Dr. Marc Faber Market Commentary March 1, 2008
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More of the Same
Marc Faber
Where Money for projects has not been
found, we will print it.
Robert Mugabe
The January 1 report ended with the comment that I was sorry
that my views were not particularly favorable for the performance of
equities in 2008. I concluded: “So, what would I buy? I like sugar, cotton
and I still recommend accumulating gold, which I expect to continue to
outperform equities for several years. Central banks around the world
have no other option but to print money and this will lead to a
further depreciation in the value of paper money against precious
metals.
Still, nothing goes up in a straight line and, therefore, investors need
to be aware that gold could still correct to around $750 or so. But when
we consider the upside potential of gold compared to its downside
risk the biggest mistake an investor could make is not to own any
gold at all (see Figure 1). Interestingly, we know a lot of gold bulls who
have already sold their positions and pray for a significant correction in
order to establish again long positions. In my opinion, the gold bull
market will come to an end when Sovereign Wealth Funds - sick and tired
of their investments in financial stocks - will finally purchase gold –
probably at above $3000 per ounce.”
Since numerous readers keep on asking me if they should buy gold
now or wait for a correction, I wanted to revisit the subject once again. It
should be very clear that increasingly the US Fed – run by a “money
printer” par excellence (since Mr. Bernanke became Fed chairman the
price of gold has doubled) - has abandoned targeting inflation when
setting its monetary policy and is desperately trying to cure the current
credit crisis with the very means that caused the crisis in the first place:
excessive monetary and credit growth.
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Figure 1: Gold, February 2007 – February 2008
Source: www.decisionpoint.com
Equally, it should be clear that if you increase the supply of paper money
while at the same time the supply of precious metals and other
commodities cannot be increased at the same rate or not at all, the price of
paper money – its value - declines relative to the asset where the supply is
limited. Hence, the dollar declines versus gold and other commodities and
this is likely to continue for as long as the US tries to bail out the system
with monetary and fiscal measures. I, therefore, continue to recommend
investors to own gold and, should someone not yet own it, to gradually
acquire a position even at current prices, which would seem to be
“relatively high”. I use the term “relatively high” because if we look at
the performance of gold in real terms (adjusted for inflation by the CPI
over all items) over the last 150 years or so, we can see that whereas the
real gold price was extremely depressed in 1929, 1972 and 2001, its price
is now in the “expensive real price range” (see Figure 2).
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Figure 2: Gold Adjusted for Inflation, 1861 - 2008
Source: Ron Griess, www.Thechartstore.com
Still, I could argue that the gold price would be in real terms far lower if
“inflation” was properly measured. I have tried to explain in earlier
reports that the CPI understates the true cost of living increases. So, it
may be better to compare gold to crude oil rather than to compare gold to
a phony CPI. And on that basis we could say that if we compare gold to
oil it would appear that either oil is “over-priced” or gold is “underpriced”
(see Figure 3).
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Figure 3: Gold Relative to Crude Oil, 1997 - 2008
Source : www.Decisionpoint.com
As can be seen from Figure 3, in 1999, it took 25 barrels of oil to buy one
ounce of gold. Now, it takes less than 10 barrels to buy an ounce of gold.
Therefore, a strategy for investors who fear that gold could sell off
sharply would be to be long gold and to be short oil at the same time with
the view that gold will out-perform crude oil.
I may add that a similar case could be made for buying agricultural
commodities rather than crude oil. In the 1960s, the price of crude oil was
static at about $1.80 per barrel. At the same time, high quality wheat sold
for an average price of $1.58. So, whereas in the 1960s crude oil and
wheat were selling for approximately the same price, today crude oil is
above $100 per barrel whereas wheat is selling for slightly more than $10
per bushel (it is up from less than $4 at the beginning of 2007). Sugar is
probably the most extreme example of the low valuation of agricultural
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commodities compared to oil. In the 1960s one barrel of oil would buy
about 30 pounds of sugar (sugar price averaged around 6 cents per
pound). Now a barrel of oil buys more than 700 pounds of sugar. In fact,
in real terms sugar would appear to be extremely inexpensive (see Figure
4).
