Book review: Tomorrow's Gold
Estimated reading time: 20 mins
Marc Faber is a true contrarian. Bored with life in Switzerland, he came to Asia almost half a century ago to work as a stockbroker. He has chronicled his experience through several books and thousands of reports.
I have read most of Faber’s publicly available writing and will try to give you a sample of his main ideas. While he is often criticised for being too negative, his writings also reveal a deep understanding of economic history. Whether you’re a bull or a bear, I believe that there is a lot to learn from him.
Growing up in Switzerland
Marc Faber was born in Zurich, Switzerland right after the Second World War. It was a quiet but happy childhood.
He was always a rebel. At age 11, Marc’s father refused to buy him a bicycle, reasoning that it was too dangerous for a young boy to cycle around on the streets. Refusing to accept his fate, he decided to take matters into his own hands. So to his father’s dismay, he worked for hundreds of hours and managed to scrape together 150 francs to buy it himself instead. He wasn’t willing to accept authority.
At college, he chose economics. His older brother had chosen law, and he wanted to differentiate himself. Besides, he found an incredible economics professor who inspired him to go down that path.
In his writings, he claims that he wasn’t a good student - that he spent most of his time skiing in the alps as a member of the Swiss University Ski team. Yet, he still managed to graduate magna cum laude, eventually earning himself a PhD.
His skiing experience helped him in unexpected ways. He got in touch with many well-to-do skiers who later became his clients. And he also felt that skiing helped him build up his confidence and conquer fear.
During the last summer of his studies, Faber got a first taste of the stock market. His father gave him some money to finish his studies. With all that cash, he decided - why not go for a gamble? So he took the surplus cash and bet on the hottest stocks of that ear: conglomerates Litton, Gulf & Western and Ling-Tenco-Vought, as well as Penn Central. It seemed like a great idea, given the impressive earnings growth they had achieved through low P/E acquisitions.
He lost almost all of the money. By the early 1970s, their organic growth deteriorated and the acquisitions came to a halt. Litton lost 86%, and Penn Central filed for bankruptcy. Battle-scarred, Faber became more conservative.
Towards the end of his studies, he looked around for a job. At the time, the hottest industries were merchant banking, advertising and stockbroking. He went for the latter and was accepted by the American investment bank White Weld for the position of a stockbroker.
White Weld
Faber started his career at an extraordinary moment. He started right in the middle of the 1970s Nifty Fifty bubble.
The popular view at the time was that one was justified in paying a large premium for growth - and particularly for earnings visibility. The P/E multiples on the stocks were often 50x or 60x.
The Barron’s roundtable of 1973 was entitled “Not a Bear Among Them”. As in - every single participant in the roundtable was bullish. In hindsight, that proved to be the exact peak of the bubble.
Although Faber wasn’t exactly a cheerleader of the bubble, his firm White weld kept issuing buy recommendations on the Nifty Fifty stocks. Faber remembers seeing his colleagues remaining optimistic throughout the entire bear market - no one suspected how long and deep the decline would be.
The “Far East”
In the summer of 1973, when Faber was 26 years old, he went to Tokyo for a business trip. He met several Japanese financial institutions but remembers being underwhelmed by the experience.
On the way back, however, he stopped by Hong Kong. A Swiss named Ruedi Bischof invited him to go waterskiing in Repulse Bay, and Faber loved the experience.
After visiting Hong Kong, he went for a holiday in Pattaya, Thailand and met a stunning girl that ran a bar close to a beach.
A fortune teller approached him and said: “You will move to Asia and never leave again”. The fortune-teller told Faber that he had “a very lucky face” and would “succeed in whatever he undertook”. He took this as a positive sign.
Faber was happy with his life in Zurich. It was comfortable but perhaps not exciting. Swiss have a habit of interfering in other people’s affairs - “neighbour watching”. Everybody keeps track of everybody else. So if you want to go through life on your own terms, Switzerland is not for you. That was part of the lure of Asia.
Also, after the devastating 1973-74 bear market, clients in Europe were battle-scarred. Whereas in Asia, where Faber did not yet have any clients, his track record remained clean.
He spent much of the first few years in hotels in Japan and later got an apartment in Hong Kong. Travelling the region, he was struck by how hard the Chinese worked in Taiwan, and he felt the same about Korea, Singapore and Hong Kong. He was also impressed by the wealth of natural resources in Australia, Indonesia and the Philippines.
His writing from this time shows an immense optimism about the region. Two-thirds of the world’s population lived in Asia, and it was growing rapidly. The population was hard-working and not yet connected to the world economy.
