Tomorrow's Gold: Asia's Age of Discovery
Tomorrow's Gold: Asia's Age of Discovery, written by renowned investment adviser Marc faber, attempts to discover the outperforming asset classes of the future. The book analyzes the past, spots the trends, and tries to describe how new trends may develop in future.
Chapter 1 - A world of change
The world has changed dramatically over last few centuries. Some of the events that has changed the world in the past includes discovery of Americas, a new trade route around Cape of Good hope, Industrial revolution and so on. Faber believes that world is going to change ever more dramatically in next few decades. He believes that rise of India, China and rest of Asia with their three billion people will have profound effect on world's economic, social and geopolitical balance. The world will become a far more competitive place, in which new winners will emerge and quickly displace established regions of prosperity and corporate entities who fail to adapt to the new conditions. Faber believes that only constant that he expects of future is continuous and rapid change in the world's political, economic and social conditions.
What is unlikely to change in human nature. Faber believes that humans are still driven by basic instincts. At times people will succumb to greed, unbound optimism, contagion, imitation, delusions and other times will be driven by fear, apprehension, desperation and pessimism.
Chapter 2 - Major future investment themes
Faber believes that there will always be a major investment theme. Due to expansionary monetary policies of central banks world wide, he believes that world is flush with money. This excess liquidity will always lift the prices of one or more asset classes.
Faber also points out that when investment community is fascinated by a major investment mania, outstanding opportunities arise elsewhere. The sectors that nobody is paying attention, generally is undervalued and savvy investors should move to such sectors as they offer huge appreciation potential. Though investment community will eventually consider hitherto neglected sector, it is very difficult to predict the exact timing.
Faber expects good, commodities and emerging markets to be major future investment themes.
Chapter 3 - A caution about high-return investment expectations
Faber shows through examples from history that no "great investments" have withstood the test of very long term. They have all produced negative returns and eventually completely vanished. For every undertaking, colonization, company, invention, innovation, conquest and merger that succeeded, many more failed. In the very long term, a buy and hold strategy is certainly a losing proposition.
Faber contends that opportune selection of "right and undervalued investment theme" and speedy abandonment of fully valued popular themes, is key to great investment success.
Faber also points out that human behavior has hardly changed and this has lead to recurring investment manias over centuries.
Chapter 4 - Another warning to emerging market investors!
Using USA in 1800s as an example of emerging market, Faber contends that every economy and every industry goes through cycles. These cycles are particularly violent in case of emerging economies, emerging industries and emerging companies, which grow and evolve rapidly and are ,therefore, capital hungry. When investors are confident and optimistic, they end up providing too much capital bringing about a spending boom and an investment mania. This certainly causes downturn later as excess capacity develops because new competitors enter booming sector. As a result, new industries and emerging economies are subject to very powerful competitive forces and rapid obsolescence in early stages of growth.
Historically investors in emerging markets and industries have always lost money. This is especially true if investor follows buy and hold strategy. Hence, investor should, from time to time, should re balance his assets to avoid being caught in declining countries/industries and should keep looking for opportunities that arise in new industries and regions that open up and sprout for a given period.
Faber points out that boom in one sector of economy is most unlikely to be followed by another boom in same sector. It is far more likely that boom will be occur in another sector or region hitherto not considered by investors.
Chapter 5 - The life cycle of emerging markets
Faber believes emerging markets go through seven phases of life cycle.
