Leeb's Roadmap for the Decade

11/01/2002 12:00 am EST


Stephen Leeb

Founder and Research Chairman, Leeb Group

Three years ago, Stephen Leeb, editor of Personal Finance, began his speeches by warning that the coming decade would be among the most turbulent since the Industrial Revolution began. He hasn’t changed his view. “I think the next decade will be a period of unprecedented risk. But it will also be a decade of unprecedented opportunity.” Here’s his roadmap for investors, including the top investment opportunities for a decade of rising inflation and higher energy and metals prices.

“I think the defining issue in the next ten to 15 years will be a return to real assets, shepherded by energy, and an ever-growing awareness that we have a major, chronic, and severe energy problem. Right now, we are tremendously dependent on fossil fuels. And I think that energy prices, which have already started to rise, are going to continue to rise inexorably, over the next ten to 20 years. Projections from the Department of Energy and the International Energy Association note that over the next 20 years we are going to have to produce an additional 50 million barrels of oil a day to keep the world running. The only marginal source of additional energy capacity in this world comes from the Middle East. How much capacity has the Middle East added over the past decade? Virtually none.

“You would think that we would be spending a lot of money on alternative energies in this country. Do you know how much we are spending a year? About $100 million. On a typical day, if Microsoft were to go up or down a ΒΌ of a point, Bill Gates would make or lose on that quarter-point change as much as we are spending in a year on alternative energy. Yet without alternative energy, we have very little hope of continuing to grow the world economy.

“I think energy prices are going to go up. They have already started, and they will continue. Here’s some basic data. These things are right in front of us. In the 1990s, oil averaged $20 a barrel and natural gas averaged $2 per million BTU. Oil today sits at about $27 and natural gas sits at $4 in the context of extremely slow economic growth. The last couple of years have been among the slowest in the post-war period for economic growth. Yet oil and natural gas during this period have broken out to new highs.

“I think the gains in energy are here to stay. It won’t be straight up; there will be periods when prices wax and wane. But there is no doubt in my opinion that energy prices are headed dramatically up. The only thing that could stop that would be severe economic recession or depression, and that is not a policy alternative that is tolerable. If policy makers have a choice between inflation and deflation, they will choose inflation. And you can see that today, as money is basically free to banks. Policy makers will do whatever is necessary to keep the economy going. They have to because of all the debt we have in this country.

“But in a world that is constrained by shortages of energy, growth is necessarily going to generate much higher energy prices, which eventually will mean much higher inflation. Since the bull market made a top in 2000, the market is down about 40%. One thing you would not expect to do well during this period is gold. Inflation may be dramatically understated in this country. Since year 2000, the S&P 500 has gone down about 40%. During that same time period – a deflationary period that should not have been particularly good for gold – gold stocks have risen about 40%. I think this is a sign that things have changed and that the markets are no longer looking forward to deflation, but inflation. When you look at what is happening to energy and gold, I think the writing is very, very much on the wall.

“How high can gold go? It can go a lot higher. I’ve never been a gold bug. But I am compelled to recommend gold and real assets in today’s world. I don’t see any alternative. In 1980, the last time we had a big bull market in gold, all the gold in the world above and below ground was worth two-and-a-half times the S&P 500. Today, all the gold in the world is worth one-quarter of the S&P. This means gold would have to rise ten-fold to be valued as it was in 1980 relative to stocks. Importantly, we should note that the amount of gold does not change very much. It becomes jewelry. Central banks buy and sell it. But it doesn’t disappear. It remains relatively constant. What changes is its price.

“I would also argue that in 1980, inflation was a political problem and as such, it had a solution. We had a war between Iran and Iraq. We had artificially high oil prices. But we had plenty of capacity to produce energy. Today it is not a political problem. It’s a problem for which there is no ready solution. You’ve got this move in gold over the past few years that nobody is paying any attention to. But it’s for real. And it’s just the beginning. And as a result, it is going to be an extremely turbulent decade.

“We are going to see vicious circles and virtuous circles. A vicious circle is when the market starts going down, people start getting depressed and stop spending as much money. Corporations stop spending. The economy gets a little weaker and stocks go down. Weakness feeds on weakness. And it takes heroic measures to get us out of there. The Federal government has gone from hundreds of billion in surpluses to multi-hundreds of billions in deficits. The Federal Reserve has basically made money free. And it is possible that they will even cut rates further to 1.5%. 

