The Rude Awakening
Chiangmai, Thailand
Wednesday, June 6, 2007 ------------------------- - Dollars or equities - pick your strength,
- Lessons from Zimbabwe's hyperinflation,
- The least-trodden road to riches and more…
------------------------- Marc Faber, offering a few words of caution from the Far East… If any difficult marriage is an exercise in irritation management, so is listening to the hype by media commentators about the soundness and superiority of the US economy and about how well US stocks are performing. I suppose that if Larry Kudlow were living in Zimbabwe, where the economy has been contracting for eight straight years and has contracted by 50% since 1999, and where hunger is spreading and life expectancy is down to 35 years, he would also be enthusiastic about the prospects for Zimbabwe's stock market, which is currently soaring, as inflation is likely to reach 5,000% this year. As in the case of the US, but in a more extreme way, while stocks are soaring in Zimbabwe, the currency is collapsing. (In fact, it is an exact replica of what happened during the Weimar hyperinflation of 1919-1923, in local currency terms, the stock market index soared into the trillions but collapsed in gold terms.) John Paul Koning, an analyst at Pollitt & Co in Toronto, and writing for the Mises Institute, has made the following pertinent observation about the Zimbabwe Stock Exchange: "The ZSE is growing some three times faster than consumer prices. This relative outperformance versus general prices is a result of stocks being a chief entry point for the flood of newly created money. Keep Zimbabwean dollars in your pocket, and they've already lost a chunk of their value by the next day. Putting money in the bank, where rates are pithy, is not much better. Investing in government bonds is the equivalent of financial suicide. "Converting wealth into foreign currency is difficult; hard currency is scarce, and strict rules limit exchangeability. As for capital improvements, there is little incentive on the part of companies to invest in their already-losing enterprises since economic prospects look so bleak. Very few havens exist for people to hide their wealth from the evils created by Mugabe's policies. Like compressed air looking for an exit, money is pouring into shares of ZSE-listed firms like banker Old Mutual, hotel group Meikles Africa, and mobile phone firm Econet Wireless. It is the only place to go. Thus the 12,000% year over year increase in the Zimbabwe Industrials. "Our Zimbabwe example, though extreme, demonstrates how changes in stock prices can be driven by monetary conditions, and not changes in GDP. New money gets spent or invested. In Zimbabwe's case, because there are no alternatives, it is stocks that are benefiting. This sort of thinking can be applied to the stock markets in the Western world too. Though western central banks have not been printing nearly as fast as their Zimbabwe counterpart, they do have a long history of increasing the money supply. It forces one to ask how much of the growth in Western stock markets over the preceding twenty-five years has been created by a vastly increasing money supply, and how much is due to actual wealth creation." Now, I don't anticipate that a Zimbabwe-like scenario will unfold in the United States soon, but the phenomenon of investors realizing that cash deposits don't give them adequate protection from the loss of their paper money's purchasing power and therefore rushing into any kind of asset is the same everywhere in the world. Also similar is the increase in asset prices in local currency in Zimbabwe and in the United States, and the collapse of the Zimbabwe dollar and, to a far lesser extent, the decline in value of the US dollar. Many investors look to investment advisers such as myself (whom they often call "gurus") for guidance on the future of the markets. But I'm not a guru. I get things very right sometimes, but also get things very wrong. So I think it is appropriate to remind my readers of these words of Lao Tzu (the sixth-century Chinese sage): "Those who have knowledge, don't predict. Those who predict, don't have knowledge." So I will not make any predictions today, merely offer a few observations… --- Energy & Scarcity Investor - Free Offer* --- We're giving away our newest high-end trading service to Agora Financial readers for a limited time only. To find out how you can grab your free subscription to Byron King's Energy & Scarcity Investor, as well as pocket a further $3,863 before the end of the year, read on here: Energy & Scarcity Investor - Free Offer* *Offer Valid only until July 5 ------------------------------------------------- "Go Where There is No Path"
By Marc Faber When financial markets become excessively frothy and bubble-like, investors should be mindful of Ralph Waldo Emerson's words: "Do not go where the path may lead; go instead where there is no path and leave a trail." Unfortunately, in today's liquidity-driven global investment environment, I find it hard to identify any asset class "where there is no path." There are far too many smart - and not so smart - treasure-hunters who have bid up every imaginable investment class right around the world. It is only in the most unusual places that I can find true value (often, however, in assets that are difficult to invest in), as opposed to relative values, which certainly do exist. The problem for investors is that, as the German theologian Dietrich Bonhoeffer wrote, "If you board the wrong train, it is no use running down the aisle in the opposite direction." (Bonhoeffer opposed Nazism and was executed in prison for his involvement in a plot to overthrow Hitler.) I mention this because it will become increasingly important for investors not only to decide which asset-class