Tuesday, February 7, 2012

Anti-pep talk - Winnipeg Free Press

Economist Marc Faber, a.k.a. Dr. Doom, says the most overlooked asset class currently is equities. (PHIL HOSSACK / WINNIPEG FREE PRESS)

Dr. Doom, diversified: Economist Marc Faber may see an upside in equities, but he doesn't shun other assets such as bonds either. Investing is often a humbling experience, he says. Even so-called experts can be wrong. "It's not advisable to be overly dramatic and say, 'I'm going to be very bearish about equities and very bullish about bonds.' There will be times when you need to be in equities, times you need to be in gold and times you need to be in bonds," he says. "I don't know when, so I'm diversified, as I pointed out, because I like to sleep at night -- ideally with someone."

The darker side of Doom: During his talk in Winnipeg, Faber demonstrated how the rise and fall of commodity prices correlate to war and peace over the last few hundred years. "It may strike you that commodity price peaks always occur during wartime, so people could conclude that wars lead to higher commodity prices," he says. "That's not correct. Rising commodity prices are symptoms of shortages, and most wars were fought over shortages of commodities because countries wanted to secure the supply of commodities." In the past, once war has broken out, commodity prices go "ballistic," he says. Unsurprisingly, Faber has a bleak outlook on the future of global peace. Given that commodities will be even more in demand due to population growth, combined with overuse of interventionist monetary policy that artificially drives up prices, war breaking out on a global scale is a possibility. "I think over oil there could be a conflict developing," he says. "The Chinese are surrounded by American military bases, and 11 aircraft carriers and 95 per cent of oil to China comes from the Middle East." China's demand for oil has tripled in 15 years, and it will continue to grow rapidly in the near term. So, too, will India's need for the commodity. "The U.S. has gotten closer to India. In the meantime, China, which has always had close relationships to Pakistan, has gotten closer," he says. These competing interests, combined with the Arab Spring -- or as Faber calls it, Arab Winter -- make for a lot of political, economic and social instability. "I don't want to go into the details of war-cycle theories, but I can tell you the conditions for war are much better today than they were 10 or 20 years ago."

With a nickname like Dr. Doom, it's not hard to figure Marc Faber might have a pessimistic take on investing, the economy and the state of the world.

Faber, a Swiss-born economist living in Thailand, is one of the world's leading investment contrarians. His investment newsletter, the Gloom, Boom and Doom Report, is widely recognized for finding good reason to be gloomy about popular investment classes while discovering opportunity in undervalued, unfashionable ones.

These days, however, contrarian viewpoints are broadly fashionable, which is both good and bad for a noted contrarian such as Faber.

On the one hand, he is more popular than ever, travelling the world on speaking engagements, including a recent stop in Winnipeg at the 47th annual CFA (Chartered Financial Analyst) Winnipeg Forecast Dinner.

On the other hand, how does an expert who makes a living talking negatively about markets differentiate himself when almost everyone is feeling much the same?

He certainly doesn't do an about-face, giving rousing speeches of unbridled enthusiasm about markets' upside.

Instead, the ponytailed Faber has taken aim at Keynesian interventionist monetary policies, the popular choice these days of governments and central banks around the globe, including here in Canada.

For those who don't remember high school social studies, British economist John Maynard Keynes is one of the grandfathers of modern monetary policy. Basically, this model calls for government intervention when economic conditions get ugly, usually after a stock market bubble bursts. Amid the fallout and uncertainty, businesses are reluctant to spend. Governments step in to save the day, spending money to stimulate the economy until it starts to grow.

But this prescription for a sickly free market has side-effects.

"The problem is Keynesian policies have always aimed at solving structural problems with short-run fixes or by creating new bubbles," he says.

Lowering interest rates, quantitative easing (a.k.a. printing money) and other measures that encourage economic activity are Band-Aid fixes.

"It just postpones the problem, but it doesn't solve it," Faber says.

He admits these policies do have their uses. It was necessary for the U.S. Federal Reserve and other central banks, including Canada's, to flood the markets with money following the 2008 credit crisis, when billions in bad subprime debt that the world's largest bankers held froze lending, bringing economic activity to a standstill. The alternative, a complete system collapse, would have been worse.

