Deflation or inflation, gold is as good as it gets, according to Jay Taylor. Jay, who developed the J. Taylor's Gold & Technology Stocks Model Portfolio, has established an enviable track record in the markets. In this exclusive chat with The GOLD Report, Jay talks about what economic insights he's gleaned from guests on his radio show, Turning Hard Times Into Good Times, and how owning gold shares can be advantageous in a deflationary period.

The Gold Report: Jay, since your radio program, Turning Hard Times Into Good Times, started 13 weeks ago, you've had lots of very interesting guests. Care to share some of their perspectives on the state of the world economies?

Jay Taylor: Yes, we've have had a lot of very interesting guests who have provided some great insights into the markets, and I believe, profit-making guidance going forward. Most of the people that I've had on my show really believe that America's economy is in big trouble and will remain in big trouble for some time to come because of two factors. First, as a country we have lived beyond our means for many, many years. Second, there is a general belief that the massive bailout programs of the Bush and Obama administrations are ill advised because they foster the survival of inefficient, sick companies, financial and otherwise. I would say if there has been a theme among my guests it is that the U.S. is in deep trouble financially because of those factors.

A second major theme has been deflation. We've had people on our show like Dr. Robert McHugh, who I think does excellent work in Elliott Wave analysis. He's been spot-on in his calls on the market; he's basically a deflationist who thinks we're going to see a huge decline in the equity markets. Bob Hoye, a very, very savvy analyst who writes a newsletter called Institutional Advisors for bank trading desks and CEOs of large companies, also points out that we are in the contraction phase of a major credit expansion and although he doesn't use the word deflation, he expects a continuing credit contraction, which points towards more deflation.

TGR: So as far as themes, we're hearing hyperinflation and major deflation. How does an individual investor try to determine what's going to happen in the next couple of years?

JT: That's a very good question and I think a most crucial one for investors because it has everything to do with the sectors where you invest your money. I put together my Inflation/Deflation Watch (IDW), which is largely comprised of leading indicators such as stocks from most of the major sectors and countries around the world. Also in my IDW are commodities, currencies and bond prices as well as gold/silver and gold/commodities ratios.

At the moment, we are seeing some relief of the deflationary pressures that commenced last fall with the collapse of Lehman Brothers. However, I think this bounce up, which Dr. McHugh labels as the B-Wave up, following the initial A-Wave down last fall, is merely a natural correction of last autumn's decline. So now, we are in this B-Wave up that McHugh expects will continue probably up to or around the third week in September. Following that we believe all hell could break loose to the downside in the equity markets.

We say that because most of what is driving this current bounce higher is artificial and based on the speculation of green shoots and not much more. There are huge amounts of money that have been pumped into the banking system from all these bailouts. But this move higher has only been a result of professional speculation. Market pros have to put their money to work in one way or another, or they lose their jobs. So you have pension fund managers, hedge fund managers, and the mutual fund guys having to do something with the money they have as per the stated purpose of their funds. So stock and commodity prices have risen during this B-Wave up. But unless we see end demand from consumers and sustainable global economic growth, I don't think this is going to continue because there will be no fuel to keep yet another bubble suspended. So this autumn, we suspect we will get yet another market disaster, this one being even worse than last autumn.

The real problem is the American consumer. He is flat on his back. That had been predicted for many, many years, but he just kept on spending and the reason he kept on spending is because, compliments of the Federal Reserve, liquidity was pumped into the system. So banks mindlessly lent to consumers until a debt-bloated consumer asphyxiated himself. Can the Chinese pick up the slack caused by the death of the American consumer? Perhaps in time they can, but they clearly are not able to do that yet and we're seeing signs in China of some very, very major socio-economic problems there as well.

And I think we are going to see some more big problems in the housing market and the commercial real estate sector is reportedly in big trouble. I don't see the growth in jobs in general manufacturing in the United States. Those basic wealth-creating jobs in the U.S. are basically gone. So I think the global economy has a huge adjustment process ahead and it's going to mean that the West is going to be less well off; it's going to be a readjustment of relative wealth toward the East. However, that process is just beginning. China and other developing countries are a long ways from consuming enough to make up for a lost American consumer. So I think fundamentally, things are playing out for Dr. McHugh's C-Wave down that he describes as a cataclysmic nation-changing event to correct the bull market that started in 1718!

