Peter Schiff is the President of Euro Pacific Capital Inc., frequent commentator on the financial media, one time Republican candidate for the US Senate (Connecticut), gold bug and general bear on the stock market.
Remember the scene in Stephen King’s Carrie where the phrase “They're all gonna laugh at you” was repeated over and over again? I imagine this is how Peter Schiff feels. A clip has been circulating on YouTube showing Peter circa 2006 explaining to the talking heads on CNBC/Fox News/CNN etc. that (at that time) the low savings rate would lead to a decline in consumption followed by a crash in home prices and ultimately a recession. The talking heads laughed at Peter (go to 3M40Sand 6M10S in the clip). Despite this laughter, and with few listening, Schiff continued to defend his point of view. We have seen, through the Great Recession, that Peter was dead on.
You would expect, as the saying goes, he who laughs last laughs best; that Peter would have had the last laugh. Yet during a recent CNBC interview Peter was laughed at again. With the 2006 clip in mind, I thought that it may be time to revisit Peter’s thoughts process. For this reason I picked up The Little Book of Bull Moves In Bear Markets: How To Keep Your Portfolio Up When The Market Is Down, published by Wiley Press originally in 2008, but updated and expanded for 2010 (the title of the 2010 edition drops the “In Bear Markets”, but I don’t think we should take anything from that).
Unsurprisingly, the book is syndical and bearish; pure Peter. Schiff defines a “bear market” differently than most. Ask your neighbour to describe the last decade and he would answer that after the recession of 2002 and 2003 the economy entered an expansion phase which eventually resulted in a lending/housing bubble which resulting a recession which started at the end of 2007. Conversely, Peter would respond that the bear market started in the year 2000, and the upturn from 2003 to 2007 was a primary trend but not the secular trend. This is the peculiar (which I don’t mean in a bad way) footing that Schiff bases his book on.
Schiff is bearish on the US economy. He believes that lax credit policies (at banks and the Fed) have resulted in an asset price bubble. He believes home prices will continue to fall and surmises that the second half of the twin deficits, the balance of trade, will force the US dollar lower.
Taking an historic view, Schiff juxtaposes the current economy to the booming 50’s (where high saving rates fueled production). Likewise, he contrasts the current recession to the recession of the 1930’s which was marred with debt and deflation (the second being a good thing because, when consumers were in a difficult spot, their dollars went further) and the recession of the 1970 which was one with stagflation and low debt (therefore allowing the government to raise rates and fight inflation). The current recession is the worst of both worlds; high debt and stagflation – unlike previous recessions there is no obvious catalysts for recovery.
Peter believes a bond bubble currently exists; he feels that interest rates are unsustainably low and have no place to go but up, in turn bond prices will fall. The commentators that I follow see the bond market as a substitute for the equity market, and when bond prices decline equities should prosper. Peter does not reach this same conclusion. He believes that the only way for the government to pay off its debt is through inflation. Therefore Schiff believes that both debt and equity markets will decline over the next decade (although some equity classes may be spared). He has clarified that he “think[s] that real equity prices will decline over the next decade, but nominal prices will likely rise.”
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Schiff believes that the dollar will continue to decline. He explains that many US dollars are held by foreigners (e.g. China) and that these holdings can lead to inflation once the dollars are repatriated, e.g. a sovereign wealth fund chooses to buy a US entity (which of course is happening).
Peter reminds us that the CPI is not inflation; inflation is in fact an increase in the money supply. Peter believes that the CPI is a poor measure of general price movements (he states that a better estimate, the amount of M3 money, is no longer provided). I’ve noted that Schiff believe that inflation will be a drag on the economy, worse yet, he states that the economy is already in a highly inflationary environment and that traditional measures understate inflation.
Schiff says more accurate measures put inflation at 8% or higher. Because of the discrepancy between his estimate and the official CPI numbers, economists, analysts and others have underestimating how bad the economy has been. For example Peter estimates that from 2000 to 2007 the DJIA fell 42% in real terms (not up 6.5% as reported in nominal terms).
Gold is the other side of the inflation/dollar coin. Given Schiff’s prognoses on the dollar and inflation it is unsurprising that he is extremely bullish on Gold. In fact he is calling for gold at $5,000 an ounce, nearly 4x above its current levels. This is a very bold prediction, I have not heard many commentators (even gold bugs) proffer such a high prediction. However, given Schiff’s stance that the USD is going to inflate away to nothing, I wonder how much of the $5000 gold price is due to inflation and how much is due to actually appreciation of the commodity (it seems Schiff excepts most of the appreciation will be due to inflation).
Schiff acknowledges, as do his critics, that gold in the 1970’s reached new highs (as it has in the last months) but then crashed. Where, in the 1970’s, interest rates were raised to combat inflation the current approach of the Fed is to keep interest rate extremely low. Therefore, unlike the 1970’s, Schiff does not believe that gold prices will crash again. (Remember, according to Peter we are actually in an inflationary environment.)
Schiff has analyzed past economic downturns and has concluded that in such times gold and gold mining companies have appreciated while the broader stock market declined. Peter comments that holding the asset directly will store value but not create (real) wealth. To create wealth Schiff suggests buying mining stocks which he likes because of their economic leverage. Schiff specifically lists Newmont Mining (NYSE:NEM), Barrick Gold (NYSE:ABX), Gold Fields (NYSE:GFI), AngloGold (NYSE:AU), Harmony Gold (NYSE: HMY) and Goldcorp (NYSE:GG).
