more of the same marc faber where money for projects has ... · dr. marc faber market commentary...

Dr. Marc Faber Market Commentary March 1, 2008

www.gloomboomdoom.com of 17 © Copyright 2008 by Marc Faber Limited - All rights reserved

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.



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).



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 “under-priced” (see Figure 3).



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



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



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).



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.



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).



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



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



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



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



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.



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



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.



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:



"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.

----------------------------------------------------------

And here below some best wishes from Mr. Bernanke!

more of the same marc faber where money for projects has ... · dr. marc faber market commentary...

Documents