Tuesday, May 18, 2010

Jeremy Grantham Guarantees Gold will Crash - By Robert Huebscher

Jeremy Grantham, the investor celebrated for his ability to spot and exploit bubbles in asset classes, guaranteed yesterday that the current bull market in gold will end. His proof? He bought some – for his own account – at the end of last week.

His tongue-in-cheek comment was part of a discussion about relative value in various segments of the market. Indeed, Grantham is bullish on two asset classes – which I’ll address in a moment – but gold is not among them.

Grantham, the Chairman of the Boston-based investment firm Grantham Mayo Van Otterloo (GMO), spoke at the CFA Institute annual conference in Boston, where he delivered the keynote address.

He predicted a real (inflation-adjusted) return of 0.3% for the S&P 500 (shown above as large-cap US equities). That, of course, follows a decade of negative returns.

Small-cap stocks offer the worst prospective returns, -1.8% inflation-adjusted.

But US high-quality stocks still offer attractive opportunities, with a forecasted inflation-adjusted return of 5.8%. He defined those as stocks with low debt and consistent returns, typically highly rated by S&P. They include the “usual suspects,” he said, such as Johnson & Johnson, Microsoft and Coca Cola. He said there is “no chance” this asset class is not undervalued.

Opportunities in emerging markets and timber

The two asset classes Grantham singled out as truly attractive were emerging markets and timber, which boast projected inflation-adjusted returns of, respectively, 4.7% and 6.0% annually.

Emerging markets are entering a bubble, according to Grantham, who called them his “favorite” asset class. He likened the opportunity in emerging markets to bubbles in the Japanese and NASDAQ markets, when PE ratios went to three-times that of markets in the rest of the world.

Commodities are Grantham’s other candidate for entering a bubble, but he said that emerging markets are “much easier to play.” Within commodities, timber is the only asset he said he could accurately analyze, and he projects for it 6.0% inflation-adjusted returns.

Grantham said timber is one of the safest asset classes outside of TIPS, and he prefers it to sovereign debt, which is exposed to inflation risk (which Grantham called a big risk worldwide). Timber has proven to be an enormous holder of value, he said, and even worked on an inflation-adjusted basis in the 1930s and 1970s. In the crash of 2008, it lost nothing. “It is a nice contra-cyclical asset class,” he said.

At the other extreme is fixed income, which Grantham called “horrible.” “It is not capitalism,” he said. “It is an administered rate.”

The negative inflation-adjusted yields in the short-term bond market are artificial and, if it were not for Fed intervention, he said they would rise 100 to 200 basis points. Those low rates are “just a way of stuffing the pockets of banks and hedge funds,” he said, because of their ability to invest with a near-zero cost-of-capital.

Grantham suggested that shorting fixed income would be a wise investment, although he said it would be difficult to do.


For a rebuttal to Grantham, go HERE.