TGR: Jay, you're saying there's deflation, but there's also a potential of inflation. Is there a way an investor can hedge those two potential outcomes at the same time?

JT: There is a way to hedge both sides and that's with gold because gold will do well in either event. Gold mining shares, however, will do better in a deflationary event, but that's another topic. As long as I'm convinced that we still have some upside, since we're in this B-Wave up period, which is a correction of the A-Wave down last fall, we have some inflation plays in our model portfolio.

We have some uranium shares and the uraniums have been hot as a pistol this year so far, although they've backed off a little bit in the last couple of trading sessions. We also have some oil and gas, which I consider an inflation hedge. And, of course, we have gold and gold mining shares and they've all done very, very well. So what we'll do is lighten up when we think that B-Wave up is over and we're going to start heading down again. Then what we'll do is take off most or all of our inflation hedges and we'll probably get a little more aggressive and maybe buy an ETF that shorts the financials because I think that's still where the most risk is in this economy and this market.

TGR: Can you give us some of your perspective on how gold or gold mining stocks should be used in an investor's portfolio?

JT: To answer that question, you need to recognize gold clearly is money. Aristotle recognized that gold has all the properties to make it ideal as a medium of exchange, a barter instrument and a store of value. Thus gold is different than all the other metals.

Given its monetary characteristic, gold has an advantage over everything else is in a credit-contracting deflationary environment. The reason for that is that most other metals derive their value from industrial applications rather than monetary applications. So when you have a global deflation and a contraction of the global economy, which we have right now, you have less demand for the base metals. You have less demand even for silver, which is, to a much greater extent than gold, an industrial metal, although it is also a monetary metal. At the same time, during these credit contractions, the fiat money system, which is a liability-based system, comes under strain, making an asset-based money system look very appealing.

Those dynamics were demonstrated in the 1930s because the real price of gold rose because as an ounce of gold would buy lot more during the '30s than it did in 1929 before the Crash. But we've also seen it last fall following the Lehman Brothers collapse. We've seen an increase in the purchasing power of gold relative to oil, copper, and labor. Labor for gold mining companies has become much more abundant. Why? Because many of the base metal mines have closed or have reduced their operations. So gold gains in real value during these major contractions. That is an insight Bob Hoye brought to my listeners on my radio program and he writes about it constantly in his newsletter. (By the way, Bob is going to become a regular contributor to my weekly show.)

This will be the sixth major credit expansion and contraction in the last 300 years. In each case, when the contraction phase of this major cycle takes place, gold gains in purchasing power. So you could have the nominal price in gold stay where it is or even come down some and actually gain in purchasing power, gain in value, in theory. Now, will that happen? I don't know. I don't expect it will. I think more than likely we're going to see gold rise even if everything else falls for various reasons.

I think that gold is where I want to be, especially given my deflationary views. Gold is also a good store of value during an inflationary period, but gold mining may not do as well during an inflationary period as it does during deflation because rising costs of producing gold during an inflation may crimp gold mining profitability unlike periods of deflation when the real price of gold rises relative to the cost of producing it. Indeed, following the collapse of Lehman Brothers last autumn, which brought about plunging energy, materials and labor costs, we have seen some improvement in gold mining operating profit margins. Certainly, during the 1930s deflation, Homestake Mining was a tremendous winner. If you had 15% of your portfolio in Homestake and 85% in the Dow, you would have avoided losing money during most of the 1930s.

The American public has been duped and manipulated into believing in Wall Street's products. But the masses are slowly waking up to the fact that Wall Street's paper products and fiat money in general are a sham. Eventually there is going to be a mass exodus from paper money to gold.

Indeed, the mainstream is catching on. I think it is very significant that Northwestern Mutual just reportedly purchased over $400 million worth of gold. A mainstream insurance company like that is starting to recognize the value of gold in its portfolio. The president of the company talked about how they have some stocks that have lost 95% of their value. He reportedly said, Gold would have to fall to $50 to compare to some of our stock losses and gold is not going to go to $50.

