Financial Market

Wheat may not have the same prestige as gold, but over the past twelve months investors have found much to please the eye and pocket in fields of the crop.

Known as ‘softs’ agricultural goods are the latest product to join the commodity boom that has already pushed up prices in oil, copper and nickel due to the demand from emerging markets such as China and India. As mentioned previously on Financial Market gold has also benefited thanks to its perception as a safe haven from troubled economies.

With oil breaching $100 a barrel and gold recording record highs in early January, Financial Market takes a look at the outlook for commodities in 2008.

Oil:
Oil prices have soared in the last twelve months and as such consumers have seen increased prices at the pumps, and with geopolitical factors such as civil unrest continuing in Iraq and Nigeria, and political stand off with Iran, prices should remain around this figure for the near future.

A continuing weak dollar will also support oil prices as importers buy dollar dominated oil supplies.The reluctance of OPEC to increase output, and the weakness in non-OPEC supplies, coupled with increasing demand from energy hungry India and China will help sustain high oil prices and perhaps even push them up further. Either way 2008 looks set to be the seventh consecutive year of oil price rises.

Gold:
The impressive performance of gold over the last year as documented in the article ‘Gold breaks a 28 year high as investors look to dollar priced commodities’ has meant that investors now need look no further for a reason to invest in some gold jewellery.

Rising more than 30% in 2007, recording new price highs in the process, gold has benefited from increased demand off the back of the sub-prime market crisis. Investors have increasingly looked toward the yellow metal as a safe haven investment, and a continued weakened dollar and mounting inflation fears will continue to push demand in 2008.

Base Metals:
Base metals such as copper and tin have in essence been the building blocks of the economic growth, particularly in India and China. But for all the benefit gained from emerging economic powers base metals as a commodity also suffer in times of economic weakness and as a result copper, lead, nickel and zinc all fell in the last quarter of 2007.

That said tight supply, particularly in copper, coupled with strong demand outside of the US should mean that base metals have a firm standing in the long term. That said if the American economic problems spread across global markets this outlook could swiftly change.

Mergers in industry related firms could be the trend of 2008 with rising costs, labour shortages and generation of cashflow fostering the perfect conditions for mergers.

Agriculture:
Many market experts believe the rally in agricultural prices may be only the beginning, and if the trends of metals and energy were seen in agricultural fields then the price of soybeans could rise another 80%.

In real terms, agricultural prices are still very, very cheap,” said Deutsche Bank’s Mr Lewis.

In 2008 world wheat stocks are expected to hit a 30 year low, partly due to heavy droughts in Australia which halved the winter wheat crop by 12 million tonnes. With poor harvests such as this, low inventories and growing demand through bio fuels, soft commodities look set to be well supported in 2008.

The UK property market is continues to experience a cooling down period after prices fell by 0.8% in November according to government figures released recently. These figures were in contrast to Octobers figures were a 0.1% rise in UK house prices was recorded.

The annual rate of house price inflation stood at 9.5% which saw a 1.8% decline on figures from the previous month. Over the three month prior to November figures fell from 11.1% to 10.5%, a more reliable indicator of overall housing price trends.

The decline in figures pushed the average UK house price down from £220,195 in October to £218,330. These average house price figures are based on sale completions and for that reason are behind other house price indexes.

The Nationwide HPI states a third month decline for January of 0.1%, whilst it states house price inflation lies at 4.2% for January 2008.

Whichever HPI is looked at, most property surveys are showing a slowing market as a result of tighter credit conditions and affordability constraints brought on by the global credit crunch.

Research compiled by the Halifax bank and Nationwide building society has showed a weakening of house prices in December in accordance to the government survey. Upon the news many market experts are predicting a flattening market in 2008, with some competitors even predicting prices will fall.

One competitor, Capital Economics, has even predicted gain seen in the housing sector over the last 18 months to effectively be nullified, with a 5% fall in 2008 and 8% fall in 2009.

“Further weakness in the housing market is likely over the coming months,” said Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors.

