What’s happening now is panic, says Joseph McAlinden, who thinks that the financial system will survive it and that a… … year from now the Dow will be dramatically higher. Chairman and CEO of Catalpa Capital LLC, and former managing director and global chief investment officer for Morgan Stanley Investment Management, McAlinden tells The Gold Report that he believes gold continues to be an asset class of choice, despite the decline during the late summer sell-off.

The Gold Report: What does it mean when major investment banks are disappearing and the federal government steps in to bail out Fannie Mae, Freddie Mac, AIG and others? Where will this money come from and what will it mean for gold?

Joe McAlinden: The events of recent weeks have radically changed the progress of what had been a pretty unpleasant business cycle experience in the past year, in particular the credit crisis. It’s unclear whether the events of the last week are a climactic “breaking of the levee after the hurricane has gone through” type of thing or if it’s just the beginning of the hurricane hitting. So, it’s a very, very challenging time.

I do think that the financial system will survive it and that a year from now the Dow will be dramatically higher, and that we will manage to avoid disastrous economic consequences, as has really been the case so far. We’ve had a pretty ugly credit environment already, yet the GDP through the second quarter was continuing to expand in the United States.

But things have deteriorated rapidly and severely since then, with the federal government having to step in, acquiring the GSEs (government-sponsored enterprises), bailing out AIG, and expanding the Fed's lending facility yet again, among other new things.

All of this has to have consequences. Now, some have argued that the consequences are going to be deflation because of the implosion of credit. You could also argue that it’s going to be very inflationary because the Federal Reserve Bank is essentially going to have to print more money to pay for all this stuff.

I fall into the latter camp. I think that gold continues to be an asset class of choice despite the decline that we have had over this late summer sell-off. And I think that the price band of $800 to $1000, which I thought would prevail (although that was penetrated on the downside), is still what your target expectations ought to be. If anything, I think it could be penetrated on the upside with the events that occurred last week.

TGR: How do you see the market recovering?

JM: What’s happening now is panic. Lehman Brothers got into trouble, and people began speculating about what would come next. Merrill Lynch disappeared; Lehman went bankrupt and there are only two left—Goldman Sachs and Morgan Stanley.

And so speculators began selling and shorting those stocks heavily and wild rumors started circulating. The companies tried to reassure people. So, it was a very ugly period. From my own experience, when things get this hysterical, it’s usually is the sign of a bottom. Hopefully the turning point will prove to be the announcement of the Paulson new rescue plan.

TGR: How did it play out in ‘29?

JM: 1929 was different. You had all sorts of fiscal and monetary policy mistakes that were made in the wake of the stock market crash. The economy was not experiencing anything like a depression.

When the stock market broke, the government went to anti-trade restrictive policies with tariffs and protectionism. Hoover actually raised taxes. And most importantly, the Federal Reserve followed a bad policy and wound up contracting the money supply when they should have been expanding it.

Now, I can’t guarantee that the same mistakes won’t be made again, but at least this Fed has the benefit of history, and has a Fed chairman who has studied what happened in the '30s very extensively and is very informed on it. So, I would bet that that’s not going to happen, which is why, rather than betting on deflation, which would lead you to shorting gold, I think the outcome of this is going to be inflation.

TGR: So, similar to what we had in the '70s?

JM: Yes.

TGR: And you think this is going to be the bottom on the Dow or the S&P?

JM: To be honest, I thought we had hit a bottom in March and then again in mid- July, but things on the credit side have worsened. Interestingly, as this has been happening, there has been evidence that home prices, which triggered this whole chain of events, are actually stabilizing. It’s very debatable, but we’re seeing things that would suggest, not that home prices are recovering, but that they’ve stopped falling, and to the extent that they’ve stopped falling, it has major positive implications for the financial community.

To use the hurricane metaphor again, if home prices are stabilizing, then what that suggests is that the brunt of the hurricane is actually past. But the follow-on rain and the accumulated water is so bad that the levees are cracking and now certain neighborhoods and people will experience the worst of the consequences, which is the slamming of Wall Street.

So, it’s tough, and so certainly people should hold on to some cash if they’ve got any left, and I definitely think that precious metals have a place in portfolios.
We know that historically September and October is a period when major bottoms are made in big bear markets. When you go back through these cycles, the fourth quarter is a period when bottoms are formed, and we certainly aren’t forming a top, that’s for sure.
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