When/if we see a mass exodus from paper, the price of gold as quoted in hugely inflated dollars is anyone's guess. The only thing I think you can bank on is that the price will be quoted in four or five digits, not three.

TGR: So gold mining shares do even better than gold bullion in a deflationary environment because gold mining profits tend to rise in that environment. However, now we have seen many of these mining stocks increase tremendously since March of this year. Are there still upsides to these stocks?

JT: Longer term I think there's a lot of upside and I'm looking at a lot of companies that are emerging producers. They're my favorite category. The bull market started in 2002, so we're six or seven years into this bull market and that's enough time for many of these junior mining companies to have expanded, develop their projects, and take them into production and we're seeing a lot of companies that are now starting to produce gold.

I think a lot of these companies are going to surprise people on the upside as some of these new producers cut costs and expand production. And because Wall Street has truly not yet focused on gold and gold mining, I think the P/E multiples for gold mining firms are likely to rise dramatically as gold mining will be one of the few industries sectors showing increased earnings during the dismal days ahead for our global economy.

So, yes, I'm extremely bullish. I think there's huge upside potential, especially if the real price of gold rises dramatically in this credit contraction. But one cautionary note is in order. When that C-Wave down comes in the fall - and I think it will come - then I think in the near term you could have a very dramatic decline in the price of most if not virtually all of these gold mining companies. So I'm telling my subscribers they should think about taking some profits off the table now and into this last stage of the B-Wave up, especially in some of the inflation plays like oil and gas and some uranium stocks.

We are even suggesting some of the gold shares be sold now to raise cash in anticipation of much lower prices after this fall's decline. We want to raise cash for three reasons. First, we want to buy a hedge instrument such as the Prudent Bear Fund or a double down S&P such as ProShares UltraShort S&P 500 (SDS) and thus profit from the equity market decline by shorting the market. Second, as noted, we want to buy gold shares at a much lower price following this fall's decline. Third, we think somewhere ahead there is going to be a major turn downward in the long-dated U.S. Treasury markets, so we want to have money available to short that market, perhaps through an ETF like TBT.

TGR: You mentioned there's a lot of upside in the emerging producers. Are there some emerging producers you're following that you could share with our readers?

JT: There are quite a few of them. One would be ATW Gold Corp. (TSX.V:ATW). It's producing gold in Australia and it's got one mine in production and it will certainly have a second. They're not a large producer right now, but it looks like they should be very cash flow positive, producing profits from two different mines very soon, with huge exploration potential. So that's the kind of thing I like. If you can find an emerging producer that doesn't have to go back to the equity markets and raise more capital to put drill holes down, but has cash flow from operations that it can expand, and it has huge exploration potential, then that's what I like to see and ATW Gold Corp. is one of those companies. Another one, a small producer that I like a lot, is Castle Gold Corporation (TSX.V:CSG) . Castle Gold is very much in the same position. It's a relatively small producer in Mexico, but with good growth potential, producing gold at about $450 an ounce.

And Apollo Gold Corp. (TSX:APG) is perhaps my favorite gold stocks. The company should produce gold at the rate of about 150,000 ounces per year at a cash cost of under $350 from its Black Fox property in Ontario. But where this story gets really exciting is in the blue sky potential it holds. The company just reported some drill results from the Grey Fox property, which is located 3.5 kilometers away and along strike with the Black Fox. The assays suggest an even higher grade for open pit mining than at the Black Fox mine where current production is taking place. And what is really exciting was an 11 ft. intersection grading 13.25 ounces per ton!

It is my understanding that geologists believe this high-grade mineralization might represent a new geological event. In other words, it is possible (though yet to be proven) that a major high-grade gold discovery may be in the making for Apollo Gold. If that isn't enough, it is my understanding that Apollo has been busy locking up ground along this gold-bearing trend, giving the company the potential to develop a major world-class gold mine. So, the combination of cash flow from production now, combined with recently exciting and very promising drill results and very considerable grass roots exploration potential, all combine to make this one of my top picks right now.