If you choose to hold the commodity directly, Peter suggests going through the Perth Mint, because such holdings don’t need to be disclosed. Apparently Peter is concerned that, as was done in the 1930’s (until the 1970’s), the U.S. government may outlaw holding gold or silver.
Peter is very bullish on all commodities. He explains that it takes time for minerals in the ground to be converted into the final product, with the booming economy of the 1990’s extraction of commodities was neglected. This created a shortage in commodities and a boom in commodity prices. Peter speculates that it is going to take a number of years for capacity to be restored. With the market in turmoil Peter believes that commodities (steel, aluminum etc.) will be counter cyclical and should outperform the broader market. Moreover, unlike previous bull markets in commodities, the demand from China and India will only add fuel to the market. Of course, commodities are highly volatile, which can be a risk or a benefit.
Schiff believes that the credit markets are going to dry up (more so than they already have); reduced lending will have a negative impact on spending. In particular, he believes student loans to be an area of concern.
With a bearish view on the USA markets, Peter believes excess returns can be generated in foreign markets. Generally, Peter splits foreign markets into two groups; developed and developing. He thinks money can be made in each.
The developed markets, Peter explains, should not be seen as risky. Reporting standards are on par with the United States, and developed markets face little geopolitical risk. If anything, Peter sees more political risk in the United States (he has concerns regarding a tax on excess profit or confiscation of gold). Moreover, Mr. Sciff believes that foreign economies are, to a large extent, decoupled from the US economy and the slow down in the US will not necessarily slow down foreign economies.
Because of inflation concerns, Schiff advocates investing not in foreign bonds, but in conservative, dividend paying stocks. Schiff, however, is weary of ADRs because (1) being so widely held, they are often fully priced and (2) they are often the most exposed to the US economy e.g. (generate sales in USD).
Schiff defines Hong Kong, Singapore. Japan, Taiwan, Soth Korea, Thailand and the Philippines as the producing/saving countries. Although these countries do export to the US Schiff thinks that as US demand is replaced by demand from Asia these countries should outperform the US over the next 10 years.
Schiff also likes the resource rich countries; Canada, New Zealand, Australia and Norway.
In addition to dividend paying stocks, Schiff advocates investing in servicing companies, commercial REITs and infrastructure companies. Above all, he recommends avoiding companies that export to the United States.
Schiff titles his chapter on emerging markets “Rolling the Dice”; evidently he views there markets as risky. But without risk there is no reward. The reward being that these markets are counter cyclical to the US and Europe.
Schiff acknowledges a variety of risks, economic, political and currency and remind the reader about a slew of defaults or currency devaluations across the globe (Russia, Asia, and South America).
However, he counters these risks by pointing out that securities in these countries are cheap. Where the S&P averages an 18-21x P/E, stocks in emerging markets average a P/E 10-14x. I was initially uncertain what was Schiff’s point in quoting this fact; I felt that the P/Es were lower (and not inflating) precisely because of the risks that Schiff points out. I asked Peter about this and he said “as the perception of political risk subsides, I expect multiple to expand” and went on to comment that he does “expect earnings to rise, as well as the value of the currencies they are earning. So you have the potential to profit four ways, earnings growth, dividend yield, currency gains, and higher multiples.”
Schiff feel that the best way to play these markets is through ETFs. He classifies the EEM, PXH, and VWO as conservative (as they cover many markets), the BIK and BFK as less conservative (covering the BRIC countries) and for people who are willing to trade, region specific ETFs are also available.
If Schiff’s track record did not speak for itself his book would likely be pushed to the side as being fanatical. Regardless of whether you believe in his doomsday prognosis, his book does provide an alternative view on the economy and, at the very least, it helps focus the reader's thinking on how to invest in the current economic environment.
(some of the securities listed below are my examples and not specifically mentioned in the book).
Where Peter Sees Trouble
- The bond market, particularly US denominated debt.
- Consumer credit, for example Credit Card companies (e.g Visa (NYSE:V), MasterCard (NYSE:MA) etc.), auto and student loans (e.g. Student Loan Corporation NYSE: STU).
- Discretionary Stocks, especially those without foreign exposure.
- Airlines and automotives.
- The US service sector (Schiff sees less of a need for accounting, legal, real estate and other similar service jobs).
- Big box retailers (e.g. in his chapter on employment, Schiff specifically cautions Wal-Mart (NYSE: WMT) employees).
Where Peter Sees opportunity
- Commodity prices, especially gold and oil.
- Foreign currencies, (he seems to be most bullish on India, China and Russia.).
- Although not glowing praise, Schiff does believe that domestic oil producing and service companies should do well (he specifically mentions Baker Hughes (NYSE:BHI), Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL)); likewise producers of basic materials (e.g. Alcoa (NYSE:AA)).
- Makers of farm equipment (e.g. John Deer (NYSE: DE), Caterpillar (NYSE:CAT)) and fertilizer companies (e.g. Potash (NYSE:POT) and Agrium (NYSE:AGU).
- Construction companies (especially those focused on infrastructure).
- Peter sees employment opportunities in the Merchant Marines and fishing industries.
Disclosure: I have no position in any security listed.