13 April 2009

Marc Faber, Hyperinflation, Equity and Gold Prices

Anybody who wants to read up on the ‘paradox of inflation’ should turn to Dr Marc Faber’s classic ‘Tomorrow’s Gold’ for guidance. Even six years after publication this remains the best investment book currently on sale.

His foresight is amazing and the most part of a chapter is devoted to explaining how high levels of inflation impact on asset prices. That investors will switch from fiat currencies to precious metals is obvious enough.

However, Dr Faber also highlights what he calls the ‘paradox of inflation’, namely that with general price levels surging asset classes like equities actually become very cheap. He cites numerous historical examples, such as Weimar Germany.

Coming inflation

Now in November 2002 when ‘Tomorrow’s Gold’ was published talk of hyper inflation looked pretty ridiculous. Yet in the Bild newspaper the German Finance Minister Peer Steinbrueck warns that the world could face an inflation crisis in the medium term, after the immediate economic crisis ends, due to the huge amounts of liquidity being pumped into financial markets.

He said: ‘What causes me concern is that the next crisis is already being programmed because of all the enormous debt-financed counter measures being conducted worldwide’. For good measure he dismissed calls for a third German stimulus package in six months as ‘nonsense’.

But Steinbrueck is being over-powered by what he previously described as ‘British crass Keynesianism’ as governments ramp up spending around the world. Last week Japan announced a $154 billion stimulus package to add two per cent to GDP.

Yet if Dr Faber’s original thesis holds true then investors ought to be dumping stocks to buy precious metals now, and then waiting for a hyperinflation to make equities a once in a generation buy. The logic is clear: gold will keep and actually enhance its buying power while inflation will undermine stocks, providing a tremendous buying opportunity.

It would be interesting to know what the original Dr Doom thinks about this theory today. But as with most paradoxes there is surely a simple explanation.

Logical paradox

In periods of inflation companies find it impossible to raise prices fast enough to keep up with rising costs, so their profits margins are squeezed and therefore their shares are worth less, although not necessarily worthless. It is the reverse of the miraculous low inflation and high profit growth rates of recent years, admittedly only sustained by the ultimately unsustainable expansion of global credit.

Investors have to adapt to survive, and jumping back into previous boom asset classes far too early is a classic error. The trick, as Marc Faber says in his book, is to spot the next asset class bubble forming and get in and out before things get out of control.

Perhaps those rushing too late into the month-old US equity bear market rally might reflect on that concept, and consider selling out to buy hard assets before inflation takes hold. Inflation is, of course, suicidal for bonds and devalues paper currencies.


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