CLSA: Ultimate Beneficiaries Of the US Financial Crisis would be Gold & Gold Stocks Not Oi

The global economy faces pressure from two contrasting sources, as described in the new quarterly Asia Maxima (Fire and Ice, 3Q08). The ice refers to the continuing savage credit crisis, a process which should be fundamentally deflationary. The fire refers to the oil-led commodity boom, a trend which should be fundamentally inflationary. Both these contrasting trades have so far continued to work for investors.
· This paradoxical situation cannot continue forever. If the ongoing credit crisis has implications for real economic growth, then it must eventually have bearish implications for the commodity complex. But the oil-led commodity complex has also benefited from the growing debris in the financial sector and from the perception that the Fed will do anything to try to prevent a further downturn in US growth. In this sense, the world has moved informally, and doubtless temporarily, on to a new oil standard.
· The continuing vigour of the oil-led commodity complex is a sign that money has begun to move away from the asset-inflation game, which has been in play ever since the benign disinflationary era in the Western world commenced with former Federal Reserve chairman Paul Volcker’s crushing of inflation at the start of the 1980s.
· The current continuing US centred “credit crisis” is not just another crisis which the Fed can bail out, leading to another credit-driven bull cycle in America. The manic excesses seen in the recently concluded credit boom mark the peak of American domination of global capitalism. The present credit crisis is the strongest possible evidence that the post 1945 “Bretton Woods” era of the US dollar paper standard is drawing to a conclusion.
· In the short term the only thing that matters for Asian stock markets is the price of oil. Asian central banks are perceived to be behind the curve in responding to the energy and food price shock. For those countries with widening current account deficits, there is also concern about further currency depreciation caused by deteriorating terms of trade, which would further fuel inflationary pressures.
· While the current oil and food driven inflation scare in Asia represents a one-off bearish relative price shock, the long term case for a structural increase in core inflation in Asia is much more bullish for the Asian domestic demand equity story.
· While oil stays so high, the potential for action from the US Congress grows ever more likely. Still, GREED & fear remains of the view that policy action is most likely to be focused on the more narrow issue of “commodity speculation”.
· The fundamental reality is that the credit excesses would never have reached such ludicrous excesses had Western central banks not kept encouraging via their actions the ridiculous notion that financial institutions would never be allowed to fail. Meanwhile, GREED & fear continues to believe that the most vulnerable economy globally remains Britain, not America.
· If the swing away from the market will inevitably occur in the West, the same will not happen in Asia and the emerging markets. This year’s oil-driven sell off in Asian equities amounts in the longer term to a fantastic buying opportunity. The reason is that the global economy will move inevitably to a new equilibrium where growing Asian consumption patterns will be a key if not the key driver of growth.
· The world has only moved temporarily on to an oil standard as capital flees to real assets in a vote of confidence against the Fed specifically and the US dollar paper standard system in general. GREED & fear continues to believe that the ultimate biggest beneficiaries of this trend will be gold and gold stocks, not oil.
· The long-term performance of the Asia ex-Japan thematic portfolio has begun to erode, though for now it still remains reasonably respectable. However, the portfolio declined by 17.9% in US-dollar terms in 2Q08, compared with a 8.6% decline in the MSCI AC Asia ex-Japan index and a 3.2% decline in the S&P500. Owners of the portfolio are still recommended, as has been the case since mid-2007, to short Western financial stocks as a necessary hedge given the collateral risk posed to Asian stocks by the unwinding of the credit bubble. This hedge worked well last quarter.
· The Japan absolute-return thematic portfolio marginally outperformed the Topix last quarter rising by 9.7% in yen terms compared with a 8.8% gain in the Topix. Higher oil prices are causing inflationary expectations to rise, which could just bring forward Bank of Japan tightening. GREED & fear’s view remains that higher short term and long term yen interest rates would be bullish for the Japanese stock market.


Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

Nothing in this article is, or should be construed as, investment advice.