train they want to board, but also, and even more importantly, whether they want to board ANY of the asset trains. If we look at the economic and financial history of capitalism, we can see that over periods of five to ten years there were always some assets that performed well. But there were times, such as in the early 1930s and the 1970s, when very few assets appreciated. Gold and gold shares performed well in the early 1930s. And in the 1970s, precious metals, and energy and energy-related shares, appreciated dramatically. But what were the chances that, in 1929, an investor would have had all his assets in gold, or, in the 1970s, in energy and precious metals-related investments? Moreover, in both cases, these investments had to be liquidated at some point because, as is always the case, "over-staying" eventually leads to huge losses. And this is where I see the biggest problem in the current investment environment. At the beginning of a bull market in an asset class, there are very few participants. But by the tail end of the boom the vast majority of market participants have become convinced that the boom will last forever or that a greater fool will soon emerge and take them out at a higher price. (This is likely to be the thinking among private equity fund managers.) So, in every boom, the majority of investors eventually get caught when the investment bubble bursts, as was the case in 2000 with high-tech stocks and in 2006 with US housing. In the April 6, 2007 edition of the Rude Awakening ("An Epic Mania"), I pointed out that a peculiar feature of the bull market in asset prices since 2002 has been that all asset prices around the world have appreciated in concert, as a result of highly expansionary monetary policies, which has led to excessive credit growth and a credit bubble of historic proportions. Therefore, if my theory of slower credit growth in the future holds, it is conceivable that, for a while at least, all asset markets (with the exception of bonds and cash) could come under pressure, albeit with different intensities. In fact, asset markets would come under pressure, even if credit growth continued at the present rate and didn't accelerate. In this instance, investors would be better off not boarding any investment train at all and, instead, staying at the station loaded up with cash. (However, they would still have to decide what kind of cash to hold.)U.S. dollars might not be the very best choice. Still, for now, there is some hope for the US dollar. As explained in last month's issue of my Gloom, Boom Doom Report (www.gloomboomdoom.com), it is not the Fed that has tightened monetary conditions, but the marketplace through the collapse of the sub-prime lending industry. Since the housing market is more likely to deteriorate further than to recover, credit problems could get much worse. Illiquidity among the US household sector, along with the reluctance of the Fed to cut rates right away, combined with the requirements for enormous capital investments for infrastructure in emerging and developed economies, could lead to some tightening of liquidity around the world. Therefore, I expect a more meaningful setback in asset prices and would certainly defer the purchase of financial assets. In particular, I am concerned by the inability of financial stocks to rally convincingly from their March 2007 lows, since financials are usually leading the market up and down. 
In my opinion, there is an ongoing deterioration in the US stock market. In the summer of 2005, the homebuilders peaked out. Last year, it was the turn of the sub-prime lenders to top out. And early this year, financial shares, including brokers, made their highs. The economy is likely to follow this slow stock market erosion and gradually deteriorate, with disappointing corporate profits to follow. [Editor's Note: Echoing Faber's remarks, Steve Leuthold, Chief Investment Strategist of the Leuthold Group, offered the following forecast in this week's issue of Barron's: "We are going to see two quarters of negative GDP by the time we get to mid-2008, which would be the official definition of a recession. Earnings may not reflect that because we have exported so much of the labor function. But it looks like maybe the consumer, for the first time in my lifetime, might actually be tapped out. I'm not expecting a huge decline or a new secular bear market. But we certainly could see a 25% to 30% kind of a correction, which would be a normal cyclical bear market."] Investors who must own US shares may find some relative outperformance among pharmaceutical companies, and oil and coal stocks. For the reasons outlined above (a relative tightening of liquidity in the world), I don't expect the US dollar to collapse immediately. However, it should be clear that in the long run, the purchasing power of the US dollar will continue to decline against sound currencies such as precious metals. Therefore, I continue recommending the accumulation of gold and silver. But it is increasingly likely that something will give soon: either asset prices will decline in a tighter liquidity environment, or the US dollar will fall sharply if the Fed continues to pursue expansionary monetary policies. For the US financial market, this means either weak equities and a strong dollar or strong equities and a weak dollar. Not a particularly appealing scenario! --- Outstanding Investments Report --- "Government Backed Gold" This new U.S. government-backed guarantee lets you own gold with no risk… but with 100% of the gains should gold prices take off. Here's the catch… You must act on this by June 19, 2007… or you risk missing the official deadline and getting shut out of this forever… The Full Report is Here: Government-Backed Gold -------------------------------------- | 