Rates were cut in December and held this month, but many are expecting another rate cut from 5.5% in February. There will also be additional continued strategies throughout 2008 to encourage first time buyers into the market which will help underpin house prices.

 With the world market feeling the effects of the global credit crunch, Financial Market takes a look at how a booming 2004 economy deteriorated as it was hit by the sub prime mortgage crisis.

Wall Street is the very epicentre of the world financial system, a place where bankers and economists decide who to lend money to and how to make money in doing so. In 2004 the economy was strong, business was booming and low interest rates meant borrowing money was about as cheap as it had ever been. Coupled with this there was the demand for borrowing which was soaring.

At this time the US economy was strong, and banks were in a position where they were accepting applications for money from applicants who would have otherwise been turned down in the past.

This low interest rate was also seen in the Euro zone and UK, reflecting a positive economies that were not just state side. House prices were going up, inflation was low and banks outside the US felt confident in lending too.

In 2005 there were changes to the world financial system. Interest rate rises meant that some sub-prime loans started to fail, and people who borrowed couldn’t afford to pay the banks back. On the back of this banks went to books to access how much equity was tied up in sub-prime loans in order to evaluate the risk and their potential losses. The money tied up in sub-prime loans however wasn’t so easy to calculate due to securitisation.

Securitisation is the creation of asset backed finances, debt securities that are backed by a stream of cash flows. In essence the conversion of an asset into a marketable security.

In terms of sub-prime loans securitisation is the process of banks packaging loans together in order to sell them on the market. An investment is then backed by cash flow or the value of the underlying asset, typically real estate. As the original sub-prime loan is at this point mixed with other debts, it is hard to see the exact figure of sub-prime specific cash that was at risk.

With the international nature of the financial market system these liquid assets had been sold across the world, with a percentage of the sub-prime debt residing up in UK. What originally had looked like a US problems turned out to have global consequences.

At this point in time there was an air of panic around and subsequently there was a break put on lending until the full potential cost of the crisis could be calculated. In summer 2007 inter-bank lending effectively dried up over night and the fifth largest UK lender Northern Rock was forced to ask the Bank of England for financial support.

Central banks responded by cutting interest rates with the aim of restoring confidence in borrowing amid fears that the knock on economic consequences would be far worse.

Soon to follow were numerous high profile institutions revealing billions of dollars of losses after one another, resulting in market fears leaping a potential slowing down of the US economy to the very real threat of recession, a situation the current financial market system finds itself in today.

Leaked minutes today confirmed that the Bank of England’s Monetary Policy Committee voted 8-1 in favour of keeping interest rates on hold in January, although the Bank of England is still widely tipped to make a quarter point cut to 5.25% next month.

The leaked minutes demonstrate the Banks reluctance to follow suit after the FED’s three quarter point cut on Tuesday, with increased concern about the risk of spiralling inflation in the UK.

A reluctance to follow suit not only being shown by the Bank of England, but by other European central banks as well. Suggestions that European central banks are also reluctant to slash interest rates in a similar style to the FED created knock on effects in Wednesdays trading which saw US and European stocks fall further.

The worry is that slower economic growth will hurt corporate earnings, and stocks fell accordingly across all sectors. With Central Banks ruling out immediate rate cuts to boost economies, it means that slowed economic growth could be the trend for early 2008 as the US and UK fight to stave off recession.

“The uncertainty about corporate earnings growth in 2008 has risen, and not only in the financial sector.” said Matthias Schellenberg, managing director at ING Investment Management.

The Federal reserve today cut interest rates by three quarters of a point to take interest rates to 3.5%, 90 minutes before US trading opened. The dramatic cut was drastic action taken by the FED in order to stop markets falling after Europe and Asia recorded record losses on Monday, when US markets were closed.

The cut failed to work however with US markets recording sharp falls when Wall Street opened for Tuesday trading. Throughout the course of Tuesday trading other markets had closed even further down on yesterday, indicating the US would too open down. The FTSE 100 briefly rallied upon news of the FEDs actions after falling 3% early on, only to fall back again later on.

The actions of the FED are a clear indication of its concern, and weren’t meant to meet until next week, making this cut something of a panic move.

