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Marc Farber and Peter Schiff interview

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    Marc Farber and Peter Schiff interview

Dr. Marc Faber is editor and publisher of " The Gloom, Boom & Doom Report."
He is one of the great f inancial and investment minds in the world today. Born
and educated in Switzerland, based in Hong Kong, he is the author of 2 books.
He appears regularly on all the f inancial TV shows, and is quoted in all major
f inancial newspapers and magazines around the world. We thank Dr. Faber for
spending this time with us.

In late february, euro Pacific President Peter Schiff inter viewed the eminent
economist Marc faber by telephone from his office in hong Kong.

Q: Marc, many thanks for taking the time for this inter view from your busy sched-
ule. i’d like to start with some macroeconomic questions, and then talk about some
of the investment implications of the larger macro questions. Let ’s start with the
stimulus and bailout, which is ver y much on ever yone’s mind. What do you think
are the long-term effects of the stimulus and bailout proposals on all the Western
countries, including the U.S.?

Mf: well, first of all, there are lots of academic studies on bailouts and stimuli; and also
on money-printing. and, in terms of fiscal spending, bailouts usually
don’t work. when the government sits in and tries to offset sagging
private demand with gov-
ernment demand, it usually does not work. This is the pattern we have
seen in the past. The long-term effect on the u.s. economy f rom all the
bailouts and deficits is basically that government’s debt will rise ver
y sub-stantially and the balance sheet of the fed will expand.
Many people think that the global recovery will begin in late 2009. I
seriously doubt that. I think it will be at least two years f rom now,
worst case maybe 10. and when we do start recover y, interest rates
will rise and inflationar y pressures will be enormous.
An economy always fluctuates around the trend line. If you tr y to postpone recession
the way the u.s. government has tried to do, then one day you will have a much big-
ger problem. If you postpone recessions through deficit financing, or through easy
monetary policies, then obviously you have ver y strong debt growth, as we have had
in the u.s. debt as a percent of GdP has expanded f rom 130% in 1980, to 360%
today. This does not include the unfunded liabilities arising f rom pensions and f rom
Medicare and social security.
The best that the government could have done would have been to take a
more severe recession in 2001, and then all the excesses that followed
would not have occurred. now, we have an environment where the patient
has died; no matter how much stimulus there is, it ’s not
going to revive the economy.

Q: Does this mean that in the longer term we’re going to
see an inflationar y environment?

Mf: There is no other way for the u.s. but to inflate. It ’s not a desirable policy, and it
has in the end disastrous social consequences. but given that we have a money-printer
at the fed and an administration that wants to expand the role of government as a
percent, the result will be, unfor- tunately, inflation.

Q: Are we looking at the same kinds of inflation we saw in the late ‘70s, or not quite as bad?

Mf: My view is that, eventually, we will see a much higher inflation rate than in the ‘70s. In the short
term, because of the collapsing asset market and increased savings rate in the u.s, we will see defla-
tionar y pressures. but in the long run, we’ ll have a much higher in- flation rate. That will be negative
for u.s. bonds and equities.

Q: Not a pleasant picture. Are there any other bubbles on the horizon?
Mf: basically, we always have bubbles and investment mania in the world. even in the 19th
century, under the gold standard, f rom time-to-time investment manias and bubbles
developed in railroads and in canals and in real estate, just to name a few. under a fixed
monetar y, or gold, standard, where the quantity of money cannot be increased indefi-
nitely; there is a natural limit to the scale of the crisis. usually when there’s a boom in
one sector of the economy, you have some kind of deflation somewhere else; that was
also the case in the 1970’s. we had a boom in commodities, but bond prices collapsed.
what Mr. Greenspan and Mr. bernanke have achieved is historically quite unique. they have man-
aged to create a bubble in ever ything, ever ywhere in the world: in
real estate, equities, commodities, art, worthless collectibles; even
bond prices continued to
rise as interest rates fell due to the loose monetar y pol- icy. since
2007 and 2008, ever ything has collapsed. but government bond prices
continue to rise, and went ballistic between november 2008 and december
2008, when 10- and 30-year treasur y yields collapsed. so my view would
be that this was the last bubble they managed to inflate. from here on,
the government bond market will fall.
In other words, the trend will be for interest rates to actually go up.

Q: if you were the chairman of the fed or the Secretary of the treasur y, what would
you recommend now to the congress?

Mf: I think the best move would be to resign, but that aside…

Q: Unlikely.

