INVESTMENT REPORT – FEBRUARY 2004
CURRENCY VOLATILITY
Japan
Japan has been benefiting from growth to exports. This is unlikely to be sustainable with the weakness in the US dollar making the US more competitive than Japan and without a stimulus to domestic demand. Stock market valuations continue to be stratospheric. Japan’s central bank made its first operating loss in 32 years in the six months to September 30 because lower bond prices reduced the value of its holdings in government securities at a time when it can ill afford to do so – the budget deficit is currently running at 7.4% of Gross Domestic Product (GDP).
Other Budget Deficits
United States 4.9% of GDP
Britain 2.9% of GDP
Euro Area 2.7% of GDP
Currencies
According to the Economist McDonalds Big Mac Index Sterling is overvalued relative to the dollar by 23%. In order to reflect a properly diversified foreign-exchange reserve the US dollar needs to lose another 15% on a trade-weighted index. Expect Sterling to fall approximately 40% over the next few years.
Which of the above currencies would you rather invest in or having a choice would you rather invest in something permanent such as gold?
Gold
Two of the world’s largest economies have amongst the lowest reserves in gold holdings as a percentage of their total reserves. China has 2.1% and Japan has 1.8%, compared to around 50% in Europe and the USA. Bearing in mind that most of their reserves are in US dollars which are falling in value significantly, they may want to divert some of their reserves into gold. If they were to increase their gold reserves to 50% of their total reserves, they would need to buy 31625 tonnes which is roughly equivalent to the combined gold reserves of the rest of the world central banks and ten times current annual global demand for gold. Even a small adjustment towards the levels of other Central Banks would be very encouraging for a rising gold price.
Nevertheless, after a year in which the gold price rose from 319.90 to 425.50 dollars an ounce (Gold mining shares virtually doubled in value from their March 2003 low), it is not unexpected to see a short term correction and do not be surprised to see the gold price revert to its underlying trend level of the last few years which would take it back to 375 to 390 dollars an ounce in the next few weeks or to 350 dollars an ounce by May (less likely), before rising again towards $500 an ounce by the end of the year.
The IC/Coppock Indicator provided a buy signal for FT gold mines in August 2003, the last previous buy signal was in the spring of 2001 following which the Merrill Lynch Gold & General Fund rose by approximately 150% in twelve months. On that basis do not be surprised to see the fund price at over £8.00 before the end of the autumn (currently £4.401).
The Merrill Lynch Gold & General Fund was launched in April 1988 at a price of 50p when the gold price was around $450 an ounce. Now with the gold price at around $400 an ounce, the Merrill Lynch Gold & General Fund price has recently exceeded £5 a unit.
Property
The debt to household disposable income ratio in the UK is now approaching 130% of disposable income compared to approximately 105% in the early 1990’s. Some investors argue that interest rates make this debt more serviceable. However, that conveniently avoids the fact that capital repayments also have to be made and that inflation in the 1970’s, 80’s and early 1990’s eroded the value of that debt. There is unlikely to be any inflation for some years to come due to excess capacity in global production.
US and UK Economies
Broad Money Supply data in the US has fallen below zero recently and falling unit labour costs suggest that core inflation could be slipping close to zero very soon. A similar indication is provided in the UK by the low level of real wage growth. Why would deflation be bad? Consumers would suffer from lower wages and reduce their spending as well as deferring their spending if they can see an opportunity to purchase goods at a lower price later on. Net wealth-income ratios and government borrowing also point to a similar conclusion. Do not expect current rises in interest rates to last.
The views reflected herein are those of Mitchell Neale Investment Services and should not be regarded as a recommendation to invest in any product or service; before investing, you should always consider personal investment advice.
Mitchell Neale Investment Services does not accept any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. Investors should be aware that the value and income from investments can rise and fall.
Mitchell Neale
Mitchell Neale Investment Services
10.02.2004