Sunday, November 30, 2008

More Rally Thoughts... Faber's on Board

His thoughts on a rally: "If governments around the world throw money at the system, a relief rally is the most likely scenario although, as in the case of Japan post 1990, it may only be temporary and not lead to an improvement in economic conditions (Japan has hardly grown since 1990 and the stock market made recently a 26-years low – see Figure 9). A relief rally from deeply oversold conditions would in my opinion lift assets that were battered the most: emerging markets, commodities and in particular gold mining companies.

"Now, let us combine these findings with the totally different investment conditions we had between 2002 and 2007, and with the ones we had in 2008 as well as with the oversold stock market condition amidst a rapidly deteriorating global economy, which is inevitably going to depress corporate profits for a long time to come. First, the oversold condition of the stock market: At their recent lows, US equities were as oversold as in November 1929 (before they rallied by almost 50% into the summer of 1930), as in October 1987 and as in the fall of 2002 (see Figure 12). So, purely statistically it would seem that the path of least resistance would be a rebound (same applies to commodities).

In my life I experienced two major trading markets (1968 – 1982) and Japan post 1992 (see Figure 9). I can assure my readers that during these trading market conditions (no net gain for the indices and in the case of Japan new lows) hardly anyone except very smart (lucky) traders made any money.

His thoughts on the longer term outlook:"In the next few years I expect asset markets to favor aggressive traders and not long term investors. I therefore still think that for the average investor precious metals such as silver and gold will be the preferred investment."

Of course, his major caveat to trading is that few actually make money doing it; so for the bulk of assets he recommends physical gold. But if you wanna gamble, he suggests long GLD, EEM, and any commodity index, and frankly any major equity index. Reverse for the short side. Keep in mind, he thinks the Fed should be abolished and that we are headed towards a new monetary system in the long term. From a source he uses: "The recent bursting of the credit bubble in the US and Europe is quickly spreading economic disruption throughout all global economies. At its core, the credit bubble was the result of an unsustainable currency bubble. Credit is simply claims on future money that must be earned or created in the future. The unlikelihood of being able to earn or create about $75 trillion in new dollars to satisfy outstanding future public and private claims was the nexus – and justification - for the credit unwinding we are now experiencing."

He argues that we have spent the last 30 years in a liquidity driven market (by the banks and securtization markets); we will now be in a liquidity supported market (by the government) until the deleveraging is finally finished. That means massive increases in the money supply WW and ZIRP. This should lead to extended periods of negative real 3 month T-Bill rates, which historically have lead to sustained inflation and solid outperformance from gold.

For long term equity investors, I think the growing consensus is that this correction will be so severe and long lasting that investor sentiment and psychology will experience a sea change. Growth managers will lose out to value/dividend managers; equity markets will have to offer a superior valuation to attract capital. So what happens to the massive amount of money still in the hands of aggressive managers in hedge funds, private equity shops and growth funds?

It will take less time time than you can imagine to drain these managers of their fire power - ongoing redemptions and changes in fund charters. At that stage we will move into a more fundamentally driven market, with lower multiples and higher premiums/dividends. It means bonds and dividend paying stocks for long term investors - to get paid for the risk.


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