After thinking this morning about commodities and inflationary prospects, I watched a Jim Rogers interview from 1995, which I have included below. You will have to fast forward a bit, because he appears toward the end. Here are a few of his predictions from 1995:
“Next year and the year after, I don’t think we’re going to have good times in the American stock market.”
“Inflation is coming.”
“Commodity prices are going through the roof.”
Best country to invest in right now: “Iran.”
“Everything in life comes down to timing.”
Well, it looks as if Jim's timing was profoundly wrong.
In fact, much of this flies in the face of what he said in Hot Commodities, published a decade later, which was to the effect of “if you went through the 1990s and didn't touch shares in technology companies then you missed out on massive gains," essentially meaning that it was a mistake caused by not being open to new things.
But, as you can see, he was saying the exact same stuff back then as he is today. And he certainly wasn't talking about technology.
Anyone who continues saying that inflation will come or commodities will rise is bound to be proven right at some point. This not to single out Rogers as being wrong, but to emphasize my stance on how difficult it is to predict macro events – unless, that is, you only have one perennial prediction.
What history shows is that, aside from short-term macro shocks, the best asset class to own, by far, is stocks. And if you can buy those stocks at depressed prices or in periods of intense fear, then your total return can be magnified significantly.
Land, labor, capital and commodities are combined to create businesses that increase productivity. And while any one of those factors may become relatively attractive during a boom, owning excellent businesses – or fractional interests, called stocks – is the best investment over the long haul.
Keynes predicted that the great financial fortunes – paper fortunes, such as the Rothschilds in his day – would be destroyed by long-run inflation. Clearly, this has not happened.
Quite the contrary: the countries with the most developed financial systems have always been the most prosperous, whether the Medicis in Renaissance Italy, the Rothschilds in 19th-century London, or today's commanding skyscraper in Lower Manhattan that reads, simply: "85".
Thus, while the gloom and doom is persuasive nowadays, I remain highly skeptical that the world – financial or otherwise – is coming to an end. I lean more towards John Paulson's prediction that massive returns will accrue to buyers of solid, yet beaten-down financial stocks, as the smoke clears and we emerge from this crisis.
Of course, if people do “flock to global macro” as the article says, it will bankrupt the strategy.
A problem with macro over the long term is that it often comes to resemble rank gambling. Managers can make billions on each trade – or lose billions. They sell the strategy with historic bets like George Soros and sterling in 1992. But I am sure they fail to mention the innumerable historic blow-outs.
Also, the catch is that global macro is usually way more difficult than it has been lately. Over the past few years, the strategy was insanely simple: long commodities, long BRICs, short the dollar, short financials. These were one-way bets with every manager on one side of the trade.
The interesting thing is, each time this happens, everyone says that funds can’t move the market. The markets that these managers operate in are too big to be influenced – like crude oil, last summer. And then the market collapses and in hindsight we find that everyone was on one side of the trade and it created a bubble. It is important to maintain a healthy degree of skepticism with virtually everything along these lines.
A current example might be oil production and supply. I’ve heard many people make claims that production is down and supply is down, as if we’re back in 2003. So after a decade of skyrocketing prices and activity in the energy sector, production and supply are down?
This is a complete lie, no matter what the numbers say. The government or the central bank or whoever else will diligently present figures showing a certain case; but you’ll always do better using common sense. The people producing the data are backwards-looking by definition, and always way behind the curve.
The benefits of Bill Ackman's strategy are relatively clear. But to address the opposite, the downsides, a few of my criticisms are how shortsighted – meaning short-term – and market-obsessed this approach is.
I have explained some of these criticisms before, and the charts included in the presentation show how Pershing is essentially pursuing a classic trading strategy, as opposed to a value investing strategy of intense patience and being unconcerned with whether the stock exchange is open or closed.
Mr. Ackman and Mr. Market appear to take each other very seriously. And this approach works – just look at George Soros or Steven A. Cohen or whichever successful trading operation. But it probably isn't replicable by individual investors, even if they're attempting to buy the same securities.