The underlying factor is that the real economy has not changed much in the last week, and as such the FED would not have to act now to make a decision on interest rates. What has ushered this move is financial market developments that are threatening to impact the real economy.

In essence if financial markets panic about what is going on in the real economy it can affect the real economy, leading to a nightmare for economy policy makers, which is a feedback mechanism of the markets being spooked by the economy, feeding back into the economy, sending everything into a tail spin.

Therefore the rate cut by the FED is designed to prevent this tail spin, but at the same time destroys confidence.

For mechanical reasons rate cuts will make it easier to borrow money and buy shares, and therefore can be used to prop up stock markets, but when market is determined to fall it is difficult to stop it. This is a similar pattern to drastic rises what a quarter point rise tends not to have an effect on growth, another cut wont solve the current downturn, but this downward phase for many is seen as a correction of the upward phase seen over recent years.

It is hard to steer and control financial markets, and central banks will say it is there doctrine not to control stock markets but to stop the economy going into a spin and if that means further rate cuts then so be it.

The implications of the FEDs cut on the UK are expected to be minimal. The UK are based in sterling and the Bank of England shouldn’t feel any pressure by the Fed to cut UK interest rates accordingly. Central banks are however looking to perceive that they understand and are in control, which in turn does put some pressure on the Bank of England to act, making the expected cut next month even more of a certainty. A FED style out of hours meeting is unlikely though unless further chaos continues in the market.

In terms of the global volatility of markets witnessed over the past two days many do expect a bumpy year although not on the same levels, and as such many experts expect markets to settle down.

But it is important to understand that this market downturn is not like 9/11, this market downturn has an economic underpinning where world markets are trying to adapt their view of the American economy. World markets have been late in understanding the crisis facing the American economy and its decline over the past year. At the moment world markets are correcting itself in a sense, a process which can be messy. The Economy will settle down and markets will learn to live with where the economy will settle down, which in turn will bring an element of stability back.

Global stock markets have tumbled today; with European indexes recording some of the biggest loses in recent years, and worst early January trading since records began on the back of growing fears of recession hitting the US.

Indexes in Europe fell as much as 7% after huge a sell off in Asia leading to the biggest single days trading losses in recent years. The selling started in Sydney where stocks fell 3% recording their 11th straight decline, spurring the way for Asian markets to follow suit.

Hong Kong’s Hang Sang index recorded its biggest fall since 9/11 falling 5.5%, with losses of between 3% and 7% seen in India, China, Britain, France and Germany.

In afternoon trading, the Dow Jones Euro Stoxx 50 was down 5.7 percent. The CAC 40 index in Paris was down 5 percent, having fallen more than 7 percent at one point. The Dax 30 in Frankfurt was down 6.25 percent, and the FTSE 100 in London was down 3.7 percent.

US markets are shut today due to public holiday, but more losses are expected tomorrow after an announcement by President Bush on a $145 billion stimulus package to encourage more consumer spending failed to lift markets on Friday.

Many are of the opinion that the stimulus package plan announced by President Bush may not be enough to prevent a recession, and investors will find it hard to argue that recession will not affect world markets after today’s trading.

“Investors in Asia have been in a state of denial about the possibility of a recession in the United States. But now there’s no debate about it.” - Adrian Mowat, chief strategist for JPMorgan in Asia

And there may be even more losses in Asia still to come, particularly as banks report the fallout from their investments in the United States mortgage market.

The US dollar fell against both the Euro and the Yen and marked a two and a half year low on the Swiss Franc on Wednesday after figures were released showing consumer prices for December in the US were higher than forecasted, increasing concerns regarding inflation at a time of slowed economic growth in the US.

Disappointing retail figures for Decembers have also suggested that the US economy might be facing deeper problems, and falling global stock markets have also fuelled speculation that the Fed could cut rates by as much as 75 basis points soon.

Investment bank Goldman Sachs has already predicted that the US economy will fall into recession in 2008, and December’s retail data will confirm the worst for many analysts’.

