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Expat Investor : January February 2008
INVESTMENTS expatinvestor.com 8 EXPAT INVESTOR January/February 2008 number of factors -- the behaviour of lending banks, the level of consumer confidence and the response of the Federal Reserve, as reflected by the setting of interest rates. At this stage it is the US where the bulk of the concern lies, and it is the US authorities who thus far have moved to cut interest rates. Bears have remarked for some time on the large deficits run by the US and the consequent reliance on funding from abroad. They have also highlighted the non-existent level of savings by the consumer and the tremendous rise in US debt dependence. If the spiralling of debt is punctured by banks becoming more conservative, this could lead to increased bankruptcies and forced Continued from page 7 asset sales, especially of housing assets. It is easy to see how this could precipitate a slide into recession, as the consumer endeavours to rein back spending and increase savings. In those circumstances investors would normally seek refuge in US Government bonds. As interest rates are cut to stimulate economic recovery, so bond prices should rise. There are two snags which could undermine this strategy, however. Firstly the dollar, which has already been quite weak, could fall further, thus eroding the benefit of bond price rises. This could happen if those foreign investors, whose capital flows have financed the US deficits, lose confidence in the value of US assets and divert their funds elsewhere. Secondly, the weakness of the dollar and the strength in DEVELOPING MARKETS WORTH WATCHING TONY WOOD, DIRECTOR, INVESTMENT STRATEGY, STANDARD BANK OFFSHORE For the Chinese, 2008 will be the year of the Rat, while the United Nations have declared it as the year of the Potato. Our investment strategies next year will contain themes attached to the expansion of industrialisation and urbanisation in developing economies and to soft commodities, in the form of agricultural products. Both themes have links to infrastructure change, most notably in China. For instance, China has a population of 1.3 billion people and 171 cities, with a population in excess of one million people. The only slight commodity and food prices (reflecting extremely buoyant demand from emerging countries, in particular China) could combine to force inflation upwards. Such an outcome would be bad for almost all asset classes, as it was back in the early 1970s. Apart from index-linked bonds, the only natural haven would be precious metals, hence the recent investor enthusiasm for gold, whose price has risen by some 20% since the summer. Neither recession nor materially higher inflation are considered by the mass of economic strategists to be the most likely outcome in the next year or so. Consensus forecasts for the US are still for some growth, fuelled by continuing rapid progress by third world countries and further reductions in interest rates, while inflationary pressures are predicted to subside somewhat as Western growth slows. Such an outcome would be good for equity markets, as present ratings are modest. Nevertheless prudent investors should not have all their eggs in that basket, given the degree of uncertainties ahead -- a properly constructed portfolio should have some 'insurance' within it, Government bonds for protection in the event of recession and some index-linked instruments and gold in the event of higher inflation. "Consensus forecasts for the US are still for some growth, fuelled by continuing rapid progress by third world countries and further reductions in interest rates, while inflationary pressures are predicted to subside somewhat as Western growth slows." doubt we have is the assumption that nothing will go wrong in China ahead of the Olympic Games, which has inflated the local equity market and attracted substantial speculative funds. Continued industrialisation and urbanisation has also reduced the amount of land available for farming. Urbanisation also changes eating habits, for instance food consumption in rural China is 63% grain, 31% vegetables and 6% meat, but in urban China it changes to 32% grain, 50% vegetables and 18% meat. If demand for meat increases, then the demand for feed will also rise, since 1kg of protein from pork requires 7kg of feed in grain. Also, climate change will impact periodically on the supply chain of agricultural products, which can push prices higher. We are less confident about the outlook for industrial commodities, oil and gas, since a US slowdown and a moderation in the pace of growth in China could create a more challenging environment. Also, we feel that oil and gas are more likely to be range bound next year. Therefore we feel that long/short strategies should outperform comparable long only strategies for these groups in 2008. Gold and precious metals should continue to be a useful hedge against further bouts risk aversion next year. There is likely to be a gradual appreciation of most Asian currencies versus the US dollar over the next 12 months, primarily to offset domestic inflationary pressures and external political "The most obvious candidate for currency appreciation would be the Chinese yuan, but its revaluation may be more problematic and initiated at a pace to suit the Chinese authorities rather than the recipients of its exports."