Review of 2009 and Outlook for 2010
Review of 2009
2009 has been a year of uncertainty for economies internationally. While there is reason for some festive cheer due to the recovery seen in the capital markets and in most asset classes, there is also reason for caution.
Loose fiscal and monetary policies, quantitative easing and money creation on a scale not seen in living memory characterized 2009. This has led to concerns that there is now a new liquidity and ‘cheap money’ driven bubble in various asset classes including equities, commodities, deposits, fixed income and gold.
Stock markets had a positive year and recovered well from the sharp falls seen in the preceding months. The S&P 500 and the FTSE have risen by over 24% and 22% respectively. Most emerging market equity returns have been even greater (although the Dubai stock market recently crashed).
Property markets which had experienced sharp falls in recent months saw a tentative recovery (particularly western residential property) towards the end of 2009. There are legitimate concerns as to whether the tentative recovery seen in some property markets is sustainable. Especially as much of the economic recovery and recovery in asset markets has been due to zero interest rate policies and massive artificial stimulus. Neither of which are sustainable in the medium to long term.
The key questions for 2010 is whether the recent recovery seen in some asset markets is a classic dead cat bounce prompted by unprecedented government interventions or have the capital markets and by extension our economies returned to sustainable growth. It is at this stage almost impossible to distinguish between the two and only time will tell. It is our guess that as central bank funding is withdrawn and interest rates begin to normalise again the risk of another global heart attack will increase.
Outlook for 2010
The outlook for asset class performance in 2010, as ever, depends on what global macroeconomic conditions the world experiences. As ever, the fundamental US macroeconomic situation and the outlook for the US dollar and for inflation will be of primary importance (more below).
Other big picture global macroeconomic factors that could become important in 2010 are:
Rising Interest Rates
There are increasing concerns about the prospect of a possible rise in interest rates, in the US and internationally, from record low levels in the second half of 2010. This may be necessary to protect the value of the dollar and contain inflationary pressures that may emerge. Disengaging political niceties from economic reality will be the ultimate test for central bankers. The markets have become addicted to cheap or arguable free money and teasing them from this narcotic may cause acute short term pain.
Commercial Property
Falling commercial property prices and yields and the huge liabilities in this sector (particularly in the UK and US; in the US there is $3.4 trillion outstanding – with $1.4 trillion maturing by 2012 alone) could easily lead to the next phase 0f the global financial crisis and could pose a risk as great, if not greater, than that of the subprime meltdown, and poses real risks to many banks solvency which could lead to further credit and systemic risk.
Increasing Sovereign Risk
There are increasing jitters in government debt markets about the massive issuance of government debt in 2010. Greece and Dubai have been a wake up call for many but there are many more countries with poor and deteriorating public finances – including some of the leading AAA rated industrialized nations.
US Economy and US Consumer
As ever the strength of the US economy will be important to the global economy and the performance of asset classes. The US economy remains highly dependent on the buying habits of the legendary US consumer who remains heavily indebted.
European Economies and the Euro
The Euro looks set to experience its first major challenge as increasing Eurozone debt and sovereign default risk (Greece etc.) could see the single currency come under pressure. There are some who would welcome a fall in the value of the euro so that European economies can compete for exports with the UK, the US and Asian and economies internationally. However, there is a risk of a disorderly adjustment and even a hint of a currency crisis would not bode well for the euro as a global reserve currency.
Chinese Economy
2010 could be the year when the Chinese economic miracle comes into question. Is the massive economic growth in China real and sustainable or based on bogus and adjusted economic statistics and cheap money and stimulus? We ponder on the ability of the Chinese authorities to manage an economic contraction similar to those faced by many western economies. Will they seek to cook the books, bury their heads in the sand and suppress popular protest? Possible scenarios include, increasing unemployment, falling domestic consumption, falling foreign consumption or a combination of all three.
Geopolitical Risks
Geopolitical risk from terrorism and war remains high with Venezuela, Afghanistan, Pakistan, Israel and Iran some of the potential flashpoints.
