in favor of these policies.

The inflationary path we are on will wipe out the middle class. Central-bank-created inflation enables speculators and Wall Street interests. It provides them with more and better ways to increase their wealth – via things like carry trades, leveraged buyouts, and net interest margin – at the expense of the entire nation.

These central bank policies and the resulting inflation will cause a huge rise in income inequality as real wages decrease and financial profits greatly increase. These policies will ultimately cause a severe breakdown in civil society.

This is how the "End of America" (a loss of confidence in our paper money) will develop. It's happened in dozens of other countries over the last few decades. It is the inevitable result of paper money systems and government-led central banks.

But thanks to these policies, you have a nearly risk-free way to make huge gains in bank stocks.

The Only Sure Way to Get Rich in Stocks

Most people think Warren Buffett became the richest investor in history – and one of the richest men in the world – because he bought the right "cheap" stocks.

Legions of professional investors tell their clients they're "Dodd and Graham value investors... just like Warren Buffett."

The truth of the matter is entirely different. And if you want to prosper during the inflationary crisis I see coming, it's critical you understand that difference...

Until 1969, Buffett was a value investor, in the style of David Dodd and Benjamin Graham. That is, he bought stocks whose stock market capitalization was a fraction of their net assets. Buffett figured buying $1 bills for a quarter wasn't a bad business. And it's not.

But it's not nearly as great of a business as investing in safe stocks that can compound their earnings for decades. Take shares of Coca-Cola, for example – they're the best example of Buffett's approach.

Buffett bought his Coke stake between 1987 and 1989. It was a huge investment for him at the time, taking up about 60% of his portfolio.

Later, other investors would bid up the shares to stupid levels. Coke was trading for more than 50 times earnings by 1998, for example. But Buffett never sold. It didn't matter to him how overvalued the shares were, as long as the company kept raising the dividend. Coke is currently paying out about $1 a year. Adjusted for splits and dividends already paid, Buffett paid less than $2 per share for his stock in 1988.

Thus, Coke's annual dividend, 24 years later, now equals 50% of his total purchase price. Each year, he's earning 50% of that investment – whether the stock goes up or down.

How could Buffett have known Coke would be a safe stock... and that it would turn into a great investment? Well, like Einstein said famously about God, Buffett doesn't roll dice. He only buys "sure things."

In his 1993 shareholder letter, Buffett wrote about his Coke investment and his approach – buying stable companies with the intention of holding them forever so their compounding returns would make a fortune.

At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it's usually poison for a corporate giant's shareholders if it embarks upon new ventures pursuant to some grand vision. We prefer instead to focus on the economic characteristics of businesses that we wish to own…
Is it really so difficult to conclude that Coca-Cola and Gillette possess far less business risk over the long term than, say, any computer company or retailer? Worldwide, Coke sells about 44% of all soft drinks, and Gillette has more than a 60% share (in value) of the blade market.
Leaving aside chewing gum, in which Wrigley is dominant, I know of no other significant businesses in which the leading company has long enjoyed such global power... The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage, setting up a protective moat around their economic castles.

Buffett is looking for companies that produce high annual returns when measured against their asset base and that require little additional capital. He is looking for a kind of financial magic – companies that can earn excess returns without requiring excess capital. He's looking for companies that seem to grow richer every year, without demanding continuing investment.

In short, the secret to Buffett's approach is buying companies that produce huge returns on tangible assets without large annual capital expenditures. He calls this attribute "economic goodwill." I call it "capital efficiency."

These kinds of returns shouldn't be possible in a rational, free market. Fortunately, people are not rational. They frequently pay absurdly high retail prices for products and services they love.

Buffett explained how another of his holdings, See's Candy, earned such high rates of return on its capital in his 1983 annual letter, which I urge everyone to read. In explaining See's ability to consistently earn a high return on its assets (25% annually, without any leverage), Buffett wrote...

It was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.
Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price.

That's the whole magic. When a company can maintain its prices and profit margins because of the value placed on its product by the purchaser rather than its production cost... that business can produce excess returns – returns that aren't explainable by rational economics.

Those, my friend, are exactly the kind of companies you want to own.

And... you especially want to own these stocks during inflationary periods. As things get more and more expensive in the coming years, capital-efficient companies will have to buy less than other companies, on average.

The result will be that inflation tends to lift their profits, rather than reduce them. In the inflationary crisis I see ahead, this is the single-best way for stock investors to grow wealth, rather than lose it.

Good investing,

Porter Stansberry