Mf: The problem is that no officials in the u.s. are telling the truth. let me give you
an example: The elderly statesman in singapore, lee Kuan yew, immediately said in
last september, “we’re going to face ver y tough times; we have to tighten our belts and
stay competitive.” This is something no president in the u.s. will say:
that you have to want for a few years, tighten your belts, and en- dure
some pain in order to safeguard the countr y ’s
economic health – for the sake of your children and for the sake of the nation as a whole.
neither party in the u.s. nor any elected govern- ment official dares to tell the electorate how disas-
trous conditions in the countr y have become. Ill-conceived policies by the last few administra-
tions, republicans as well as democrats, were de- signed to stimulate
consumption. as a result of these policies, we will now have a period
of subpar growth for quite some time. The gov-
ernment ’s policy should have been to stimulate capital formation, education, and
r&d, and to encourage people to save.
If I had been fed chairman, I would have kept interest rates at a much higher level after
2001. I also wouldn’t have cut interest rates as aggressively as Mr. bernanke did after
september 18th, 2007. don’t forget, low interest rates actually hurt savers. ere are a
lot of people in america, like retirees, that have money on deposit, and now don’t get
much interest on their deposits. so, it basically forces them to speculate.

If I were at the treasur y, I would let the financial institutions that overly leveraged
themselves and gambled with other people’s money, like aIG and fannie Mae and
freddie Mac, go bankrupt. you can still protect the depositors and the policyholders
of these companies. but let the system, through the market mechanism, deal
with the problem.

Q: it looks like iceland‘s on its way to
bankruptcy. Do you think there are any
other countries that are going to be in a
similar shape to iceland? Which coun-
tries are vulnerable?

Mf: I’m sorr y to say I think the whole
world is an Iceland. I think we have
countries like britain and Ireland and switzerland that have problems
similar to Iceland, though they ’re not as bad as Ice- land. basically,
Iceland became a huge hedge fund. ey raised money in the international
capital market; they then leveraged that money to buy assets all over
the world. so, when asset prices stopped rising, banks and institutions
in Iceland had a major problem. banks
were some of the worst offenders. They raised money f rom depositors, and by issuing
bonds and certificates of deposit. Then, they gambled on poor investments, believing that
markets couldn’t fall. They are children of the bull market. but when asset markets started
to turn down, they were screwed. The value of their assets had declined, whereas their li-
abilities remained at the same level. That ’s why so many banks are insolvent.

Q: can America learn anything from the Japanese stagflation, the “lost decade”
as many people call it?

Mf: I think the Japanese had a peculiar situation. first of all, the stock market in
Japan was probably more over valued than the u.s. market in the year 2000 or in the
year 2007. also, the real estate market was in ‘ cuckoo-land’ in Japan. the good
thing about Japan af ter 1990, when the recession hit and a period of no-growth
began, is that the t ypical household never suffered ver y badl y, for the simple rea-
son that prices for assets, things like golf course memberships, nightclubs, housing
prices, etc., all went down. so, their salaries didn’t rise
any more but stayed at the same level, and ever ything
else fel l in price – we had deflation. so the t ypical
household actuall y increased its standard of living.
In the u.s., the problem is that the household sector is
terribl y indebted. that wasn’t the case in Japan. In
Japan, the corporate sector was indebted and the banks
and real estate companies were overleveraged, but not
the household sector. and the household sector in Japan still had a savings rate of
around 12 percent when the recession started. In the u.s., the household sector had
stopped saving out of current income throughout the 1990s. In 1990, the saving rate
was nine percent; then it went to zero. now, the savings rate will have to go up. the
household sector will realize that savings out of illusor y asset price gains, like stocks
and real estate, are not permanent; and therefore, if we want to have
money for retirement, we have to save money f rom current income. and
that has, of course, a negative short-term impact on the economy.

Q: Marc, i’d like to ask you now a few investment questions. i assume that your in-
vestment philosophy flows directly from your economic point of view. if you were a
U.S.-based investor with a five-year investment horizon, how would you allocate
your assets now, and might you make a change with them in a year or two?

Mf: It would depend obviously on the cash flow of that particular investor, his risk pro-
file, if he has real estate or a pension account ,or is he well-insured and this and that;
so there are many different factors to consider.

Q: Let ’s assume he owns his own home, he’s not overly leveraged, and he has a job.

Mf: In general, I don’t like stocks. The Japanese market, as an example, is at the same
level it was in 1981. so it ’s 30 years behind. If the u.s. just went down to the level of
1990, the s&P would be at 300. It indicates that the asian markets are at either 20
year lows or 30 year lows. The dividend yields on asian stock markets
is about three times the bond yields in those countries. relative to
the u.s., asia is quite in- expensive. so I think that, yes, emerging
economies will be a place to look, and I would allocate probably now,
ten to 20 percent into emerging economies.
Also, the commodities have totally imploded. The shares of mining companies and ex-
ploration companies and resource producers have also totally collapsed. since no-
vember 21st, however, some stocks like freeport-McMoran and newmont have
roughly doubled in price. They ’re not quite as attractive as they were two months ago.
and I would still own some gold, say ten percent in gold.