But these measures are becoming more extreme with each crisis because in the long run, they make the problems they're intended to cure worse.

"It is like giving more drugs to a drug addict or more alcohol to an alcoholic," he said. "It relieves you temporarily -- at least it does in my case."

Though a pessimist, Faber isn't dour and serious. In his mid-60s, he still enjoys a good night out on the town, and even his market analysis isn't all gloom and doom.

If he didn't find an upside somewhere, high-net-worth investors wouldn't hand over money to his advisory and investment management firm, Marc Faber Ltd. He might be cynical, but Faber has a knack for finding overlooked, undervalued assets before they become favourable and overvalued.

The overlooked asset class of the moment is hiding in plain sight: equities.

Ironically, it's loose monetary policy that makes investing in stocks favourable.

Why? The quick answer is inflation. Because central banks increase cash in the marketplace, the value of money -- in real terms -- decreases.

Goods and services haven't increased in value intrinsically, but the cash chasing them has. The effect is inflation, and that's really what governments -- and their at-arm's-length central banks -- are often trying to create. They pour money into the market to encourage growth so prices increase rather than decrease, which has a nasty habit of further slowing economic activity.

For consumers, this is both good and bad. It's good because most people stay employed; it's bad because their money buys less. For investors who hold shares of a company, however, inflation can be beneficial.

If you own shares in a good company, their price will increase over time because a buyer will need more money to buy them because the value of the currency is worth less in real terms.

The effect is the same with commodities such as copper, gold, oil and grain. When governments lower interest rates, for example, to stimulate borrowing so business can expand and consumers can borrow to buy homes, cars and other goods, demand increases and so do prices of commodities used to manufacture the goods. For central bankers, this is the intended effect. But Faber says when governments put too much money too often into the marketplace, that money pushes prices too high too quickly, creating bubbles with increasing frequency. The bubbles eventually burst, leading to equally rapid price drops.

Markets become more unpredictable and manic as a result.

That's exactly what has happened over the last decade.

The Fed cut interest rates after 9/11 and the tech bubble, and the easy money flowed into housing, consumer goods and oil. Consumer goods stayed relatively stable, but only because the money from consumers flowed to the nations producing those goods, such as China. But oil and homes hit record highs.

"The Fed cuts interest rates to stimulate consumption and support the consumer, but at the same time, oil prices go ballistic and double, and so the consumer pays an additional $500 billion for oil, which is like a tax on the consumer," he said.

By 2008, housing and oil peaked and crashed. Many investors lost money; a handful got richer. Average folk got spanked, and the world's poor sank deeper into poverty."

"That is an unintended consequence of the Fed's actions: It punishes savers, decent people who have all their lives saved and said, 'I don't understand anything about the stock market; I'll just keep my money in the bank,' " Faber says. "Now they can't live off their deposits."

Today, GICs and other interest-bearing investments yield next to nothing, but commodities and equities have ascended -- just not like anything resembling a straight, gently sloping line. They increase rapidly and tend to decrease rapidly as well -- and then repeat.

Making matters more precarious, governments become ever more indebted as they repeatedly stimulate the economy to manage the increasingly frequent crashes. If they carry on long enough without increasing taxes and/or cutting spending, they risk a very dire consequence.

Excessive government indebtedness and loose monetary policy can lead to hyperinflation, as it did during the 1980s in Mexico when an oil bubble burst and falling prices crushed the Latin American nation's oil-based economy. The peso fell in value against the U.S. dollar by 98 per cent in less than 10 years.

While bad for the Mexican people, investors in its stock market eventually made money. Mexico's stock market increased from 1,000 to a peak of 343,000.

"There was the October crash in '87, and it closed at 139,000," Faber says.

"So the index went up by 139 times while the currency plunged by 98 per cent."

Now, Faber says that doesn't mean the same thing will happen in Canada or the U.S., but governments printing money distort prices all the same, and in the long run, those owning assets should preserve their wealth.

"It's not that I'm highly bullish about equities," he said. "I'm just saying that if you're as bearish and suicidal as I am, you're probably better off in equities than government bonds."