One example is Borders Group, where Pershing intervened in a potential liquidity crisis and became a creditor, obtained valuable warrants, as well as an agreement to potentially buy Borders' high-quality Paperchase business at an undervalued price. This delivered substantial value to Pershing at the expense of common shareholders. (Why would shareholders benefit from selling Paperchase to Pershing for half price? Would Warren Buffett make this move?)
That said, Ackman makes it clear that Borders is exactly as I noted – a very cheap call option – and also makes clear that a mere 1% of his portfolio is at risk. Yet, another distinction between Pershing and common shareholders is that the former began accumulating Borders shares at above $20 each, whereas the latter can now accumulate them for about 50 cents.
I strongly believe that shareholders are best served by owner-operators, who make disciplined decisions – often unpopular decisions, when short-term fixes are available – to deliver excess returns over the long term, and to build great businesses.
Paulson's merger arbitrage commentary is particularly interesting, in the sense that buying Anheuser-Busch stock would have been an incredibly risk-averse investment over anything but the short-term; and the upside was a 90% return when calculated on an annualized basis. This is a strategy that almost anyone could have implemented.
Also, Paulson explains the reasoning and analysis behind his historic bet against subprime and financials, which is extremely valuable reading. Paulson states that we are halfway through the crisis; yet he has liquidated his bets against subprime and is beginning to make select investments in distressed debt and other long positions within the credit and financial space.
Going forward, he makes it very clear that being a long investor in financials will generate immense returns when the markets rebound, throughout either 2009 or 2010.
I encourage you to read the entire Grantham interview; yet his specific views on China are below.
Last year, a friend and I sat in on a lecture given by Eswar Prasad at Cornell University, on the renminbi and China's banking system. It began to dawn on us that the emergence of China as a dominant economic power is quite possibly the greatest dogma in all of finance and economics, and anyone who says otherwise is labeled not a skeptic, but a heretic. (Or at least an idiot!)
Lawrence Summers, an economist, Presidential advisor and former president of HarvardUniversity, remarked that “[China's] economic significance dwarfs the Industrial Revolution or the Renaissance.”
We will see whether or not Summers is correct. Either way, I have no entrenched view or vested interest. But there is no doubt that when it comes to global-macro speculation – whether stock markets, currencies, commodities, or the wealth of nations – China is still the biggest game in town.
What is your bold prediction for the future?
Keying off the word "bold," my prediction is that China will be a substantial disappointment. The reason I say "keying off" is that this is far from being a certain prediction. But I have a strong hunch China will disappoint, and maybe even bitterly disappoint.
That's the nature of the hunch, I look at everything and my stomach tells me they've been extraordinarily lucky in the last 15 years. It's hard to separate good luck from talent. I have a suspicion that a lot of what other people see as skill was good luck. And that they have a difficult job, and under this stress their modest talent will be revealed. The modesty of their talent.
What are some ways they got lucky?
They got lucky that the U.S. decided to run a huge trade deficit when they needed to run a huge surplus for political reasons. And it balanced out, as long as we ran an equal deficit. They were presented with the strongest global economy in history in which to sell their cheaper products.
Everyone else seems to be quite happy [with China]; maybe they're right. That's why it's a bold prediction rather than a high-confidence near certainty.
You had mentioned that the Chinese are new to capitalism, so their bench is not very deep.
Are they really so much better that they can handle an economy growing at four times the speed of the U.S. with a lack of experience? It doesn't compute, but we will find out.
Possibly the best article I've seen by Nassim Nicholas Taleb, which discusses the comparative advantages of the United States. One of his most important points is our culture of risk-taking and creativity, as he addresses the most common criticisms of America as a declining power in the age of globalization.
...
Before the discovery of Australia, Europeans thought that all swans were white, and it would have been considered completely unreasonable to imagine swans of any other color. The first sighting of a black swan in Australia, where black swans are, in fact, rather common, shattered that notion. The moral of this story is that there are exceptions out there, hidden away from our eyes and imagination, waiting to be discovered by complete accident. What I call a "Black Swan" is an exceptional unpredictable event that, unlike the bird, carries a huge impact.
It's impossible for the editors of Forbes.com to predict who will change the world, because major changes are Black Swans, the result of accidents and luck. But we do know who society's winners will be: those who are prepared to face Black Swans, to be exposed to them, to recognize them when they show up and to rigorously exploit them.
