"The future belongs to physical assets"

 He is a congenital contrarian. When the markets yell boom, he looks for the seeds of doom. His big claim to fame was predicting the Asian crisis of 1997 and the tech bust of 2000.

 He makes his predictions looking through a rearview telescope, by studying market behaviour and business cycles over the past.

  Meet Dr Marc Faber, 57, economic historian, former managing director of Drexel Burnham Lambert (HK), and author of a dramatically-titled monthly investment newsletter called The Gloom, Boom & Doom Report - named after the market's tendency to oscillate between irrational exuberance and extreme pessimism.

 Says Dr Doom: "Once a major investment theme goes ballistic (gold in the late 1970s, the Japanese stock market in the late 1980s and Nasdaq in March 2000), and then ends with a severe bust, the leadership always changes, as investors finally shift to new sectors."

 It is this premise on which Marc Faber's predictions are built. So what is he gloomy, bullish or bearish about now? He is extremely bullish on Asia over the long term, primarily on account of the enormous potential of the Chinese economy (and India).

 But his contrarian nature assets itself, and he says that since the whole world is looking at Asian markets favourably, there could be reason to worry.

 The real surprise among his predictions is the asset class he advocates.

 Even though stocks remain the most glamorous asset class to talk about, Faber predicts that real money is not going to be made in the stock markets, but elsewhere. He is bullish on commodities, including gold, silver and oil, among others.

 The main reason for the assessment: As more and more money chases a limited amount of commodities, their prices will have to rise. The almost unlimited printing of money by central banks, particularly the US Federal Reserve, will make financial assets lose sheen compared to hard assets, he believes.

 The following is a synthesis of an exclusive interview Faber gave to The Smart Investor, with insights added from his latest book Tomorrow's Gold.

 PREDICTION ONE

 Hard assets will do better than financial assets

 According to Faber, it is difficult to find stocks around the world that look cheap or which could go up 10 times.

 In the mid-1980s in Asia, when the markets were lying low and shares were selling at five times earnings and yielding seven to eight per cent, stocks were incredibly cheap.

 Ditto with Latin America in the late 1980s, when markets were depressed because of hyper-inflation, causing an erosion in the value of the currency. One could then buy the entire stock market in Argentina for $700 million.

 "That I don't see anywhere in the world. There is too much liquidity sloshing around the world and there are too many treasure pumpers, looking for stocks to buy."

 On the other hand, all commodities, including gold and silver, are poised for a secular bull run driven by increased consumption demand from the Asian region, particularly from China and India.

 Favourable demand - resulting from an increase in per capita consumption in Asian economies, particularly heavily populated countries like China and India - and the prevailing low prices of commodities set the stage for a secular rise in commodity prices.

 Global economic recovery and the depreciation of financial assets due to excessive printing of money will make commodities appreciate in relative terms. Besides, real estate also throws some good investment opportunities, says Faber.

 COMMODITIES: Never before in the history of capitalism have commodities been as inexpensive compared to the consumer price index or to financial assets than they are now after a 20- to 30-year bear market, says Faber in his book.

 Some may disagree, but Faber says that all commodity bull markets start with a low that was put in place by oversupply. The present-day glut in many commodities will one day be replaced by tight supply or a sharply falling US dollar could lead to a rise in commodity prices.

 Today's situation is very similar to what happened in 1969-70, the eve of one of the greatest commodity booms.

 Then too commodity prices were very depressed compared to equities, and experts argued that crude oil prices, which then hovered around $1.70 a barrel, would fall to less than $1 in the 1970s because the market was so glutted.

 No one could, at that time, imagine that oil prices would approach $50 a barrel on the spot market in 1980, and that gold and silver would rise more than 20 times over a decade.

 While there may not be a repeat of the 1970s, commodity prices today are even lower than they were in the beginning of the 1970s.

 So if there should be, as the optimists claim, a synchronised economic recovery, then in all likelihood commodity prices will increase sharply - primarily for industrial commodities which are extremely depressed, and where inventory levels are rather low - as in copper, lead, aluminium, tin, zinc and nickel.

 For individual investors, the way to participate in the coming commodities bull market is to buy commodity futures and roll them over periodically.

 Apart from gold and silver, which are at the beginning of a long-term bull market, there may be better intermediate opportunities in commodities that are far more depressed such as coffee, sugar, rubber, wheat, corn and cotton, says Faber in his book.

 Also, the performance of the emerging markets has a strong correlation with the performance of the US Commodity Research Bureau Index.

