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Tomorrow's
Gold: Asia's Age of Discover
Surging prices for energy, farm goods and metals have lifted major commodity indexes 11% so far this year. Copper is up 43% from last year’s price, iron ore is 16% stronger, and platinum is 24% higher. Soybean prices on the Chicago Board of Trade have soared more than 45% in the past year, while corn prices have jumped more than 25%. Global transportation rates are soaring, in part due to demand from China.
Dr. Marc Faber in a recent book entitled “Tomorrow’s Gold” argues that investor themes change over time, along with inflationary and deflationary expectations. Interest in different asset classes is cyclical, sometimes ending in a valuation bubble. During the equity boom in the late 1990’s stocks – mainly large capitalization and technology stocks – formed a bubble as the sector fascinated investors and they bid prices up to unsustainable levels. While central banks create monetary assets, Faber notes they have difficulty controlling where those asset are invested. In the late 1990’s the money flowed into the stock market. But Faber notes trends change if the valuation bubble deflates, sometimes quite quickly. Leadership in that case almost always changes as investors shift investments into new areas, with capital “leaking” from the most popular and overvalued sector into a neglected sector. Predicting where such monies will flow is impossible, but investors can make an educated guess. Once an investment bubble bursts history tells us that a sector does not return to favor quickly. Many times Faber claims it will take decades for that sector to regain the attention and favor of investors. For that reason Dr. Faber does not think large capitalization or technology stocks will regain favor any time soon. Faber also notes the market valuation of the major indexes (made up of larger companies) is still extended by historical standards, even with the partial recovery of the markets. European stocks correlate closely with the S&P 500 index, so Faber reasons they probably will not provide significant leadership any time soon.
Which asset class attracts investor’s attention next is uncertain, but Faber claims real estate, bonds, emerging markets, the U.S. dollar, or other currencies are classes of assets that could provide leadership. Because central banks are supplying an “endless money stream” into the world economy to avoid deflationary pressures, Faber argues that bonds “may continue to outperform equities in the U.S. for some time” as the economy gradually expands with the liquidity. Longer term he has concerns that excessive monetary stimulus will create inflationary trends, ending any gains that might be achieved in the bond market. Real estate has benefited from low interest rates and the loose monetary policy, posting impressive gains the last few years. Faber sees this trend continuing short term, but longer term thinks that the lack of income gains and a weak economic environment will eventually cool the real estate market in the U.S. Due to existing fiscal and monetary policies Faber also sees little strength in the U.S. dollar.
As investors have focused elsewhere Faber notes commodities have been ignored. On a relative basis commodities have become very undervalued – especially compared to equities. In real terms, he claims that as of early 2003 many commodities were cheaper than in the early 1970’s – the start of the last commodities bull market. Due to the emergence of Asia and China as a major player in the world economy Faber notes that demand for commodities should increase substantially, which will impact global prices. His prediction – his book was published a year ago – appears to be on mark with regard to demand from China. Unlike others, Faber is very cautious with regard to investing directly in China. Competition, regulation, and the markets make it very difficult to evaluate opportunities. "China is an unbelievably competitive economy. If you discover something, next day 50 people will have sprung up to compete with you," Faber says. "There is also the issue of whether companies will deliver value to shareholders. Up to now, they have not delivered much." In a nutshell, Faber’s advice is to buy a basket of commodities and hold them. Global monetary policy will most likely mean that the major currencies will decline in value versus hard assets. Demand for commodities in the global markets will continue to expand. The relative lack of investment in the commodity sector over the last two decades means that supplies may not be as plentiful as expected. And valuations are more attractive than equity markets.
Several observations on Faber’s conclusion: First, academic studies indicate a majority of the return on an investor’s money will be determined by the asset class - not by stock selection or other variables. So the determination of what asset class to invest in – real estate, bonds, equities, cash, gold, oil, etc. – is the most important decision an investor will make. Faber recommends focusing on commodities, which will become more costly as inflation erodes the value of paper currency. Second, commodities tend to correlate very poorly with large capitalization stocks and indexes like the S&P 500. When constructing a portfolio, this fact can be used to help diversify one’s investments and can help an investor move their portfolio toward the “efficient frontier” of maximum return with minimum risk. Third, commodities tend to correlate more closely with small and micro-cap stocks (see the review of Stephen Leeb’s new book). When commodity prices are increasing small cap stocks tend to do very well according to Leeb’s research, most likely due to the fact that small firms can exploit profitable niches in the market. So a bullish commodity market might also signal a bullish market for smaller capitalization firms. Fourth, demand for many commodities increases with population growth and economic development, as we have seen with China. The globalization of the commodities markets makes the sector an investment opportunity fueled by international developments. In all, a very interesting book. Short term economic trends add credibility to the author’s theme. That said it was not the easiest book to read, and some of the topics appear interesting but a bit off theme. But the argument he makes is a powerful one, and the use of historical data was excellent. This is another investment book well worth reading.
Web Note: Also hear Jim Puplava's interview with the author, Dr. Marc Faber on this important book. Contact
Information |
Fill
up the car, go to the supermarket, purchase a house, or buy a load of
lumber these days and it will be hard to escape higher prices.
Inflation, regardless of what the Consumer Price Index indicates, has
begun to invade a large part of the U.S. economy.
Investment Themes Changing – No Return to Technology Stocks
