What will be the prospects in 2010? How equities will compare with the commodities as an investment class?
Equities, commodities, currency markets, fixed-income securities all other investments will depend on three scenarios involving:
1. The consequences of the Western World’s response to the credit crisis
2. Fears of an asset bubble in China
3. Possible Sovereign defaults
1) The credit crisis was not unprecedented (Japan’s Lost Decade is one example), but was never experienced to such a large scale. What was unprecedented was the global response to the crisis, with trillions of dollars pumped into economies all over the world. The most striking and important example is the US, where the Fed and the Gov worked hand in hand to pump trillions of dollars into the market. It is common knowledge that all this money was printed, and the Fed balance sheet is packed with questionable assets. I cannot comment on how the Fed will unwind its balance sheet as I am still analysing this issue, but the fear is that inflation will pick up as the world economy recovers. Such an increase in the M1 money supply (i.e. actual cash and liquid bank deposits) means that is a lot more money floating around. The only thing keeping inflation low is the dramatic fall in the velocity of money as the economy continues to deleverage. Now one problem the Fed may face is its ability to raise interest rates if inflation picks up. The economy is still weak and the Feds messy balance sheet means it will actually impact its own financial abilities in increasing the fed funds rate. This is one reason gold is trading at such high levels. Excess liquidity in the world leads to my next point, China’s economy.
2) Many analysts have begun sounding the alarm of China’s overheating economy. With constantly growing GDP figures, consumer spending, and most recently a boom in exports, some analysts began sounding the alarm of a formation of a bubble in China. The economy, almost the second largest, has been the force behind the recent global rebound in the world economy, boosted by China’s government injections and increased bank lending. House prices have risen 50% in 2009, equities have rebounded after the recent slump and most importantly, commodity prices are continuing their rally even as China builds up its stockpiles. In 2008, the fear was dried up liquidity in the world, now the problem is too much of it, especially in China. Everything that goes up must always come down, and China is definitely no exception. The question is when, and how steep the fall will be. My fear is that the more the Gov pumps up its economy, the worst the result could be. Yet again, one could argue that China’s build-up of foreign reserves and commodity stockpiles are a symbol of sound financial management and the ability to grow this rapidly. But would argue that this liquidity itself, boosted by an artificially low currency, can be the reason behind a bubble burst. These reserves will not build the bridges and produce cars, but the ppl will, and it is the ppl and not the nominal reserves that will drive the economy. What an economy needs to ensure is a financial system which can transfer wealth to produce economic growth, and the system seems to be in jeopardy as rampant speculation poses a threat to sustainability. China’s future will be a key drive in all commodity prices, especially metals and oil. Gold could continue to become a hedge, especially since the US dollar could face trouble due to China’s enormous dollar-denominated reserves.
3) Lastly, countries such as Greece, Latvia and Ireland could face serious trouble in the not-too-distant future, especially after S&P’s junk rating on Greece. This relates to the first point, where I mentioned the world deleveraging. The most recent example was Dubai, which was bailed out by Abu Dhabi ad is now restructuring its debt. These countries have taken on too much debt, and now that the time has come to repay lenders, it is feared the Govs will not be able to get the money they need. This is more of a problem in the Euro are, where countries cannot set their own monetary policy and do not have their own currency which they can print to pay their debt. Sovereign defaults are not necessarily a catalyst for the global economy, but they can cause more damage to an already strained global financial system. In this case, gov debt might suffer and equities may retreat, and again gold, and in this case the US dollar should prove to be a good hedge for investors.
In brief, there is a global financial imbalance between the Western world and the emerging markets (particularly China), caused (not limited) by excess liquidity and a devalued Yuan, and the Western world growing on leverage and rampant speculation.
Hope this helps.
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