 Rising commodity prices have always been favourable for emerging markets, while declining prices have led to economic problems and poor performances.

 Thus, if commodity prices are at the beginning of a multi-year rise, then investors should be overweight in emerging markets - particularly the resource-rich ones, he explains.

 GOLD: According to Faber, the demand for gold will be driven by higher demand for jewellery as countries become more prosperous and people start purchasing more gold.

 Also, he points out that some investors look at gold as an insurance against stocks (or defensives). So gold actually performs better when stocks crash.

 In 2001, gold bottomed out as low as $258 and started to move up because some smart people realised that there was more money chasing every ounce of gold than before.

 "The gold market is perhaps smelling now that it is not deflation, but inflation that will come in the US next," says Faber. Currently, gold is ruling at a seven-year high.

 REAL ESTATE: The best environment for the housing market would be a weak economy and a poorly performing stock market that would keep interest rates low or even lead to further declines. People can then shift money out of poorly performing equities into property.

 However, the humongous increase in US mortgage debt for residential real estate and the fact that a weak economy would finally take a toll on personal income gains and employment could ultimately lead to fall in property prices.

 As Faber has elaborated in his book, in a number of Asian emerging economies, property prices tumbled after the Asian crisis as a result of collapsing demand, repossessions and currency depreciation.

 Prices then stabilised in 1998 and 1999 and, more recently, have begun to rise.

 Therefore, with prices for luxury condominiums in cities such as Kuala Lumpur, Jakarta, Manila and Bangkok hovering between US$1,000 and US$1,500 per square metre, the Asian property markets would seem to offer both relatively high current rental yields as well as the potential for future capital gains.

 The world is experiencing a colossal change in economic geography. Cities like Shanghai, Beijing, Moscow, Ho Chi Minh, Bangalore and so on are developing very quickly and becoming far more important economically and, therefore, real estate prices will rise there in the long term.

 Conversely, cities like Hong Kong, that thrived as long as China and Russia remained closed societies, because they served as trading and financial intermediaries, will underperform.

 Faber believes that US residential real estate will not be the next major investment theme whereas property prices in some emerging markets such as in Asia, Eastern Europe, Russia and even Latin America, could yield very high returns in the next five to ten years.

 PREDICTION TWO

 Asia will beat all other regions

 According to Faber, after 1997 all Asian markets have actually been quite a disaster.

 As a result, they have become quite undervalued in the period 1998-2002. "Now, they have built the base from where bull markets may start," he says.

 In the last two years, international investors have purchased a record amount of US assets in the form of direct investment and portfolio flows.

 Recently, this has subsided somewhat. So money flowing to the US will be invested elsewhere. Undoubtedly, some will find its way into Europe and Japan, but the valuations of equities are so much lower in emerging economies that some will also flow into this asset class.

 Whereas the earnings picture in the US is still very murky, in emerging markets the corporate earnings cycle is improving, driven less by exports than domestic demand.

 The latter is driven by excess liquidity, accumulated savings not being spent, and the emergence of a rapidly expanding consumer credit market (as in India), says Faber in his book.

 A better pricing environment for commodities and commodity-related products seems to be underway. Faber favours emerging markets that will benefit from a pick-up in commodity prices, including Russia, Indonesia, Malaysia, Thailand and the Philippines.

 According to Faber, emerging market economies today are the lowest cost producers in practically every sector of the global economy.

 Oil and gas in West Asia, minerals in Russia and South Africa, software in India, electronics in China, textiles in Bangladesh, shoes and coffee in Vietnam, steel in Brazil, pulp and paper in Indonesia and healthcare, entertainment and cosmetic surgery in Thailand - all can be produced or provided in these countries far cheaper than anywhere else.

 The point is that the more the economic climate deteriorates around the world, the more likely it is that the lowest-cost producers will perform relatively well, as they will be the last to go out of business.

 The only caveat to this statement is obviously that this will only be true as long as global trade doesn't collapse under new-found American protectionism!

 Besides, Faber says that most emerging economies have made substantial progress in terms of infrastructure, modern business methods have proliferated, management has improved and standards of living have in many instances leapt forward.

 Till now the Asian economies have depended heavily on the US for both exports and FDI. Going forward, Asia will be much more integrated into the Chinese economy.

 The Chinese economy will be rather favourable for the entire region, as each country will increasingly benefit from its competitive advantage.

 "Over the long-term some sectors like manufacturing will remain a growth sector and will continue to squeeze out other manufacturers around the world, particularly in the western world. If I look forward to the next 10 years, Asian assets will appreciate either through currency appreciation or through appreciation of stock markets or a combination thereof," says Faber.