- Long lasting economic stagnation or slow contraction in the real terms
- Real per capita incomes are flat or have been falling for some years
- High unemployment
- Little capital spending and international competitive position deteriorates
- Unstable political and social conditions (strikes, high inflation, continuous devaluations, terrorism, border conflicts etc)
- Corporate profits fall
- No foreign direct or portfolio investment
- Capital flight
- Little tourism (unsafe)
- Hotel occupancy is only 40% and no new hotels have been built for several years. Hotels are run down
- Curfews at night
- Little volume on the stock exchange
- Stock market has been moving sideways or moderately down for several months/years. In real terms stocks have become ridiculously undervalued
- No foreign fund managers visit the country
- Headlines in the press are negative
- No foreign brokers have established new office, no country funds are launched, and no brokerage buy research reports are published for a long time
- Middle east prior to the oil boom in 1970s
- Communist regimes post world war two till late 1980s
Phase one - The spark
- The social, political and economic conditions begin to improve(new govt, new economic policies, external factors, discoveries, the rise in price of an important commodity)
- Improvement in liquidity because of an increase in exports the repatriation of capital and increasing foreign direct and indirect investments.
- The outlook for future profit opportunities improves significantly
- Increase in cash balances and wealth
- Consumption, capital spending, corporate profits and stocks begin to rise sharply
- Stocks suddenly begin to pick up
- Tourism improves
- Foreign businessmen become interested in joint ventures and other direct investments
- Hotel occupancy rises to 70%
- A few foreign funds managers begin to invest
- Curfews are lifted
- Tax laws are changed to encourage capital formation and to attract foreign investors
- China after 1990
- Thailand after 1985
Phase two - The recovery cycle
- Unemployment falls and wages rise
- Capital spending in order to expand capacity soars as the improvement in economic conditions is perceived to last forever (error of optimism)
- Large inflows of foreign funds propel stocks to overvaluation
- Credit expands rapidly, leading to a sharp rise in real and financial assets
- Real estate prices several fold
- New issues of stocks and bonds reach peak levels
- Inflation accelerates and interest rates begin to rise
- The business capital resembles an enormous construction site
- Hotels are full of foreign businessmen and portfolio managers. Many new hotels are under construction
- Headlines in the international press are now very positive
- An avalanche of thick bullish country research reports are published by foreign brokers. Foreign brokerage offices are opened up. Country funds are launched.
- Th e thicker the reports the more offices that have opened up and the more funds that are launched the later it is within ===Phase two
- Countries in Phase two tend to become favorite travel destinations
- Japan between 1987 and 1990
- Entire middle east between 1978 and 1980
Phase three - The boom
- Over investments leads to excess capacity in several sectors of the country
- Infrastructural problems and an excessive credit expansion lead via rising wages and real estate prices to strong inflationary pressures
- The rate of corporate profit growth slows down and in some industries corporate profits begin to fall
- A shock ( a sharp rise in interest rates, a massive fraud, a business failure or some external shock) leads to sudden and totally unexpected decline in stock prices
- Many condominium and housing projects and new hotels , office buildings and shopping centers are completed
- The business capital resembles a boom town-lively night life and heavy traffic congestion
- Frequently a new airport is inaugurated and a second one is in the planning stages
- New cities are planned and developed
- Real estate and stock market speculators flourish, make the headlines with their rag to riches tales, and fill the night clubs
- The stock and real estate markets become a topic of discussion. There is active retail and speculative activity much of it on the borrowed money
- The locals begin to invest actively overseas in things (they have no understanding of art , real estate, stocks, golf courses etc)
- Japan in 1989
- Oil producing regions in 1980
Phase four - Down Cycle Doubts
- Credit growth slows
- Corporate profits deteriorate
- Excess capacity becomes a problem in a few industries but overall the economy continues to do well and the slowdown is perceived to be only temporary
- After an initial sharp fall, stocks recover as foreign investors who missed the stock market's rise in ===Phases one and two pour money into the market and interest rates begin to fall
- Stocks fail to reach a new high because a large number of new issues meet demand (the sellers are local who either know better or are strapped for cash)
- Condominiums have reached prices that exceed the purchasing power of th locals. They are now advertised overseas
- Offices capital values and rentals begin to level off or fall.
