Sunday, January 25, 2009

Faber College

Barron's Online
Monday January 26, 2009

Faber: I'm not optimistic about the global economy. The next Madoff case -- the next Ponzi scheme -- is the U.S. government. It will go bust. It is only a question of time. The fascinating thing about asset markets today is that everything is connected -- the dollar, the economy, equity and bond markets, currencies. When one thing moves, so does something else. That makes the market ideal for short-term traders. Last year it was easy to see that the dollar was oversold and pound sterling was overbought, that the yen was relatively cheap and financial markets were expensive, that the economy would worsen and commodities would come under pressure. Today the private markets are deleveraging, governments around the world are throwing money at the system, and there is huge volatility. Everybody says stocks are cheap because they're down 50% from the peak. But Japan was at the same level four weeks ago as in 1981. Korea was at 1988 levels. These markets are relatively cheap because in 20 years there has been progress. If the U.S. went back to 1990 levels, the Standard & Poor's 500 would be at 300.

It's not impossible.

Faber: That would be an interesting entry point. Having said that, the market gave back in the 14 months ended Nov. 21 as much as in 1973-74. Stocks became oversold. People may interpret the coming fiscal and monetary reflation as slightly more favorable, and stocks might rise. You can have a horrible economic backdrop and markets that move up.

Also, the worse the crisis, the greater the polarization between good companies and those that don't have money to do R&D and expand market share. And by the way, it is a grave error to support weak companies like General Motors [GM]. In a deflationary crisis you want to get the supply down as quickly as possible.

How you play this market depends on your time frame and objectives. If you want to build some exposure in Asia, buy high-quality companies that will survive. In Singapore, that includes Fraser & Neave, United Overseas Bank and OCBC, which is run by an American, David Conner. In Hong Kong, I like Swire Pacific and Sun Hung Kai Properties. Asian banks never understood CDOs [collateralized debt obligations], so they didn't buy a lot.

Nobody understood them.

Faber: Asians might go to casinos and gamble, but in their businesses they are ultra-conservative. In Thailand, buy Bangkok Bankand, Glow Energy, and in India, Icici Bank and Infosys Technologies. Banks in Singapore sell for 1.3 times book. In Thailand they are below book and have relatively high dividends. If all these companies drop another 50%, which I wouldn't rule out, buy more.

What are their approximate P/Es?

Faber: Maybe 10, 12 times earnings, but who knows what earnings will be?

When market volatility goes up dramatically, you want to be in defensive groups like pharmaceuticals and food. When volatility diminishes, you want to be in cyclical industries. Among the most cyclical stocks are resource producers. They were driven up by incremental demand from China, and then collapsed. In the next six months they could have significant upside. I like Rio Tinto, BHP Billiton and CVRD [Companhia Vale do Rio Doce].

The financial crisis and collapse in commodities will keep supplies out of the market. Nobody is exploring now. There is no money, and projects are being postponed. Whenever the recovery comes, in five or 10 years, resources stocks will go ballistic from today's low levels. If you're optimistic about the next six months, too, when the news may be slightly better than today, you should own them. Freeport McMoRan Copper & Gold fell from 127 to 15 and is now 26. Xstrata, in Switzerland, is another one. A lot of these stocks are more attractive than gold, because gold is at a 20-year high relative to industrial commodities.

Rio Tinto's balance sheet isn't in good shape. They have a refinancing issue.

Faber: Worst-case, the Chinese government could buy them out. China has taken a big stake in the company. Meryl recommended Kaiser Aluminum [KALU] earlier today. I would add Alcoa.

You're not saying this is the beginning of a big bull market, but of a base-building process from low levels.

Faber: Correct, but when stocks decline by the magnitude seen in resources shares, or the Nasdaq after 2000, a base-building period follows that can extend for several years. When you print money, you can get an artificial bull market that exceeds everyone's expectations.

In a recovery driven by easy money, zero interest rates and fiscal deficits, emerging markets -- the most cyclical part of the global economy -- can rebound. There is 50% upside in the Morgan Stanley India Investment Fund, the iShares MSCI Brazil Index, the Templeton Russia and East European Fund, the Greater China Fund, the iShares FTSE/Xinhua China 25 Index and the Turkish Investment Fund. Everything is bad in Japan, but they're used to it for 20 years, so Japanese stocks might not go down more.

Next, the Treasury market won't continue to rally. The inflection point in long Treasuries may have arrived. The yield on the 30-year bond is back up to 3%. The U.S. Treasury market is the short of the century. You can short it through the TBT [ProShares UltraShort Lehman 20+ Yr exchange-traded fund.] It goes up in price when bonds go down and yields go up. As an ultrashort fund, it moves 200% inverse to the move in Treasuries with maturities of longer than 20 years.

That's leverage.

Faber: We're used to leverage. It may take two years to work out. On the long side, the Nicholas-Applegate Convertible & Income Fund trades around 5. The junk-bond market and convertible securities could rally substantially, as corporate bonds have done. The Federal Reserve's move to buy up assets will lead others, including Bill Gross at Pimco, to front-run the government and buy the same assets. High-yield bonds and mortgage-backed paper could rally.

I agree with Felix's bullish view of gold, except that gold prices might not go up until later in the year. The price was up 5% in U.S. dollars and much more in other currencies in 2008, and people may sell it first to buy something lower-priced. Felix pointed out [in last week's Roundtable installment] that gold-exploration companies have been decimated by the financial crisis. I see the potential for a huge rebound. A lot of exploration companies are selling for 2 or 3 a share, which is like buying an option with a very, very long expiration date. If the global economy improves, they can probably produce. If not, prices will go ballistic because there will be no new supply. Gabriel Resources, in Canada, trades for 1.60 Canadian dollars. Newmont Mining [NEM] owns a sizable stake.

Valuing such companies is difficult. They will either work out and you'll make five or 10 times you money, or they won't.

Faber: One day the price of gold will be higher than the Dow Jones. The CRB, a broad index of commodities, fell for 20 years in nominal terms, from 1980 to 1999. It is now up 12% and is still inexpensive. The Dow and the S&P are up substantially from the 1980s or early 1990s. Everyone thinks fiscal and monetary measures will work to fix the financial system. I don't. They will be disastrous and fuel inflation. But the supply of oil, gas and copper is relatively limited compared to paper money you can print.

Recently I bought some U.S. stocks for the first time in a long time. If you buy Intel , Cisco , Yahoo! , Oracle and Microsoft , you will do much better in the next 10 years than you would with Treasuries. These stocks will double and even triple -- before going to zero.

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