Faber felt that the people in East Asia seemed more interested in developing their economies and acquiring wealth rather than fighting wars on ideological grounds - as was often the case in the Middle East. He felt that was an explanatory factor behind Japan’s success, and increasingly Taiwan’s and Korea’s.
Travelling stockbroker
As a stockbroker, Faber became a friend to many of the investor greats of that era. Marc Rich became a client and invited him to his home in St Moritz. He went skiing with Giordano’s Jimmy Lai. Larry Tisch connected him to former Quantum fund associate Jimmy Rogers, who also became a close friend. He made many friends across the industry.
After the Nifty Fifty debacle, investors lost interest in growth stocks. After inflation picked up, they all rushed into inflation hedges instead: gold, real estate, oil, stamps, farmland, mining. Towards the end, it became a self-fulling prophecy: as prices were bid up, they led to further increases in consumer price inflation, which escalated the panic further.
As sugar price went to the moon in the mid-1970s, Faber became friends with a prominent Filipino sugar grower called Aurelio Montinola. Faber gave him a word of warning. With sugar prices rising 10x in a short period, there was a significant risk that they would eventually fall back to earth.
The Philippines experienced a massive boom during the later part of the 1970s as well. Under dictator Ferdinand Marcos, the country was glamorous and booming. Houses in Manila’s Forbes Park cost more than similar properties in Beverly Hills. A seat on the booming Makati Stock Exchange cost about three times as much as a seat on the New York Stock Exchange at the time. Faber had several clients in the country and considers the 1970s boom and the ensuing bear market of 1981-82 one of the greatest he has ever seen.
The gold and oil bubbles
In 1978, Faber became a managing director at Drexel Burnham Lambert, the American investment bank.
Indonesian Budi Hartono became a client in the 1970s. He and his brothers owned the second-largest tobacco company in Indonesia. Faber told Hartono that gold prices were going up as inflationary pressures were taking hold. That was a prescient call.
On a visit three years later, Hartono jumped at him and “Marc, you were right, yes you were right!”. As prices kept rising, Hartono became more and more bullish.
His strategy was simple: “When it goes up, I sell, and when it comes down, I buy!” This strategy was profitable during the up-cycle as the gold price moved from US$100/ounce to US$200 in 1978 and to US$850 in 1980. At the peak of the bubble, the whole world followed gold price movements 24 hours a day on their Reuters screens. Large speculators such as Hartono had their largest exposure at the top.
Hartono made significant losses after the gold’s significant collapse. Ever the bear, Faber advised him to clear out his entire position. Luckily, Hartono didn’t listen to him but instead doubled down, rode a massive bear-market rally and got out of the gold bear market largely unscathed.
In 1979, Faber read a book called The World’s Greatest Salesman, telling the story of the apostle Paul, who travelled extensively to preach the teachings of Jesus Chris. He was inspired and decided to follow Paul’s example in looking for business further afield.
His travels took him to the Middle East, where he met Hilal Al Mutairi, who ran the Kuwait Investment Company. Faber gave him a warning concerning the potential for the Kuwaiti stock market to collapse. But no one took Faber seriously, as he was 18 months early. His credibility in the Middle East was tarnished and his efforts didn’t get a lot of traction.
One person who believed in his theory was Farouk Sultan. He agreed with Faber that the market would eventually crash “but not now, maybe in a year”. The total market cap of the oil-fuelled Kuwaiti stock market reached US$90 billion by 1981, more than Switzerland, France, the Netherlands and Australia. Land prices went ballistic. Not even land in Tokyo in the late 1980s could compare with the prices paid for Kuwait land at the time. Much of the boom was driven by the use of margin debt in the form of post-dated cheques.
With the disappearance of oil surpluses in about 1982, the economic climate in the Middle East began to deteriorate. The Kuwaiti stock market collapsed, and the transition from boom to collapse became complete. In Kuwait, hotel occupancy averaged less than 25%. Sales of Mercedes-Benz luxury cars and precious stones fell precipitously. Farouk did not get out in time. He later told Faber that he wished he would have listened to him.
In the early 1980s, it was clear that inflation had peaked. Paul Volcker became Fed chair and halted the growth in the US money supply. A recession soon followed. By then, interest rates had moved from less than 3% in 1949 to over 10% by the early 1980s. The dividend yield on US stocks had moved from over 8% to less than 3% over the same time period.