Global Macro – Inflation or Deflation
Crystal ball gazing based on future conditions remains foolish – particularly given the degree of uncertainty with regard to possible deflationary or inflationary global risks.
Should the US dollar continue to decline in value this could see stagflation in the US. Politicians and central banks internationally may seek to devalue their currencies versus the dollar and consequently versus the alternative global reserve currency that is gold. This scenario could see governments try to inflate away their large and rapidly growing debts – as they are currently doing. Today, this seems quite possible and has been warned of by astute commentators such as Jim Rogers, Marc Faber and Liam Halligan.
George Soros has warned of this risk. "The moment this fear of deflation turns into a fear of inflation, you’ll find interest rates rise in the long end which is going to choke off the recovery," he says. "If we are successful [in reviving the economy] we are heading from the prospect of deflation to stagflation . . . that’s the fear that drives people into gold."
The ‘inflationists’ believe that the preemptive use of the printing presses and massive electronic money creation by Bernanke and central bankers internationally makes deflation and a 1930’s style Great Depression scenario unlikely.
However, should the huge levels of debt in the US and internationally lead to another bout of deflation and particularly asset price deflation than the world could see another serious deflationary spiral a la the 1930’s and 2006/2007. Most banking economists and deflationists such as Nouriel Roubini, Robert Prechter and Roger Bootle adhere to this view.
Outlook for Gold
As ever it is best not to try and predict the future for the economy or to predict the future price movements of individual asset classes. Investments can fall as well as rise and given the degree of economic uncertainty in the world, it remains prudent to be properly diversified and have healthy allocations to various asset classes, particularly international equities, short dated international government bonds and gold bullion. It remains imprudent to be overweight any one geographical region or asset class.
The beginning of 2009 saw gold at €625/oz and it is set to finish 2009 close to €780/oz (see table and chart) resulting in an increase in value of some 25% in local currency (euro) terms. Gold rose similarly in all major currencies including dollars and sterling.
Rather than gold rising in price what is actually happening is that the world’s major currencies are being devalued through unprecedentedly loose monetary and fiscal policies which is seeing paper currencies fall in value versus the finite currency that is gold.
This process looks set to continue for the foreseeable future. Until politicians and central bankers are able to withdraw massive stimulus spending, restrain public spending and increase interest rates back to more normal levels, paper currencies look set to fall further, particularly versus gold.
Unlike property, equities and most asset classes (even oil) which have risen to multiples of their previous record nominal highs , gold remains less than half the price it was in 1980 ($2,300/oz) when adjusted for inflation. Gold has risen gradually since 2000 and is now up some 320% in dollar terms and less than 200% in Euro terms in the 10 years.
In January 1980, gold became a bubble after rising by a massive 2,400% in dollar terms and by more than 700% in Deutsche Mark terms – one of the strongest paper currencies in the world during the 1970’s.
Inflation remains a real risk. Gold was a hedge against inflation in Germany after World War I and World War II and more recently in Mexico, Russia, Yugoslavia, Argentina, Zimbabwe and other countries that experienced currency crises and virulent inflation. Gold was a great hedge against inflation and the stagflation (low or contracting economic growth and high inflation) of 1970’s America and Europe.
The Great Depression also saw gold act as a store of value. While the Dow Jones fell by 90% from peak to trough, gold was revalued (dollar devalued) from $20/oz to $35/oz or by some 75%.
The finite currency that is gold is both a hedge against inflation and a store of value in deflation and thus could be a good each way bet again in 2010.
This is why central banks (such as in China, Russia and India) became net buyers of gold in 2009 and look set to remain net buyers in 2010.
Conclusion
While ‘cash is king’ now, fiat currencies are being devalued and cash can become ‘trash’ quickly as savers found out to their detriment in the 1970’s. That’s why real diversification remains essential.
The old Wall Street adage to always keep 10% of your wealth in gold and hope that it does not work remains wise. Leveraged speculation should be avoided and real asset allocation, lifetime cash flow planning and tax and estate planning are crucial in order to protect, preserve and grow wealth.
In 2010, it will again be wise to be prudent and hope for the best but be prepared for less benign scenarios.