 However, he is pessimistic about Asia, particularly on the Chinese economy in the near-term.

 "While most analysts and fund managers are wildly optimistic on Asia, I expect a correction in the financial markets now."

 Investors should not invest in China right now, as it is very difficult to make money. "As an investor it is very disturbing for me that China is written about in every magazine and the whole world is only thinking about how to participate in China in terms of investments when foreign direct investments are at such a high level. I would rather invest currently in an economy when there is no FDI and has just started rising," says Faber.

 His main principle is to invest in the phase zero or phase one of an emerging economy and not phase three - where everyone is joining the rush.

 "The Chinese economy will have some problem next year as industrial production growth slows down and some sectors have overheated. What disturbs me about China is that we always have to distinguish between economic development, short-term development, long-term development and financial markets development. Near term I am not very optimistic about the Chinese economy."

 According to Faber, between 1800 and 1915 America had 15 economic and financial crises and a civil war.

 Yet the country did exceedingly well and became the largest power in the industrial world in the early part of the 20th century.

 But in a rapidly growing economy there will always be excursions into prosperity and excursions into depression. So it is natural that one day China will have a setback, Faber explains.

 PREDICTION THREE

 India will outperform on a relative basis

 Faber says he is reasonably positive specifically on India primarily because of the outsourcing opportunity.

 Faber explains: In the next 10 years on a relative basis India could do well simply because the hollowing out of the manufacturing sector in the west has already occurred, first through Japan, then through South Korea and Taiwan and over the last 10 years through China.

 Manufacturing employment has already shrunk dramatically in the US as a percentage of total employment (15 million out of 285 million people). The service sector is larger. Due to new technology, many more services have become tradable services than ever before.

 So, the outsourcing process is still in its infancy and that is the next big shift. Lots of services can be transferred to lower cost countries like India which have a very large educated population.

 Faber is primarily bullish on the Indian technology and pharmaceutical sector. Besides, he believes that India is globally competitive in some manufacturing sectors as well. India may not be clubbed with South East Asian countries which are losing marketshare to China.

 Going forward, India's tourism sector could also see robust growth if the airports are restructured and bureaucratic hassels are done away with, especially for tourist visas.

 On equity valuations, Faber says, "Even the Indian markets have lagged behind in dollar terms, taking into consideration the decline of the stock market from its high and the depreciation of the rupee. I am positive about India."

 PREDICTION FOUR

 The dollar is doomed

 The US dollar, which is now almost as overvalued as it was in the mid-1980s, is likely to have started a multi-year bear market.

 However, this bear market is unlikely to be as dramatic as the 1970s - when the dollar fell by almost 70 per cent against European hard currencies - as neither Europe nor Japan nor any emerging economy would wish to have their currency appreciate by much more than another 10-15 per cent against the US dollar.

 Therefore, the most likely scenario will be that all currencies will depreciate against a basket of commodities, including gold and silver.

 "We could see an environment one day when the central banks will say we are uncomfortable holding so much dollar assets - so they will either repatriate, or let their currencies appreciate," says Faber.

 PREDICTION FIVE

 The Asian and US markets will decouple

 Will Asian markets sink if the US economy and markets do not perform well as it happened in 1994(when there was a mass outflow of funds away from Asia on account of redemption pressures faced by US funds)? Or is there a possibility of emerging markets tanking in case American markets do not fare well?

 Perhaps not. Faber believes that the stock market correlation between the US and Asia is more a near-term correlation than a long-term correlation.

 If you look at America in 1990 and now it is up about six times in terms of the S&P index and about four times on the Dow Jones and more on the Nasdaq Composite.

 In the same time, the Japanese market was down 70 per cent. In the long run, thus, there was no correlation at all as emerging markets went down and were a poorly performing asset class. "So, going forward, too, decoupling is a possibility," says Faber.

 PREDICTION SIX

 Currency appreciation will not affect competitiveness

 Faber does not believe that the weakening of the dollar against Asian currencies will affect the latter's competitiveness in any significant way.

 "Strong economies have strong currencies. If a weak currency were of any help, Latin America would have the richest currency in the world," he says.

 The cost difference between Indian IT and Chinese manufacturing compared to America is so huge that the Indian rupee would have to go up four times to make a difference to competitiveness, he explains.

 And in the meantime, Indian companies would become more efficient as an appreciating currency will force them to do better. Having said that, Faber believes that a currency appreciation in Asian countries will not happen unilaterally for any country but for the region as whole.

 FABER