San Gold Corporation (TSX.V:SGR) is certainly another one of my favorites because it has a major discovery called the Hinge Deposit and I think San Gold could really rise very dramatically as a result. They're in production, still not making money, but are more or less breakeven on a cash flow basis. But they're going to start feeding in this extremely high- grade Hinge Deposit material within the next few weeks, I believe, and when they start to do that, I think we're going to start to see some positive cash flow. But the big news there is they have what some people are suggesting could be another Red Lake discovery. Red Lake was the company-making gold deposit for Goldcorp.

I might just mention one silver play that I like a lot, Great Panther Resources (TSX:GPR). I'm not as big on silver as I am on gold, because as someone who believes we have big deflation problems ahead of us, silver generally doesn't perform as well as gold because silver has more of an industrial component to it. That said, however, Great Panther is now a profitable company. It's making money in its two silver mines in Mexico, and has huge exploration potential. It's got a third project that, if it goes into production, will make this one of the larger silver producers.

So those are some ideas in terms of producers, which as I said, are among my favorite categories. I also follow many companies that are nearing production or have advanced stage projects but are not quite there yet. One of my favorites in that category is Pediment Gold Corp. (TSX:PEZ) (OTCBB:PEZGF) (FSE:P5E). They've got a couple of projects that are advanced stage in Mexico that I think could be in production within a couple of years. One was a former producer that could be put back into production first.

TGR: Do they have the cash in the bank to last those two years?

JT: They have a good cash hoard, around $15 million. They did a good job of raising capital when their share price was higher and they have Chester Millar and some other very good people working with them as well. I think that's a company that's likely to be successful. So I like Pediment a lot, too.

I also really love Hawthorne Gold Corp. (TSX.V:HGC). You've always got to look at management. Hawthorne has Richard Barclay and Michael Beley leading the charge. Those two fellows are the senior members of this management team. They were instrumental on the technical side in putting both Bema and Eldorado on the map as gold producers. And they acquired the Table Mountain high-grade gold property, which I've known for years because I followed the company called Cusac Industries that had it before. Hawthorne acquired Cusac and with it has acquired all the permits in place to start production. They expect to put this mine back into production later this year. With a grade of about one-half ounce gold/ton, it should throw of a good amount of cash that can be used to explore and develop a couple of world- class low-grade gold bulk tonnage targets. All of this company's operations are in politically safe B.C. I think this management team is likely to succeed again and if they do, this penny gold stock will make some wealthy shareholders.

TGR: Jay, any final words you'd like to give to our readers?

JT: No, other than just that I think people need to be cautious right now, and not be swayed by the mainstream media to get back into the equity markets. Be very, very careful because Wall Street and their propaganda tools like the major media networks are helping them sell increasingly worthless paper instruments. Wall Street can't create gold or silver, which are real money. They can create fake money - paper money - and they like to sell you products made from that. It's buyer beware and that is exactly what I try to do on my radio show. Make buyers beware of the horrendous downside to this market as well as ways to make a profit. But as I said, for the most part, gold is where I want to be.

I personally and/or my family own the following companies mentioned in this interview:Apollo Gold, San Gold, Hawthorne Gold

I personally and/or my family am paid by the following companies mentioned in this interview: None of the companies have paid me or my family anything for recommending them in my newsletter. All of them have purchased a reprint of reports written for my paid subscribers or have become sponsors on my radio show.

A baby boomer born in Ohio, Jay Taylor was drawn to the world's financial capital in 1973, when he went to New York to work for Barclay's Bank International after earning his master's in finance and as he followed the demolition of the U.S. gold standard and the rapid rise in the national debt, Jay's interest in U.S. monetary and fiscal policy grew, particularly as it related to gold. Jay began publishing North American Gold Mining Stocks in 1981. He was involved in the first modern-times gold loan made in the U.S. (to Amax Minerals, a 250,000-ounce loan facility led by Citicorp). To better understand the potential of the mining stocks he researched, Jay added a BA in geology to his CV in 1988. In August 1997, he left his position in the ING Barings mining and metals group to pursue his avocation as a new full-time career - including publication of his weekly Gold, Energy & Technology Stocks newsletter.

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