Marc Faber: Prepare your portfolio for inflation

Marc Faber smokes. A lot. This, as it turns out, is something of a problem if you are trying to interview him.

I have scheduled an hour with him just after he has given a talk at the Halkin conference in London. His talk is to be followed by one with our own Bill Bonner, and then Faber is to join Bill for a panel discussion about just how soon the end of the world is coming. But when I catch him outside the conference room, he can't talk right away. He has to go outside for a bit. It is 20 minutes before we are sitting down.

Faber's talk had been as miserable as one might expect. He looked at the possibilities of two different scenarios deflationary bust or ongoing government profligacy, money printing and inflation. The first, he says, "will happen one day", but for now there is no way to stop the money printing.

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The pain will keep being put off

A good 70% of American government spending is mandatory, something that makes it legally as well as politically tough to cut. Who's going to support changes to the law in the name of austerity at a time when "49.1% of the American population live in a household getting some kind of government benefit"? At the same time, the debt is utterly out of control: add in all of America's unfunded liabilities and it is around 800% of GDP.

I ask him if he sees any way out of the mess. Only the obvious, it seems cut governments. There is no "correlation between government spending and economic growth... so austerity wouldn't impact on growth permanently". If you were to cut entitlements by 50%, "then you have for one or two years a major problem". But "you can't fix something without imposing pain on the system".

However, governments won't be willing to impose this pain until there is a major problem which is exactly what will happen. Governments will spend "until there is no more capacity" and then "there will be defaults". At the same time, with government so big (Faber reckons that when government spending goes above 20% of GDP its effects start to be negative), you can expect to see more rises in regulation and for that to be nasty for business: "people who have money will prefer to speculate than to build a factory and hire workers".

High inflation is already here

I ask him if he sees yet the evidence of the very high inflation he reckons is the endgame. He does. You might not see it in consumer price indices, he says, but you can certainly see it elsewhere. Taxi prices in New York recently went up by 17%, for example. "A Warhol painting that sold for £2m ten years ago now goes for £25m."

So "we have an idea that cost of living increases are higher than those the government is publishing" and not just in America. The Federal Reserve only looks at its own official numbers so it "really believes that there is no money in the system". It doesn't consider asset price rises to be inflation and every time the price of a consumer good rises, it labels it "temporary".

But the "trick" to investing at times such as these is to know that "even in a money-printing environment, occasionally asset prices retreat" as the technology-focused Nasdaq index did in 2000 and the housing market did in 2007, for example. "So the money doesn't flow evenly into all asset classes, but into one asset class and then into the next." That means investors need constantly to be aware of the extreme volatility of markets and to ask themselves where the next bubble will be.

The next big asset bubble

OK, I say, where is it? "I think it could be in equities." Why? Partly because they "aren't terribly expensive" compared to cash and bond yields and partly because the Fed might end up extending its quantitative easing (QE) programme and buying stocks. We've just had a huge rally, but the Fed really doesn't want to see the market fall back. So "if the S&P drops by 200, 300 points, I think the Fed could easily come in and buy stocks".

Investment lessons from Mexico

However, while that might be where the new bubble will be, it isn't safe to focus entirely on equities. The only route to safety is via diversification. Faber therefore suggests being in a mix of different currencies (although he still see the US dollar as being less bad than the likes of the euro), equities (mostly Asian thanks to the fact that Asia has no "entitlement societies"), American and Asian real estate, and precious metals. The latter he would hold physically in Singapore and Hong Kong.

And regardless of whether equities will soon bubble, Faber makes the point that not only do they offer a pretty good yield (5% or so from a good basket of Asian equities), but they also make a pretty good hedge against very nasty inflation.

When inflation soared in Mexico between 1979 and 1987 it was equities that best weathered the storm for the simple reason that they held claims on real assets: had you bought and held on in 1979 you would have made 153 times your money in nominal terms, something that would have "basically maintained your purchasing power".

He also notes that between 1900 and now, those holding either cash or bonds in Germany have lost their money three times over. Those holding shares in good blue-chip stocks mostly still have them.

Chinese stocks could bounce

What of China? Faber isn't a believer in a Chinese collapse. That's because it is such a huge economy that "different provinces have different economies". Plus "the government's finances are reasonably sound".

Even local government? No, "that is a bubble". I wonder if he is buying Chinese stocks. He hasn't been, but given how much the market has fallen, "Chinese stocks could have a 30% bounce from here despite weakening fundamental positions, simply because people say they are cheap".

I can see Faber beginning to need to go outside again so we move on to talking about society. Most of the investment advice he is giving seems to be about preserving rather than increasing purchasing power. I wonder if he thinks that this is the best anyone can hope for at the moment. And if so, does he worry about the ongoing rise in wealth and income inequality in the West? He does.

The percentage of GDP going to labour in America is at its "lowest ever" and corporate profits are "too high" (something by the way that means investors should worry about rising corporation tax rates). This is all bound up in the financial crisis, in that falling real wages (that is, wages adjusted for inflation), alongside various American policies, encouraged people to borrow more than they should have.

Karl Marx was right

There's no doubt this makes a difference just as it did in the 1920s. "The people who wanted to consume had no money. The rich had that money. But they didn't want to consume. They already had everything." That's a pretty Marxist interpretation, I say, (albeit one regular readers will know I am on side with). It is, says Faber, but there isn't any other way to look at the kind of "mindboggling" wealth inequality we currently live with.

Then, 22 minutes in, and before I can ask how he might deal with the problem, he has to go and smoke some more. Still, the message for investors is pretty clear. Buy gold. Buy Asian equities. Prepare for inflation. Expect bubbles. Stay out of cash. And sell US Treasuries.

Who is Marc Faber?

Marc Faber was born in Zurich, Switzerland, in 1946. He gained a PhD in economics from the University of Zurich aged 24. A keen skier, he competed with the Swiss National Alpine Ski Team before leaving the country to work for American investment firm White, Weld & Co in New York.

The firm sent him to Hong Kong in 1973 and he's lived in Asia ever since. He went on to land a job at the Hong Kong office of Drexel Burnham Lambert, a Wall Street firm, and worked there until its eventual collapse in 1990. Undeterred, he established his own Hong Kong-based investment advisory firm, Marc Faber Ltd.

By this point, Faber had already earned a name as a shrewd investor, having warned clients before the Black Monday crash in 1987. And his 2002 book, Tomorrow's Gold: Asia's Age of Discovery, only added to that reputation, predicting the rise of oil, precious metals and other commodities on the back of rising demand from China.

As Asia's economies have grown increasingly important, Faber's status as one of the few long-time regional experts has risen. He now lives in Thailand, but keeps a small office in Hong Kong and his newsletter, The Gloom, Boom & Doom Report, is read widely.