Faber felt that the ratio between stocks and bonds would mean revert. He, therefore, recommended clients buy US bonds and stay out of stocks.
He made several other epic market calls. He bought into Philippine stocks close to the bottom in 1985. He bought Korean stocks in 1978, well before foreigners were officially allowed to do so. And he bought into the Singaporean and Thai stock markets in 1986, right before a massive boom.
Cycle theories
Marc Faber’s writings from the 1980s show attempts to systematise the observations he had made about stock market bubbles throughout his career.
He came up with a number of indicators that investors can use to gauge whether a market was early-stage, developing or mature:
News headlines: Near the market lows, the news is bad. At the peak, media shifts its attention to the stock market.
Margin debt. Margin debt is a sign of speculative activity. Faber felt that for a major low to occur, margin debt should contract by at least 40-50% from the level reached during the previous stock market high.
Breadth. In a rising market that is healthy, an expanding number of stocks should be making new highs. If breadth starts to deteriorate, that’s probably a sign to get out of the market.
Volumes. Volume expands near tops and contracts near important lows. High trading volume in second-liners vs blue-chip stocks as a sign of a market top. Near lows, Faber believed that investors tend to purchase only on blue-chip shares.
Advance/decline line. Another way to judge the direction of the market is the advance/decline line. Compared to the index, this advance/decline line tells you more about the direction of the median stock.
Stock splits. Faber believed that stock splits were frequently announced at the top of the market. Stock splits are not bullish - instead, they are a sign that smart investors are looking to unload their expensive shares on a confident and greedy public.
New stock offerings. Near market bottoms, the volume of IPOs is low because companies do not want to issue new shares at low prices. The public would have no appetite to buy them either.
Research reports. Faber was suspicious of thick and overly detailed reports published by stockbrokers. In his own words: “What is good is usually also quite simple, so lengthy explanations should not be necessary.”
Brokerage activity. The number of brokerage company account executives tends to increase across the cycle. Brokers expand their footprint near market tops and to close down their offices near market lows.
Swindles. The increasing incidence of frauds, swindles, dubious practices and catch-penny schemes is closely associated with speculative manias.
Fund premia. After an extended rise in prices and when the mood is optimistic, shares will often sell at a premium to their net asset values.
But the main indicators that Faber paid attention to was the trading volume and the sentiment of investors active in the market. He wanted to bet on markets with low activity and negative sentiment and bet against markets with excessive activity and euphoria.
Further, he felt that the key focus of investors should be to ride the long-term trend:
“My experience has been that investors make much better investment decisions by not looking constantly at quotation machines and when removed from the influence of the moment…. I believe the key to success lies in recognising a long-term trend and staying with it.”
“Dr Doom”
Throughout the 1980s, Faber increasingly became known as a doom prophet. He would issue bearish calls on the Japanese market in the late 1980s, for example, expecting the market to drop.
But since he became bearish too early, he risked looked foolish for a year or longer before the bubble eventually burst. He would often be treated as an outcast.
“If an adviser takes a different view, the investment community will treat him as an outcast… since he is taking the opposite stance from everyone else, it is likely that he will be wrong for a while.”
Part of his refusal to participate in late-stage bubbles might have stemmed from his conservative Swiss background. But he also loved expressing contrarian views. He wanted to be seen as separate from the crowd - more intelligent, better-informed.
He felt that the excessively greedy public deserved to be punished. The foolish public did not understand that when asset prices go up too much, they become overextended and therefore risk a collapse.
The 1987 crash
Black Monday is associated with one of the worst stock market crashes in history. But if the American experience was bad, the one in Hong Kong was an order of magnitude worse. The Hong Kong Stock Exchange was closed down for four days. When it reopened, the Hang Seng index had fallen 33% from its previous close. And the index fell by almost half in a week’s time.
Faber felt vindicated. He had advised investors to get out of the stock market before the October 1987 crash and even had small short positions. He covered all of his short positions in the panic
Several of his friends and clients confessed to him that they lost a lot of money in the crash. But since the crash had happened so fast, few of them had sold. Faber’s conclusion was that investors were still eager to buy shares. And he felt that such optimism signalled that the low was not yet in.
In a typical Faber fashion, he expressed disdain about the unthinking crowd and felt a need to separate himself from them.
“These careless bulls, who acted like sheep, are now presented by Santa Claus with a 50% loss on their investments.”
The absence of a complete capitulation among investors, therefore, made it difficult for him to turn bullish.