- Tourists arrivals slow down and are below expectations. Hotel vacancies rates rises and discounts are offered
- Brokers continue to publish bullish reports
- Political and social conditions deteriorate ( a coup, a strong opposition leader , strikes social discontent, increase in crime etc)
- Thailand and Malaysia after 1994
- US investors in early 1930s
Phase five - Realization
- Credit deflation
- Economic but even more so social and political conditions now deteriorate badly. Consumption slows noticeably or falls (car sales an housing and appliance sales are down)
- Corporate profits collapse
- Stocks enter a prolonged and severe downtrend as foregners begin to exit the market
- Real estate prices fall sharply
- A big player goes bankrupt(one who made the headlines in ===Phase three)
- Companies are strapped for cash
- Empty office buildings, high hotel vacancy, discontinued and unfinished construction sites are now common
- Research reports become thinner. Country funds that sold at a premium during ===Phases two and three now sell at a discount
- Stock brokers lay off staff or close down
- The country is no longer a favorite tourist destination
- Thailand and Malaysia after 1994
- US investors in early 1930s
- Investors give up on stocks. Volume is down significantly from the peak levels reached in ===Phase three
- Capital spending falls( error of pessimism)
- Interest rates decline further
- Foreign investors lose their appetite for any new investments
- The currency is weakening or is devalued
- Headlines turn very negative
- Foreign brokers finally turn bearish
- Flights, hotels, and night clubs are empty
- Taxi drivers, shopkeepers, panwallas and night club hostesses tell you how much they have lost by investing in stocks.
Chapter 6 - Business cycles - Alive and well!
Faber shows that business cycle will always occur. The economy will always be subject to above the trend line growth, followed by phases of below the trend line growth. These economic fluctuations cannot be eliminated by interventions from government or monetary authorities. He also suggests that business cycles are enormously complex phenomena and cannot be explained by one factor.
Chapter 7 - Long waves in economic conditions
Faber argues that there are long waves in economic conditions, through the analysis of studies done by Kondratieff and Schumpeter.
Chapter 8 - New eras, manias and bubbles
Faber categorizes markets as speculative and non-speculative markets.
Non speculative markets are usually depressed and undervalued. They have following characteristics (a) Low trading volume (b) Stocks are sold below book value or replacement cost (c) Very few or no initial public offerings(IPOs) or right issues (d) Lack of foreign participation (e) Market capitalization as a percentage of economy low (f) Low confidence amongst public (g) Low or non-existent capital gain expectations (h) Only few people (insiders) participate and public at large does not participate.
On the other hand, speculative markets end up having either a minor or major manias. A minor mania is a speculative bubble, which once burst, does not lead to widespread economic damage. Following a sharp but brief sell-off, the market uptrend resumes. Some examples are 1987 global stock market crash. These may occur every few years.
Major manias, are usually once in a generation affairs that lead to serious economic damage, once they burst. They occur during culmination of a long term secular uptrend, that may have lasted 10 to 25 years. In the terminal phase of mania, prices may accelerate on the upside, hitting new milestone highs. Faber feels it is impossible to predict how long such a mania would last and how much higher prices would move before bubble bursts. After the bubble bursts, milestone highs are not exceeded for another 10-20 years. Faber cites example of US stocks in 1920s, Japan in 1990s, and NASDAQ in 2000s.
During peak of such manias, there is universal drive to participate. Public sees only profit and no risk. Corporate sector overestimates demand for its products and is overly optimistic about its future. Professional investors cannot afford to sit out, though they understand that markets are overvalued. Foreign investors usually enter the markets towards the end and are responsible for final spike. Local investors too continue to buy anticipating more foreign inflows.
Another sign of speculation mania, is host of new issues of investment pools (for e.g. mutual funds) and IPOs. The IPOs are grossly oversubscribed and jump to huge premiums on listing. Towards the end of issue boom, offer prices of IPOs become excessive and quality of companies going public deteriorates. Many new books and magazines are published. Bookshops allocate disproportionate shelf space to business books and to books about market in which mania is taking place.
In the final blow off phase of mania, leadership becomes narrow. Only a handful of stocks soar and continue to increase index while broad market becomes lethargic.
