[A-List] New economy bull

["Keaney Michael" <Michael.Keaney@xxxxxx>]

Surprise surprise, the knowledge economy wasn't such an everlasting
engine of growth after all...


Markets get physical
Financial Times: April 30 2002

Gold briefly traded at $312 an ounce on Monday, its highest since
February 2000. The crude oil price has rebounded sharply from its
end-2001 lows. House prices are booming in the US and the UK. Suddenly,
real assets look a lot more exciting to investors than financial assets.

Property seems particularly appealing. To the private investor,
residential property offers an asset that he or she can understand
(unlike pensions or insurance policies) and that tends to rise in price.
To the institutional investor, property offers an attractive yield and
the potential for capital growth.

But does this recent shift into real assets signal a longer-term trend
that will revolutionise investors' portfolios, rather like the
inflationary era of the 1970s? Hugh Hendry, manager of Odey Asset
Management, the hedge fund group, certainly thinks so.

"The game in the 1980s and 1990s was disinflation," Mr Hendry says.
"Investors took advantage of duration, which meant buying highly priced,
fast-growing companies. We saw the cult of the growth stock." But all
that has changed, Mr Hendry believes. "The policies of central banks
will inevitably result in the end of disinflation and possibly the
return of inflation. Duration will be a killer."

Mr Hendry argues that central banks have repeatedly shown their
willingness to dig the financial system out of a hole by cutting
interest rates, whether it was after the 1987 stock market crash, the
1998 Asian crisis or the terrorist attacks of September 11.

All this liquidity, he believes, tends to seek an inflating asset to
invest in. In the 1990s, that asset was equities - and particularly
technology stocks. Traditional equities are now unattractive in
valuation terms and now the focus has switched to real assets such as
property and commodities.

So far this year, Mr Hendry's strategy has paid off. The FTSE World
Mining index is up 14.7 per cent in dollar terms since the end of 2001
and sectors such as construction, forestry, real estate and oil have all
outperformed the overall market.

But how long can such a pattern last? Until recently, most commentators
had focused on the dangers of deflation rather than inflation, with new
technology and the forces of globalisation seen as restricting the
ability of the corporate sector to raise prices.

Commodity prices have certainly rebounded but the scale of the rise is
nothing like that in the 1970s, when the gold price went from $35 an
ounce in 1971 to $850 an ounce by the end of the decade. Gold has
bounced from $260 an ounce in early 2001 but even at $312 an ounce it is
63 per cent below its all-time high. The rally in the oil price from $17
a barrel in late November to a peak of nearly $27 a barrel earlier this
month looks impressive but it leaves the price of crude oil well below
the $37 a barrel seen in September 2000. The Economist Commodities All
Items index has risen from 62.3 in late October 2001 to 68.9, a 10.6 per
cent rise, but it remains well below 2000 levels.

So far, the rebound in commodity prices may merely reflect two things:
the increase in Middle East tension and the upturn in economic growth
since late 2001. "A large part of the commodity strength looks to be
cyclical rather than secular," says Michael Hughes, chief investment
officer at Baring Asset Management.

Tony Broccardo, chief investment officer of Invesco, the fund management
group, agrees. "We are unlikely to see massive switches of assets from
equities into commodities," he says. "Eventually the cyclical play tends
to run its course and other themes start to be played."

Sceptics also say that there may be technical reasons for the rise in
some commodity prices. In the case of gold, many producers have
materially reduced their hedge books. According to John Reade, precious
metals analyst at UBS Warburg, the effect this year will be to bring
about 8m-10m fewer ounces to the market - about $2.4bn-$3bn
(£1.7bn-£2bn) worth of gold.

Furthermore, part of the rise in the gold price may be because of demand
from Japan. Japanese gold imports rose 569 per cent in the year to
March, with demand for gold triggered by the end of full government
guarantees for bank deposits on April 1. Some Japanese savers are
preferring the security of gold to that of the fragile financial system.

Others doubt whether the inflationary surge can last very long this
time. "This is not a return to the 1970s," says Nigel Richardson, senior
investment strategist of Axa Investment Managers. "The 1973-74
quadrupling of oil prices was a real shock to the economy. At the time,
the mone tary authorities had no anchor for policy after the end of
dollar convertibility into gold. But now central banks have inflation
targets."

But will the central banks react to rising real asset prices by raising
interest rates? Mr Hendry argues that so much debt has been accumulated
by the private sector that central banks may be wary of raising interest
rates because of the potential for a Japanese-style debt crunch.

It may also be difficult for the central banks to know when to act, just
as it was when equity prices were rising rapidly in the late 1990s.
There is little sign of high street inflation in the US and Europe, in
spite of the rise in house prices, gold and oil. In any case, would
central banks really be justified in targeting house prices or gold when
they have no idea of the "correct" price for either asset? US house
prices rose 9 per cent in the year to February - strong growth but not
overwhelming evidence of a bubble.

Even in the UK, where house prices have traditionally shown quite a
strong link with consumer spending, the Bank of England has so far seen
no need to act by raising interest rates. There has been some evidence
that higher house prices have been leaking into the economy through
equity withdrawal, with home-owners diverting some of their profits into
spending on goods. But the Bank seems to see the strength of consumer
spending as a welcome offset to weakness in the manufacturing sector and
the global economy.

Perhaps the best test of the potential for asset price inflation to
spread to the rest of the economy is the bond market. The "bond market
vigilantes" have traditionally acted swiftly to sell the debt (thereby
pushing up yields) of any country that appeared to be taking risks with
inflation.

There have been some mutterings in the market that the US Federal
Reserve may have kept short-term US interest rates too low, at 1.75 per
cent, for too long following September 11's terrorist attacks. But there
has been no sign of significant problems in the market: the benchmark
10-year US Treasury bond yield rose from 5.04 per cent at the start of
the year to 5.43 per cent at the end of March but has since edged down
to 5.07 per cent.

The evidence suggests that inflation expectations have increased.
According to Tim Bond, global strategist at Barclays Capital, the
break-even inflation rate for US bond investors (calculated by
subtracting the yield on index-linked bonds from conventional bonds) has
moved up from 1.5 per cent to 2.1 per cent in recent months.

So far, however, the bond market is showing mild concern, rather than
alarm. It will need the rise in commodity prices to feed through to
final goods prices before bond investors get really worried.

Perhaps that moment will come later in the year. As the late 1990s mania
for technology stock showed, once fund managers start to back a theme it
can develop a momentum of its own. Real assets have the momentum at the
moment and the industry may be ready to jump on to the bandwagon.

Full article at:
http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT3NR3GOM0D&live=true

Michael Keaney
Mercuria Business School
Martinlaaksontie 36
01620 Vantaa
Finland

michael.keaney@xxxxxx