Global economy may slow down


The US central bank is widely expected to raise rates by 25 basis points. The dollar has been gaining ground in recent days as investors losing their appetite for risk. An Investment expert commenting on the current global market scenario opines that there are chances global economy may slow down.

Acceleration of liquidity growth is essential to sustain very strong bull markets. When liquidity growth slows down, markets can slump. The rise in interest rates is symptomatic of relative tightening because the rate of inflation is probably somewhat higher than the Fed fund rate in the US. Credit growth actually accelerated in the first quarter of this year in the US very sharply and so there is no absolute control.

However, liquidity in the world is not growing as rapidly as before and the market started to sell-off from a technically weak position, which is what is seen as an impulsive downward move. This may continue for a while and markets frequently change direction and one doesn’t know exactly why they change direction. This may be clear only after about six months or more.

In other words, market can go up and one doesn’t know exactly why, but then suddenly six months or a year later reasons will be known because there was such and such an improvement. Equally a market can begin to sell off for reasons that we don’t know yet exactly, but that will be known only in the future.

The question arises whether ‘boom markets’ need liquidity in order to sustain. With interest rates going up and liquidity going down may possibly on the cusp of a bear market.

An acceleration of liquidity growth is a must to sustain a very strong bull market. When liquidity growth slows down there can be a slump.

For example in the Middle East, there was rising oil prices and rising oil production between 2000 and 2005, whereas we still have record oil prices and same oil production. So, in other words there is still plenty of liquidity in the Middle East, but it is not growing as rapidly as before. This implies liquidity is growing at a decelerating rate and so suddenly the markets in the Middle East were down 50%.

There is relative control all over the world. There is an absolute tightening in Japan, meaning the monetary base that doubled between 1999 and 2005 is now contracting.

The Yen is a popular choice for carry trade, which is a huge source of liquidity and it seems to be drying up. In this environment, looking back at what happened from October 2002, when these bull markets in assets began. The situation has to be reviewed for next 3-6 months and thereafter to have a clear picture for investments.

Some of the markets went up the most and became the most popular bull markets like BRIC, Brazil, India, China and Russia. These markets went up dramatically with the exception of China.

India, since 2003, quadrupled to its recent high and now obviously is vulnerable to a significant correction. It doesn’t mean that bull markets thereafter cannot reassert themselves that is possible. But one has to be careful with markets like Brazil, India, and Russia, since these markets had a faster upward movement. Even one should be equally careful in the US, of midcap stocks, the Russell 2000 (The Russell 2000 Index offers investors access to the small-cap segment of the US equity universe), which made new highs, the value line index.

When markets begin to decline in an impulsive fashion such as we had recently in the US and in other markets, one just doesn’t know if it is a correction or is it something more serious, namely a bear market. A correction would be defined by, ‘a market that goes up like India to 12,600 and drops to around 9,000 and subsequently in the next 6-12 months makes a new high around 14,000, 15,000,’ that would be a correction.

A bear market would be defined as ‘an Indian market that went to 12,600, drops to around 9,000, rebounds and then goes down again and doesn’t make new highs for the next 6-12 months.’ That will be considered a bear market and one doesn’t know in the world, whether we are not faced with something more serious.

The best time to buy stocks is obviously when the global economic outlook looks disastrous. The best time to sell stocks is when everything is booming. Because a booming global economy drains money out of the financial markets into real economic activity, namely down payments for condominiums, capacity expansion, building of entire new cities, and so forth. So that is not particularly a good environment for financial assets.

Let us come to recent drastic upward movement of gold. Despite is current trend in the long-term gold is relatively attractive. Now that money has relatively tightened and that interest rates have gone up somewhat and the US dollar has stabilized, the gold price obviously had the declined.

In the case of the US in the long run the Federal Reserve will essentially increase the supply and the quantity of money. That will lead to essentially a higher gold price over time. Not to mention the Asian central banks have a very low exposure to gold. They will over a time period may increase the portion of their reserves that they will hold in gold.

There had been a bear market in commodities for more than 20 years that ended between 1999 and 2001.Thereafter there was 5 years of bull market for commodities. That is why a significant correction was overdue. For example the price of copper went from 60 cents a pound to over $4 a pound in 4 years.

There can be a significant correction for above cited reasons. In the last great bull market for commodities, wheat, corn and sugar already peaked out in 73 and thereafter though other commodities went up, these commodities didn’t make a new high.

The above reasons make us to draw an inference that the global economy will now slow down and industrial commodities can be now more vulnerable.

Gold on the other hand is not an industrial commodity, it is much a currency. Gold will be relatively resilient having also risen much less than say the price of oil or price of nickel and copper over the last couple of years.

Basically copper is a proxy for industrial production and the proxy for the incremental demand that has come from China. It has some other peculiarities. There are some supply constraints in the copper industry; it is very difficult to find new copper mines and to bring them on stream and so forth.

It is recommended to buy gold and copper mining shares that own the reserves in politically very stable countries such as Canada, Australia, United States and even with some reluctance that have resources such as Venezuela, Bolivia, Ecuador, and even Mongolia.

Silver is to some extent an industrial commodity more so than gold. But at the same time the supply like gold is relatively limited compared to the supply of money a central bank can ‘print’.

The US performance has been very disappointing compared to foreign markets. One must not forget that US bonds have been very weak and in other words interest rates have gone up a lot and sentiment has been extremely negative about bonds.

In the long run gold will outperform US financial assets and since year 2000 the Dow Jones has lost half its value compared to gold. The US dollar has lost more than half its value against gold and that trend may continue.

The Japanese economy, that is also partly driven by exports may also slowdown somewhat. But let’s say the trough of the Japanese economy has been reached in 2003. We are in a long-term recovery phase, where by we can forget about expecting Japan to ever grow at 5-7% as it did in the 1960s and 1970s that is simply not going to happen.

Growth in Asia has shifted out of Japan, South Korea, Taiwan into China, India, Vietnam and to new centers of rapid economic growth. But the Japanese corporate sector is doing well.