An investment mania usually is usually transmitted across countries, through contagion of investors or speculators. Investors argue "if such and such a market soared last year, why cant our market do the same this year?".
While bust of mini mania can lead to change of leadership, bust of a major mania is followed by change of leadership and also direction of the entire market.
Chapter 9 - Opportunities in Asia
In this chapter, Faber analyzes the growth of various economies since 1970s leading up to 1997 crisis. As a lesson from 1997 crisis, Faber contends that investors should be wary of countries that depend on large foreign capital flows to sustain their excessive spending. He believes a crisis in USA is coming due to exact same issues of 1997 crisis.
Chapter 10 - The economics of inflation
In this chapter, Dr Faber discusses about "paradox of inflation". Faber notes that equities and real assets become undervalued, in real terms, in countries with high inflation or hyper inflation. Faber's primary reason is excessive currency depreciation, due to "massive capital flight" from such countries. Using examples of Argentina from 1977-1987, Germany from 1919-1923, Latin America in the 1980s, and Russia after the fall of communism, he shows that investing in equities and real assets in a country with high inflation or hyperinflation can provide spectacular returns to courageous investors.
Faber also cites the opposite case – that countries with low rates of inflation tend to have richly valued equity markets. Such as Japan in the late 1980s, or the Western world in the late 1990s.
Chapter 11 - The rise and fall of centres of prosperity
In this chapter, Faber describes the rise and fall of many prosperous cities, empires and countries. He argues that world's economic geography will change dramatically in coming future and investors will lose out if they think otherwise. Today's richest cities are unlikely to remain so in future. New cities and countries will be displace the current prosperous ones. This change may take far less time than in the past due to tremendous advances in science and technology(especially transport and communication).
Chapter 12 - Why the US is unlikely to provide the next leadership
Faber begins the chapter by describing characteristics of "new era thinking". Faber says that, from time to time, people become very optimistic about future and this optimism spreads around the world like bushfire. People believe that a new era has arrived which would bring unimaginable riches and prosperity. This usually leads to investment manias. Faber calls the phenomenon "new era thinking". This new era thinking has been associated with discoveries (new gold deposits), new inventions (canals, rail roads, computer, internet etc), rising commodity prices (oil in 1970s), peace treaties (end of cold war), or strong economic performances in hitherto unconsidered countries. The new era thinking usually engulfs the country or the world, not at the beginning of an era of prosperity, but towards the end and there is some sort of "rush" or investment mania. Faber goes on to describe two such manias that occurred in early 1700s, the South Sea Bubble in England and the Mississippi Scheme in France.
Using the example of Mississippi scheme, Faber says that financial system based on paper money, depends completely on public's confidence in the currency issued by monetary authorities. If the confidence is badly shaken, it leads to disastrous consequences. Faber says that foreign investors will eventually lose confidence in US dollar, due to money printing by Fed. And when this happens, either US dollar will depreciate against other currencies or against commodities and real assets. It could lead to soaring prices of real assets and commodities.
Faber suggests that ambition of any country to have an "empire" is ill-fated. He suggests that maintaining a large empire is always costly, leading to high inflation, rising interest rates, a depreciating currency, debt default or a combination thereof. He uses the data from Roman, British and other empires to support his claim. He recommends investors to look for other opportunities than in "empires" suffering from weakening currency.
Faber concludes by saying that it is unlikely that US would provide the next leadership due to its flawed monetary policies and increasing government deficits. He contends that US is most likely to face stagflation and US dollar is expected to depreciate against basket of commodities and gold.
Chapter 13 - Asia in transition
Faber believes that Asia is in a transition phase from ad hoc feudal system towards more liberal, more structured, constitutional systems. There has been many changes in political scene, with many countries liberalizing their economies.
Faber contends that, in future, Asia will depend less on exports from West. Instead, trade within Asia would increase. In addition, Asian countries are more likely to export to western nations, due to their competitiveness. China is likely to become world's dominant economic power. Asian companies are likely to grow to become truly global multinationals.