Figure 4: Sugar Adjusted for Inflation, 1913 – 2008
Source: Ron Griess, www.Thechartstore.com
But what is scary about the money printing press is that it is supported
by the Wall Street elite. Consider the following: Recently Standard &
Poor reaffirmed the AAA ratings on the two large monoline insurance
companies MBIA and AMBAC (ABK), notwithstanding the fact that the
previous day MBIA was notified that it was being sued by the law firm
Coughlin Stoia Geller Rudman & Robbins for allegedly issuing false and
misleading statements about its exposure to CDOs. Now, what is most
bizarre is that MBIA sold just recently bonds yielding 14%! So, the rating
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agency S&P thinks that MBIA is a AAA credit rating whereas the market
believes MBIA (MBI) deserves a rating below junk status. Peter
Boockvar, an analyst with Miller Tabak, sarcastically: "What S&P is
saying is that a bond yielding 14% in the marketplace is also AAA. It's
now a game among the rating agencies, regulators and banks with
whether the bond insurers are rated AAA or not when they clearly are not
and their securities don't trade as they are [sic]. This is being done in an
attempt to prevent the banks from going through another round of
writedowns." My friend Bill King pointed out “how worthless and
corrupt the S&P and Moody’s ratings actually are. Forget that the foxes
are watching the henhouse, it appears that the regulators, banks, insurers,
and the SEC, the Federal Reserve – pretty much anyone else you can
think of – are all in cahoots with each other. It’s American Socialism at
its finest….” My friend Bill Fleckenstein is not much kinder. According
to him, the rating agencies continue to be a farce: “How can someone
who has to pay 14% for its debt and then have it trade at a discount to par
(I'm speaking here of MBI), how could an entity like that ever possibly be
considered Triple-A? The whole world knows they're not Triple-A. Why
don't we just cut to the chase and start calling a spade a spade. If these
credit agencies ever would like to have one shred of credibility again
ever, they might as well start now. But of course, just like every aspect of
sanity that some of us might like to see break out, it seems to be
politically unacceptable for anyone in a position of real responsibility to
act like an honest adult”.
But it gets even more interesting when one compares MBIA to other
highly rated companies.
Mish Shedlock of www.globaleconomicanalysis.blogspot.com compared
the financials of MBIA (MBI) which has Moody's top rating of AAA and
Pfizer (PFE) recently downgraded by Moody's to Aa1 and by Fitch to
AA-Plus from AAA” (see Table 1).
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Table 1: Pfizer’s Financial Statements, December 31, 2007
Source : www.globaleconomicanalysis.blogspot.com
I would consider the financials of Pfizer to be rock solid with cash
exceeding total debt by a wide margin (I bought recently some shares).
Now let us look at MBIA! Here we have a company which is incurring
heavy losses and whose debts exceed cash by a factor of 3 (see Table 2).
Yet the rating agencies assigned a higher credit rating to the monoline
insurance companies than to Pfizer.
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Table 2: MBIA’s Financial Statements, December 31, 2007
Source : www.globaleconomicanalysis.blogspot.com
Mish Shedlock then compares the financials of the two companies and
asks “if the financials of MBIA look “gilt edged”??? (see Table 3).
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Table 3: Financial Comparison: MBIA (MBI) and Pfizer (PFE)
MBIA Pfizer
• Profit margin -61.76% vs. +17.07%
• Return on Equity -35.54% vs. +12.13%
• Revenue $3.12 Billion vs. $48.61 Billion
• Earnings per Share -$15.22 vs. +$1.20
• Total Cash $5.73 Billion vs. $20.30 Billion
• Total Debt $17.44 Billion vs. $8.69 Billion
Source : www.globaleconomicanalysis.blogspot.com
Mish concludes: “Is there any other way to interpret the above ratings
other than incompetence or corruption? If there is, can someone please
tell me what it is?” I may add that Pfizer’s credit default swap (CDS)
spread is only 38 basis points whereas MBIA’s CDS spread is 603 basis
points (Pakistan’s CDS spread is 534 basis points!)
