U.S. consumer prices plunged by the steepest amount since records were tabulated in 1947, the Labor Department reported Wednesday. Prices fell 1% in October, with energy prices plunging 8.6%, yet food prices rose 0.3%.

The U.S. dollar and stocks fell on the first whiff of major consumer deflation, while gold prices steadied. Should we expect more deflation in 2009?

Deflation can be just as devastating to an economy as inflation. Today we have much lower oil and gas prices over the last year and that is deflationary, but also have a home that is worth a fraction of its value a year or two ago as well. Many of the products and services we use are still up this year, such as food, medical care and college tuition.

So, while deflation is positive if you are looking to buy a home, fill your gas tank or buy stocks, it is very debilitating to a country like ours which depends so heavily on debt and ongoing housing and asset inflation as our primary means of saving for the future.

Our growth over the last decade or two has come as a direct result of consumption, which relied heavily on borrowing against real estate or other inflated assets. I believe the deflationary loop we are presently in will end by the middle or end of 2009 as the government pours liquidity into the economy.

As bad as it seems today, with all the rhetoric about being the worst since the Great Depression, keep in mind that 6.5% unemployment today is not 25% as it was in 1929-1933. We likely will have a negative 3% GDP starting in 2008 fourth quarter which may continue for 2 more quarters, but that’s not 45% negative growth we had in 1929-1933.

The solution to both inflation and deflation is to own more gold, which maintains its buying power no matter what. During deflation if the dollar continues to strengthen its value should drop to reflect a falling cost of living. When inflation heats back up the dollar will fall and gold prices will rise to reflect a rising cost of living. Gold is the perfect wealth insurance against both inflation and deflation.

I expect in 2009 we will see the rise of both oil and gold prices, despite deflationary pressures. I think oil prices will rise because we will take our eye off the ball now that gas prices are near $2 a gallon instead of $4.50 a gallon. Offshore drilling could easily move to the back burner. We have a history of seeing a shock, then complacency, shock, etc. So I expect we will again revisit $100 a barrel oil in 2009.

I am confident we will see $1,000 an ounce gold in 2009 and perhaps far beyond that depending on international tensions. If we have a challenge to Obama’s administration by foreign powers, such as we have been warned to expect, you could see gold prices rocket based on its unique safe haven status.

Regarding which type of gold I recommend, I’ve always recommended early American $20 gold pieces as the best way to hold physical gold. The reason is that although they don’t always rise as fast and furiously as bullion on the way up the usually catch up and do not come down as fast as bullion after the fireworks are over.