The lifecycle of emerging markets
In 1992, Faber wrote a report on “The Life cycle of emerging markets” - analysing investor psychology through each phase of a market cycle.
Stock markets resemble human life. They start in the embryonic stage. They reach adolescence, grow rapidly and become more accident-prone. And as they mature, they lose their energy and volatility, become tired and finally die.
He divided each market cycle into six phases, from total disinterest in phase zero to euphoria in phase three. Following a bear market rally in phase four, the cycle is finally complete in phase 6.
Faber suggested the following indicators to try to classify where in the cycle a particular market might be in:
In phase 0, economic conditions are weak, and there is zero investor interest in the market. Trading volumes are low, and stocks are cheap. There is no “catalyst” on the horizon. Faber mentioned the Middle East before the oil boom in the 1970s and Communist countries until the late 1980s.
In phase 1, an event sparks an improvement in economic conditions. It could be a rising commodity price, economic reforms or an opening up of global trade. Unemployment will tend to decline. He mentioned the Middle East after OPEC decided to raise the oil price in 1973, Thailand in 1985, Indonesia after 1987 and China after Deng Xiaoping’s Southern tour in the early 1990s.
In phase 2, the country is booming again. Large inflows of foreign funds, credit expands rapidly, IPO activity is high, and inflation starts to accelerate. Everyone is bullish. Texas in the late 1970s was in that part of the cycle, as was the Middle East for a similar reason. Japan between 1987-90 was also experiencing a boom.
In phase 3, the excess capacity becomes apparent. Credit growth grows faster than GDP. Insiders are selling. Business people become folk heroes, and taxi drivers start to discuss stocks. Buzzwords such as LBOs, M&A and “Asian tigers” become popular. The oil-producing regions in 1980 qualified, as did Hong Kong in 1973 and 1980. As well as Singapore during the peak of the real estate boom in 1980-81 and Japan in 1989.
In phase 4, the downcycle begins. Credit growth slows, corporate profits deteriorate. Yet foreigners keep on buying stocks. Property prices are so high that locals cannot afford them anymore. Brokers also remain bullish. Examples of markets in phase 4 include Latin America in the early 1980s, Thailand and Malaysia after 1994 and US investors in the early 1930s.
In phase 5, credit becomes tight, and bond spreads widen. Real estate prices start to fall. Scandals emerge, and real estate vacancy rates begin to rise. Unemployment goes up and stockbrokers are laid off. Singapore in 1982 and 1983 fit the profile.
In the final phase 6, total capitulation follows. Investors give up on stocks. Trading volume is down as much as 90% from the peak. The currency depreciates or suffers from a devaluation. Flights, hotels and nightclubs are empty. And everyone tells you how much they lost in the market. The US in 1932 and Hong Kong in 1974 were perfect examples of markets in phase 3.
Around the time Faber wrote his essay on the lifecycle of emerging markets, he felt that the Hong Kong property market was becoming extended yet again. In 1993, he recommended shorting the Hang Seng index along with emerging market telecom companies. He was especially bearish on property developers, who had grown accustomed to rising prices and whose margins were unsustainable given that land prices had risen significantly. He, therefore, felt Hong Kong property was becoming a phase 3 market at risk of developing into a phase 4.
Russia in 1994 qualified as a phase 0 market, in his view. Faber noted that Surgutneftegaz, which produced 2% of world oil output, was valued at just US$170 million. Meanwhile, Gum Department Store in Moscow was valued at just US$24 million. He felt that as the bull market would start, Russian stocks could potentially rise 10x to 20x.
The Paradox of Inflation
In 1994, Faber wrote a report on “The Paradox of Inflation”. He argued that while hyperinflation can cause an incredible rise in the domestic price level, currencies often drop even faster than inflation. Such depreciation invariably caused bargains in the stock market.
He took the example of the Philippines in the early 1980s. At that time, high inflation and poor economic, social and political conditions brought down the stock prices and the peso’s value. By 1985, the Commercial Stock Index was down 76% in US Dollar terms. But the mining index was down 94% and the oil index down 97%. The market cap of the six largest companies had fallen to only US$340 million. Even Peter Lynch got interested in the market, investing in Philippine Long Distance Telephone at a P/E ratio of less than 2x.
Likewise, the Weimar hyperinflation of the 1920s provided the best buying opportunity for German stocks in the entire 20th century.
Moving to Thailand
Through the 1990s, Faber spent more time managing money and writing his monthly report than seeking new clients. He also wrote a weekly column in Apple Daily.