Well, market participants have voted with their senses. Despite the Fed
cutting the Fed fund rate from 5.25% to 3% within less than 5 months
credit spreads have widened and the economy has continued to
deteriorate. David Rosenberg of Merrill Lynch explains: “The Fed has
cut rates 225 basis points and yet not only is the S&P 500 down 11%
since the first easing but credit spreads have widened across the board –
and they have not stopped widening. In other words, financial market
conditions are still tightening, regardless of how accommodative
monetary policy appears to be. Mid-term bank spreads have widened 86
basis points, Baa spreads by over 100 basis points, high-yield spreads by
a huge 284 basis points and jumbo mortgage spreads by 33bps. And look
at the actual rate levels — they have barely come down. In fact, mid-term
bank funding rates and investment-grade corporate bond yields are at the
same level as when the Fed started cutting rates and junk bond yields are
up 161 basis points, jumbo mortgage rates are down, but 35 basis points
is a big deal in light of what the Fed has done for the government curve?”
(See Table 4 where current yields on selected fixed interest securities are
compared to the beginning of the easing cycle). “We confess that we have
been in the business for 25 years and have never – and repeat never –
seen a cycle like this one. The equity market in 1987 and the credit
market of 1998 were scary but lasted a few weeks at most and the Fed
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waved its magic wand and all was well. The difference is that this is truly
the end of the secular expansion in the credit cycle and the extent of the
bad paper that was issued in the past five years is catching even the
biggest "bears" (we prefer the label 'realists') like us by surprise”.
Table 4: Pushing on a String: Rising Yields amidst Massive Easing!
Source: David Rosenberg, Merrill Lynch
Aside from widening yield spreads there is another problem with the
Fed’s monetary policy. As can be seen from Figure 5, US import prices
from China have begun to increase.
Figure 5: US Import Prices from China, 2005 – 2008
Source: ABN-AMRO
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In other words, whereas between 2001 and 2007 China was a deflationary
force for the US in as much as consumer good prices at Wal-Mart and
other retailers declined it is now becoming aside from soaring energy and
food prices also a source of consumer price inflation. What this means is
that in due course not only yields on lower quality bonds will have
increased but that yields on longer dated Treasuries will also head north
(see Figure 6).
Figure 6: Yields on Long Term Treasuries also set to go higher!
Source: Ron Griess, www.Thechartstore.com
So, I should like to reiterate that although the Fed is easing massively and
totally irresponsibly (since the dollar is extremely weak and since
inflation is accelerating), the market place is actually tightening financial
conditions. As a result the excessive liquidity the Fed is creating does not
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find its way into the real economy, which is already in recession, but
flows into assets such as gold.
In fact, we may be faced with a new “conundrum”. The more the Fed
eases, the more yields increase even on high quality long term bonds (see
Figure 7).
Figure 7: 30-Year Treasury-Bond Yield likely to Increase!
Source: www.Decisionpoint.com
However, as the Fed cuts the Fed funds rate further – probably to zero
under the regime of money printing and in economic matters totally
confused Mr. Bernanke – the Fed can make US equities a relative
attractive proposition compared to risk free cash because of a further
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dollar depreciation and negative real returns on risk free fixed interest
securities, such as Treasury Bills. After all, as the Bank Credit Analyst
suggested, there is a huge and growing pool of liquidity – currently more
than $ 3 trillion – parked in money market funds, which could be forced
through zero interest rates into stocks (see Figure 8).
Figure 8: Institutional and Retail Money Market Funds 1983 - 2008
Source: The Bank Credit Analyst
I am, therefore, despite of disastrous looking economic and financial
fundamentals reluctant to short US stocks. As I have explained before
(see market comments of February 1), US stocks could rally in US dollar
terms to around 1450 on the S&P 500 whereas they continue to decline
against a currency of integrity such as gold (new highs for US stocks are,
however, unlikely because of the expected increase in long term interest
rates and because of declining corporate profits). Personally, I am
standing on the sideline and would consider either shorting the S&P 500
around the 1450 level with a tight stop loss order or buying the Index if it
fell to below 1300.
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Simply put, I would be interested to purchase the ProShares Ultra Short
S&P at between 55 and 57 (see Figure 9)
Figure 9: ProShares Ultra Short S&P 500, 2007- 2008
Source: www.Decisionpoint.com
As the eminent historian Paul Johnson recently wrote in the Financial
Times (see below), “what we must beware of is unrestrained impatience
and excessive greed – each fueling the other.” Consequently, I advise
against making huge bets in a system that is manipulated and highly
corrupted.