Q: Now, would that be in physical gold, or would that be in an etf, or individual
mining companies?

Mf: The mining companies are cheaper than physical gold, but the mining industr y has
its own set of problems. I would own physical just as insurance, because we cannot
trust central bankers anymore – ever y person has to be his own central bank. I have a
negative view of the u.s. dollar in the long run, as I expect a revival of inflation. to
some extent, I think real estate will protect you; in particular, real estate in the countryside, rather than in the city.

Q: Would you consider, as a U.S. investor, real estate overseas? i know there are some
reits in Singapore and in Australia that have a terrific yield.

Mf: yes, these yields will come down because they will have to cut the dividends. but say in sin-
gapore you have reIts that yield 15 percent. so even if they cut the
dividend, I think they will still be good, because the bond yield in
sin- gapore is less than two percent. even at a five percent yield, in
what I would consider a very solid currency in a ver y solid countr y,
reIts would still be attractive. singapore is probably the richest
countr y in the world, ever ything considered.

Q: Global equities ten to 20. So that adds up, if you figure about 20 percent for
resource stocks, to about half of the por tfolio. Would you have the rest of your
money in cash?

Mf: yes, in cash.

Q: Which currencies?

Mf: well, in the short term, I think the u.s. dollar is okay. but obviously at some point
it won’t be okay. but right now, I don’t see how the u.s. dollar will totally implode.

Q: Do you prefer the Asian markets in general
over the U.S. markets?

Mf: I ought to have mentioned this before: in asia
the valuations are more compelling, because the
markets are back to 20 year lows or 30 year lows, and
because the dividend yield is three times the bond
yield. we have in asia a lot of companies that ser ve
the domestic markets. They produce cigarettes or
beer or food. They ’re not going to be affected that badly by the global slump. e valuation of the
stocks may be affected, because obviously there is
liquidation; but I think that their fundamentals are
sound, and that they ’ ll survive under any environ-
ment; and that you will make money, and in the
meantime, you’re receiving the high dividends.“

Q: in general, would you say that dividends in Asian companies are more sustainable
than yields with U.S. companies?

Mf: as I said about the asian reIts, they will probably have to cut the dividends. but
if you produce, say, food inTailand, I don’t see that the global recession would have
a huge impact on food sales in Tailand. It would have some impact, but not huge; so
these dividends are relatively safe in many cases.

Q: in terms of commodities, do you prefer any sector over another? Agriculture or
energ y or metals or…
Mf: well, I think that oil is now again at a relatively low level and I would probably
play the oil market by buying oil exploration companies. and I think agricultural
commodities have come down a lot again, and maybe there are some opportunities
there. but as I said, I’m not an expert on each commodity. I think sugar is quite at-
tractive at this level. the problem is for the individual to play the commodity mar-
kets if he doesn’t have a commodity-trading account and he can’t buy and sell; he gets
stuck because he has to stay the course. and so for individuals the best way to play
commodities is to buy a good mining company, a good oil company, or a good ex-
ploration company, or just physical gold. I don’t believe that individuals are ver y
successful at investing in commodities and commodity-related structure products.

Q: okay, Marc, i think this would wrap it up, but i’d like to just ask you one question.
if you had to leave one message with our readers to take away from all this, what
would that be? What would be the big take-away for them?

Mf: we live now in an environment of ver y, ver y high volatility, because on the one
hand you have the private sector that has tightened lending conditions,
and wealth has been destroyed, and households will save more and be
more prudent financially
than they ’ve been; in other words, credit or liquidity is tightening.
Then on the other hand you have these clowns in government that think that they can
solve any problem. as Mr. Geithner said recently, “we know how to fix the problems.”
well, if he knew so well how to fix the problems, why did he let the problems happen in the first
place? He was the new york fed chairman when the conditions were created! and Mr. bernanke
was the fed chairman since, I think, 2005, and he was the architect of this ultra-expansionar y mone-
tary policy. They have no credibility at all, and in my opinion they ’re going to make matters worse.
and the worse the economic conditions will be- come, the more Mr. bernanke will throw money at
the system; and that will lead to huge volatility in the market. you can have rebounds in individual
stocks, and in whole markets, of 30 percent in one month, then they can
drop 20 percent in a month; don’t forget, between november and the end
of the december, the 30-year treasury ran at 20 percent;and f rom its
peak at the end of december it dropped 20 percent.

Tere is huge volatility, and the same will happen in equities. and that ’s why I think
it ’s very difficult to make long-term predictions. when you have a perfect f ree-mar-
ket, it ’s difficult to predict the future. but when you have a market that is disturbed by
government manipulation and money-printing, it ’s impossible to make any predictions.
Q: Well said.

Euro Pacific Capital Special Report

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