Things, it turns out, are all too often discovered by accident--but we don't see that when we look at history in our rear-view mirrors. The technologies that run the world today (like the Internet, the computer and the laser) are not used in the way intended by those who invented them. Even academics are starting to realize that a considerable component of medical discovery comes from the fringes, where people find what they are not exactly looking for. It is not just that hypertension drugs led to Viagra or that angiogenesis drugs led to the treatment of macular degeneration, but that even discoveries we claim come from research are themselves highly accidental. They are the result of undirected tinkering narrated after the fact, when it is dressed up as controlled research. The high rate of failure in scientific research should be sufficient to convince us of the lack of effectiveness in its design.
If the success rate of directed research is very low, though, it is true that the more we search, the more likely we are to find things "by accident," outside the original plan. Only a disproportionately minute number of discoveries traditionally came from directed academic research. What academia seems more masterful at is public relations and fundraising.
This is good news--for some. Ignore what you were told by your college economics professor and consider the following puzzle. Whenever you hear a snotty European presenting his stereotypes about Americans, he will often describe them as "unintellectual," "uneducated," and "poor in math," because, unlike European schooling, American education is not based on equation drills and memorization.
Yet the person making these statements will likely be addicted to his iPod, wearing a T-shirt and blue jeans, and using Microsoft Word to jot down his "cultural" statements on his Intel-based PC, with some Google searches on the Internet here and there interrupting his composition. If old enough, he might also be using Viagra.
America's primary export, it appears, is trial-and-error, and the innovative knowledge attained in such a way. Trial-and-error has error in it; and most top-down traditional rational and academic environments do not like the fallibility of "error" and the embarrassment of not quite knowing where they're going. The U.S. fosters entrepreneurs and creators, not exam-takers, bureaucrats or, worse, deluded economists. So the perceived weakness of the American pupil in conventional studies is where his or her very strength may lie. The American system of trial and error produces doers: Black Swan-hunting, dream-chasing entrepreneurs, with a tolerance for a certain class of risk-taking and for making plenty of small errors on the road to success or knowledge. This environment also attracts aggressive tinkering foreigners like this author.
Globalization allowed the U.S. to specialize in the creative aspect of things, the risk-taking production of concepts and ideas--that is, the scalable part of production, in which more income can be generated from the same fixed assets through innovation. By exporting jobs, the U.S. has outsourced the less scalable and more linear components of production, assigning them to the citizens of more mathematical and culturally rigid states, who are happy to be paid by the hour to work on other people's ideas.
Let us go one step further. It is high time to recognize that we humans are far better at doing than understanding, and better at tinkering than inventing. But we don't know it. We truly live under the illusion of order believing that planning and forecasting are possible. We are scared of the random, yet we live from its fruits. We are so scared of the random that we create disciplines that try to make sense of the past--but we ultimately fail to understand it, just as we fail to see the future.
The current discourse in economics, for example, is antiquated. American undirected free-enterprise works because it aggressively allows us to capture the randomness of the environment--the cheap Black Swans. This works not just because of competition, and even less because of material incentives. Neither the followers of Adam Smith nor those of Karl Marx seem to be conscious of the prevalence and effect of wild randomness. They are too bathed in enlightenment-style cause-and-effect and cannot accept that skills and payoffs may have nothing to do with one another. Nor can they swallow the argument that it is not necessarily the better technology that wins, but rather, the luckiest one. And, sadly, even those who accept this fundamental uncertainty often fail to see that it is a good thing.
Random tinkering is the path to success. And fortunately, we are increasingly learning to practice it without knowing it--thanks to overconfident entrepreneurs, naive investors, greedy investment bankers, confused scientists and aggressive venture capitalists brought together by the free-market system.
We need more tinkering: Uninhibited, aggressive, proud tinkering. We need to make our own luck. We can be scared and worried about the future, or we can look at it as a collection of happy surprises that lie outside the path of our imagination.
Nassim Nicholas Taleb is an applied statistician and derivatives trader-turned-philosopher, and author of The Black Swan: The Impact of the Highly Improbable.
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