Marc Faber: Crash Of 1987 Revisited

| About: Sprott Physical (PHYS)

According to Marc Faber, we will revisit the 1987 crash in the second half of this year, if there is no QE3. The root cause will not be Greece, but the slowdown of China and India. Marc Faber is known to have accurately predicted the 1987 crash. So we better prepare for this event.

As we already can see on the federal balance sheet, there has not been any QE3 since July 2011 (Chart 1).

Chart 1: Federal Reserve Balance Sheet

What happened in 1987 (also known as Black Monday)? And what to do about it? Let's go over all asset classes one by one.

1) Equities

The Dow Jones Industrial Average (DJIA) dropped by 508 points to 1738.74 (22.61%) on Monday October 19, 1987 . Considering the fact that the Dow/Gold ratio was lower in 1987 than it is now, I predict that the crash will be even harder if it were to happen this year.

So you should get out of stocks as soon as possible. The Dow/Gold ratio is going down anyway, so the Dow will underperform gold. I analyzed the Dow/Gold ratio already in this article.

Emerging market stocks will be hit even harder as shown historically (Australia fell 42%, New Zealand fell 60%).

2) Bonds

U.S. treasuries were a safe haven during the crash. The yield on 30 year U.S. treasuries fell from over 10% to 9% (Chart 2).

Chart 2: Dow Jones VS. 30 year U.S. Treasury Yield

I believe this could happen again. But there is one difference: today the U.S. treasury yields are much lower than in 1987 (Chart 3). So there is less incentive to flee in U.S. treasuries.

Chart 3: 10 Year U.S. Treasury Yield

3) Real estate

The 1987 crash was based on the bursting of the real estate bubble, just like in 2008. From 1984 to 1988, home prices doubled on average. After the crash of 1987, the economy deteriorated and real estate plunged in specific parts of the U.S, with a delay of 1-2 years. For example in Connecticut, real estate dropped 20%. The same happened in Boston. Real estate prices had only recovered back by year 2000. So holding real estate isn't such a good idea.

4) Cash

The origin of "cash is king" is not clear, but is possibly derived from the Black Monday crash. It was used in 1988, after the global stock market crash in 1987, by Per G Gyllenhammar, who at the time was Chief Executive Officer of Swedish car group Volvo. So it is needless to say that cash was a very good bet during the 1987 crash.

5) Gold

Gold held up very well and even went up a bit during the crash of 1987. That's why they say gold is money. The gold stocks on the other hand were actually following the broader stock market and dropped even more than the Dow Jones. The XAU (gold and silver mining companies) dropped 30% from $US 142/share to $US 95/share. That's why I always recommend to hold gold instead of the gold mining stocks (just like Jim Rogers advises). As for gold's little brother: silver held up as well and went up shortly after the crash. However, this time we could have a different outcome in the gold mining stocks. The reason I say this is because the P/E ratio is at a very low level historically. For example, today Barrick Gold (NYSE:ABX) has a P/E ratio around 8, while the P/E ratio was 20 on average in the 90's (Chart 4).

Chart 4: Barrick Gold Historical P/E ratio

Conclusion: The only safe assets during a crash are bonds, cash and gold. As bond yields are very low and the currency system is flawed (federal reserve will probably inflate the currency), I can only recommend you to hold physical gold (PHYS,GLD), which protects you against all possible doom scenarios.

Disclosure: I am long PHYS, PSLV.

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