As consumer spending accounts for two-thirds of the US economy, the retail figure for December could go a long way to supporting that Goldman’s fears are in fact correct

The high December prices coupled with a slowing economy however, leaves the Fed in a delicate position. Fed chairman Ben Bernanke’s has made comments suggesting that the central bank is willing to take “substantive additional action” to maintain growth which leads many to hold expectations of at least a half percentage point cut in the Fed’s benchmark interest rate, but lower rates cut the attractiveness of dollar-denominated securities and reduce demand for the dollars to buy them.

Citigroup has also reported its first quarterly loss since its establishment in 1998, and being the first bank to release its results for the last three months of 2007, its figures are seen as an indication of the effects the crisis in the sub-prime mortgage sector will have on the rest of the banking sector.

With a further decline of the Dollar brought on by figures supporting more weak bank earnings, inflation could rise further leading many to question and the Feds aggressive rate cuts.

“A rise in the core (inflation) to 2.4 percent could start to question the Fed’s presumed path of aggressive rate cuts — sending equities sharply lower,” said ING in a note to clients.

Figures released toady by the Consumer Prices Index show UK inflation remained steady in December.

The Consumer Prices Index is the governments preferred measurement for UK inflation, and in December the figure held at 2.1% for the third consecutive month.

Putting the most pressure on UK inflation was the continuing high prices of food according to the Office for National Statistics.

While the rise in the cost of food was offset by falling electricity and gas bills in December (7% annual decline in - the steepest such fall since comparable records began in January 1997), preventing annual CPI inflation moving higher still, energy companies are starting to rise their prices once again.

The Retail Price Index inflation measurement, which includes mortgage interest payments, eased to 4% from 4.3% in November.

Although holding at 2.1% the UK inflation figure still holds above the Bank of England’s 2% target figure, which continues to highlight the dangers of rate cuts in order to boost economic growth.

The figures were released at the same time as additional figures which showed annual factory gate price inflation running at its highest rate for more than 16 years.

The MPC cut base rates from 5.75% to 5.5% on December 6, and economists are forecasting a further quarter-point reduction next month. This data will however provide the MPC with food for thought as it weighs worrying price pressures against the increasing danger of a sharp economic slowdown.

The price of Gold today reached a new all time high when it was traded at $914 an ounce, up on the $866 high mentioned on Financial Market on the 3rd January.

With continued safe haven buying as investors seek a protection from looming recession in the US Gold has continued to set all time trading highs.

A continued weak Dollar has continued to boost the metal as foreign currency investors look to take advantage of their strong position in world trading. This time however it was other precious metals that were also recording all time trading highs for themselves, with Platinum also trading at $1,587 an ounce, and silver hitting a 27 year high of $16.58.

Precious metals are surging after the collapse of high risk sub-prime home loans market spurred a global credit crunch. Now investors are looking for investments with a perceived lower risk.

The World Bank released its Global Economic Prospects report for 2008 today, in which it predicts 2008 will be a year that developing countries will play a crucial role in preventing global markets suffering heavy landings as they suffer slowing economic growth at a time when the credit crunch continues to hit world economies.

In the report the World Bank has stated that the resilience in developing economies such as China and India will help to soften the impact of the current economic slowdown, and lead world markets in terms of growth in 2008.

The report from the World Bank was reiterated by Lord Jones who has encouraged medium sized British firms to actively look for opportunities in these high growth markets.

The prediction of a weakened landing however could be threatened by a continued weakened dollar and increasing volatility in world markets.

‘External demand for the products of developing countries could weaken much more sharply and commodity prices could decline if the faltering US housing market or further financial turmoil were to push the United States into a recession,’ World Bank

2008 growth predictions
The report outlines that slowed world economic will slow to 3.3% in 2008, from 3.6% in 2007. The growth of developing countries however is projected at 7.1% for 2008. US specific growth is tipped to slower even more to 1% in the first half of 2008, whilst China is tipped to record more than 10% growth.

‘strong spending by oil-exporting countries and firm expansion in China and India will keep developing country growth at 7% or more this year and next.’ World Bank