By the late 1990s, he became increasingly bearish about Hong Kong, his home since the 1970s. He felt that the city was becoming too expensive and would lose out to cities on the mainland, which were cheaper and in closer proximity to key manufacturing hubs.
So in the year 2000, Faber moved to Thailand’s Chiang Mai together with his wife and daughter. He remodelled an old house and packed it full of Chinese Communist Party memorabilia, books on economics and other artefacts that he collected throughout the years.
From his home in Chiang Mai, he writes his monthly Gloom, Boom & Doom Report on investing as well as other current topics that he finds interesting.
Tomorrow’s Gold
In Faber’s 2003 book Tomorrow’s Gold, he offered a more optimistic view on the future. He predicted that Asia would drive growth in the coming decades as China became an industrialised nation.
Ancient cities and civilisations have gone through cycles of flourishing and withering. He felt that China would be no exception. Several Chinese cities had been the largest globally before the country turned inwards during the Ming Dynasty in the 15th century. Faber felt that China’s opening up would lead to a rejuvenation in Chinese influence worldwide.
He compared the emergence of China into the world economy with that of the United States a few hundred years ago. He predicted that China’s rise would lead to a massive increase in demand for commodities such as oil and metals.
With China’s rise, Faber also expected neighbouring emerging markets to benefit. As developed markets increasingly became overindebted, they would cease to become the major driver of demand for manufactured goods. Instead, he believed that China would become an exporter to other countries in Asia and the rest of the world.
He also believed that following the Asian Financial Crisis, Asian stock markets were likely to start outperforming the United States yet again. The ratio between the two had been building a base for several years since 1999. They also enjoyed large current account surpluses and rising exports. And so felt that in the wake of the Asian Financial Crisis, the outlook for stocks in the region was the best they had been in years.
In his book, he offered negative views on the US housing market. While he was dead-on in this prediction, he stayed bearish too long. As the US stock market crept higher throughout the 2010s, he lost fans in the process. But he continued to be a mainstay speaker of investor conferences in Asia and elsewhere.
In 2017, Faber wrote a series of insensitive and foolish remarks about the role of race in America’s development. He refused to retract his comments and was later forced to resign from board memberships. He was also banned from most mainstream media outlets.
Faber’s views on the future
Marc Faber continues to believe in the Asian growth story. He is bullish on large-cap Hong Kong property stocks, which trade at 50% of net asset value. He believes that Hong Kong’s future is bright, but only as part of China’s booming Greater Bay Area. He especially likes asset-rich conglomerates such as Jardine Matheson, Cheung Kong and Swire Pacific.
He thinks that cyclical stocks are due for a rebound generally. “Pure growth”, on the other hand, should be underweighted by investors. He’s particularly interested in non-tech stocks in emerging market stocks, which have underperformed for many years now.
He thinks that the FAANG stocks (Facebook, Amazon, Apple, Netflix, Google) display certain similarities with the Nifty Fifty in 1973. There is a tremendous amount of speculative activity in US tech. Such speculative manias usually end badly and he thinks that FAANG will be no exception.
While recovery from COVID-19 seems likely, Faber remains bearish about the long-term prospects for economic growth. He feels that speculative activity in the stock market is high and that caution, therefore, is warranted.
My personal reflections
Marc Faber believes that markets move in long-term cycles. The bull and bear markets mentioned in his writing - the Nifty Fifty, the Middle Eastern oil bull market, the gold frenzy, the Asian Financial Crisis - all share certain commonalities. Identifying where we are in a bubble can help us find the long-term trend. And it can help avoid the most vicious bear market.
At the same time, being contrarian by default is not always helpful. On the way to euphoria, markets climb a wall of worry. Only at the last moment when virtually everybody has joined the bullish camp - that will be the right time to worry.
Applying his “lifecycle of emerging markets” model today, US tech stocks seem to be in phase 4. Foreign investors now own 6x more in US stocks than they did in 2008. Even here in Singapore, most retail investors prefer to speculate in US tech stocks these days.
Conversely, I wonder if Indonesia might be in phase 1. Could the omnibus law and ongoing labour market reforms spark a boom in the manufacturing sector? Could a unified property registry and lower rates spark a boom in the property sector? With credit growth accelerating, perhaps we are in the early stages of a bull market.
The key lessons from Marc Faber’s writings are that investors need to maintain a long-term perspective. Markets move in cycles and one should never get carried away.
When everybody is disinterested in a specific market, we should pay attention. And when everybody rushes in, consider taking a bearish view.
Thanks for reading!
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