Impatience + Greed = Trouble
By Paul Johnson
Dr. Marc Faber Market Commentary March 1, 2008
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When markets enter a period of turbulence observers moralize about the
frailties of human nature that are responsible for the upset. This ignores
the fact that markets require corrections, even violent ones, from time to
time. They themselves reflect human nature and must, over a period, hold
the balance between optimism and pessimism.
All the same, markets are determined by moral strengths and weaknesses,
and it is useful to identify what those are at each major episode. The state
of the present market is the consequence of undue impatience combined
with excessive greed.
Impatience led many thousands of ordinary people to acquire properties
of much higher value than their savings justified. They thus sought to
borrow collectively immense sums that they could not hope to repay for
many years and, in some cases, ever. As a rule, this would not be a
problem; banks and other loan agencies should simply have turned down
such borrowers. The borrowers would then have had to contain their
impatience until their savings accumulated to a level at which they could
borrow prudently.
Unfortunately, impatience coincided with excessive greed on the part of a
number of bankers. Many of the world's top bankers lead highly
competitive, high-spending lifestyles and are tempted to increase turnover
– thus increasing their salaries and bonuses – through generous lending.
The consequences of this behavior could be catastrophic.
Is More Legislation Needed?
Certainly not. All powerful human impulses are constructive as well as
destructive. Impatience is an interesting case in point. The desire to get
on, not slowly and patiently, but to get whatever it is one wants and have
it now is a form of human eagerness that creates dynamism. If all people
were models of patience, content with their lot and not eager for change,
we'd still be living in primitive hunter-gatherer societies. Economic
progress is created when vigorous impatience is combined with existing
ways of doing things.
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All periods of rapid advance, such as the Renaissance and the Industrial
Revolution, have been marked by impatience. Thomas Edison was a
notoriously impatient man, as was James Watt, who greatly improved the
Newcomen steam engine by adding a separate condenser. Some of the
most useful inventions are symbols of furious impatience: The zipper
grew out of an impatience with buttons; safety razors with the old
cutthroat razors.
Without impatience bankers would just be static strongboxes for storing
cash. There's nothing wrong with the vast majority of ordinary people
being impatient to have better houses. Impatience becomes dangerous
only when it parts company with reality. People who borrow money in
amounts they cannot reasonably hope to repay in their lifetimes are
dangerous to the whole principle of credit – and should be disciplined by
the banks.
This, of course, is where greed on the part of the bankers – encouraging
excessive impatience – turns a dynamic force into a highly destructive
one. Indeed, it's hard to think of a more dangerous combination than an
overimpatient borrower and a too greedy lender.
Agent for Growth and Progress
Notice I write of "too greedy." I risk censure by the absolute moralists by
pointing out that greed, in an economic sense, is not necessarily or always
evil and harmful. Economic growth is not possible without a certain
amount – usually a great deal – of greed, any more than it's possible
without impatience. Greed is merely a harsh word for what, in objective
terms, we call the acquisitive instinct. This desire to amass quantities of
money or goods lies at the heart of capitalism and, thus, at the heart of
any expanding economy. Acquisition is beneficial so long as what is
acquired is put to constructive use and not just hoarded.
All energetic men and women are greedy to some extent. Expending their
energies on systematic acquisition is one way of preventing the energy
from going into more nefarious activities. As Samuel Johnson put it:
"There are few ways in which a man can be more innocently employed
than in getting [i.e., accumulating] money." Keynes put it another way:
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"It is better that a man should tyrannize over his bank balance than over
his fellow-citizens." What's important is that the greed can be combined
with the desire to render a service or supply useful products to society.
Capitalism is the most reliable source of modern progress precisely
because , when it functions at its best, it combines the realism of
acquisition (or greed) with the idealism of serving the public.
So let's not despise impatience and greed. Some measure of both is
necessary for the economic system to function well and for progress to
advance. What we must beware of is unrestrained impatience and
excessive greed – each fueling the other. At the center of any financial
system there have to be powerful individuals and bodies that can detect
these excesses and take action to control them.
That's the job of those who run the reserve banks. They must be moralists
as well as financiers – able to smell the sin of intemperance, to come
down hard on it and in time.
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And here below some best wishes from Mr. Bernanke! |