“Vicious circles give birth to virtuous circles. Just as weakness fed on weakness, for the next six to 12 months, strength is likely to feed on strength. As the market goes up, two things will happen. One, investors will feel better and will spend a little more money. Two, corporations will feel better and will probably start spending some more money. And as the market goes up, ratings agencies will get more bullish. And the economy gets better. And in turn, so does the stock market. And just as we’ve already been through a vicious circle, I think we will now go through a virtuous circle. The surprise over the next six to 12 months will be a stronger than expected economy and stock market. 

“What’s going to stop it dead in its tracks? It won’t be a bubble in financial assets. What will stop it is high energy prices and inflation. No one really knows how much marginal capacity OPEC has right now. But I can envision that there may not be enough oil if there is a cold winter in 2003, without seriously drawing down world inventories. It may then dawn on people that we’ve reached the limit. Maybe OPEC has extra capacity for a three million barrels a day. Probably not much more. If we grow a little faster going into next winter, we could be producing oil at 100% capacity worldwide. That means much higher energy prices.

“Bonds and stocks may be good investments over the next year, they will not be good investments over the next five years. It’s almost sad to see people pouring money into government bonds. It’s okay as a hedge against deflation. But to somehow believe you are putting money into an ultra-safe investment is crazy. It just doesn’t make any sense. Between 1964 and 1981, government bonds returned –50% - including all the interest that you got. Reinvest all those coupons, and you’ve lost half your money. That’s what inflation does to financial assets. It’s going to be hard to make money over the next ten years. And I think you’ll get beat up if you have a policy of just buying stocks for the long term.

“The only way to successfully invest in this expected long-term environment is through a laser focus on a few select groups. Obviously, energy is one. I think virtually anything in the energy patch will work in the long term. Any good, well-managed firm from Chevron-Texaco (CVX NYSE) to Schlumberger (SLB NYSE). The major oils are the safest. You’re not going lose a lot during periods when energy prices decline, but you also won’t make as much as if you’re invested in the independent producers, such as Anadarko (APC NYSE) and Apache (APA NYSE). And, in turn, these won’t gain as much as the oil drillers like Noble Energy (NBL NYSE) or Nabors (NBR AMEX). I think energy has to be a ‘must’ investment. It has to be a significant part of your portfolio.

“I could go on and on about how under invested people are in metals. Wall Street asset allocation models used to have a small position in metals. They don’t do that anymore. If just a few mutual funds took a 5% position in gold stocks, there would be none left. The total value for gold stocks is just $50 or $60 billion. Individual investors have a big edge over the institutions, because you can easily buy gold shares now. We like many of the major gold stocks. The upside is hard to fathom.

“But my favorite of all the metals stocks isn’t a gold play; it is silver. Apex Mines (SIL AMEX) has potentially a billion ounces of silver. By including their zinc, this silver can be mined for virtually nothing. And, it’s wildly profitable. The stock is capitalized at about $500 million, with one billion ounces of silver. Who is investing in this company? The Soros family – both George and Paul. And a bunch of other hedge funds. When someone like George or Paul Soros, or Moore Capital pay $10 for a stock, they don’t do it because they want to cash out at $20 a share. They do it to cash out at $100 or $150. If silver were to go to $10, this company would have mine-able assets of potentially $10 billion. Even if you only have silver at $4 or $5, this stock could be a bonanza. 

“Another sector to look at is property and casualty insurers. Why? Because we live in a difficult world. Property and casualty insurers, in a way, transmit these difficulties and profit from them. There is a pretty ready relationship between the amount of capital in the property & casualty insurance industry and its pricing power. The less capital, the greater the pricing power. If insurers are flush with capital, they will compete with prices. When there aren’t a lot of disasters out there, these companies are flush with money so they compete on prices. Everything that went right in the 1990s for insurers is now going against the industry. And worldwide environmental disasters have increased exponentially. As a result, capital in the industry is likely to decline. And while some companies will get wiped out, those with the strongest capital bases and most conservative management will benefit. Our favorites are Warren Buffett’s Berkshire Hathaway (BRK-B NYSE) and HCC Insurance Holdings (HCC NYSE).”

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