May 2012 Investment Report


Global View

Global economic growth is now slowing as we suggested and the gold price and gold mining shares, in particular, have been falling as we anticipated.


1. Index Linked Gilts also fell 5.5% from their peak levels.


Our clients have been very patient in waiting for these corrections which are providing the buying opportunities that we have been waiting for. We cannot guarantee that we are buying at or near the bottom of these markets or indeed that they will rise in value. We must evaluate the potential risk of further falls in value and the prospects for potential gains. Having done so we feel that whilst there may be some short term risk of further falls these are more than offset by the potential rewards over the next few years.


The risks of further falls would rise should the developed world continue with its austerity plans without offsetting this with some strategy for economic growth, which would produce the income that would make the vast amount of public and private sector debt more serviceable. Brazil, Russia, and India have all reduced interest rates and China have widened their currency peg with the US. Japan, the ECB (European Central Bank) and the UK have all recently been printing money and now the heads of the ECB and the IMF (International Monetary Fund) are calling for a more growth orientated approach to resolving the crisis. Consequently, we believe that the strongest commitment is to avoid a depression and to stimulate further, potentially prompted by efforts to avoid an escalation of the debt problems in Spain and Italy.


This could prompt a strong rebound in some developed economies growth rates (even the UK) of perhaps as much as 4% in the next twelve months, but is likely to be accompanied by a significant rise in inflation. Our current research which is based on past cycles and demographics suggests that inflation may rise to 6% in the next twelve months and 15% within three years. Five years ago we were predicting inflation of 5% when most other commentators were anticipating 2%. This rise in inflation should cause a rise in interest rates next year and make this economic spurt short lived as governments, individuals and companies struggle to cope with the increasing cost of their debt.



2. The Chinese have become a nation of property speculators and shadow bankers. They borrowed money short term from unofficial lenders to get their hands on deposits and bought flats all over China’s major cities. Before the repression of deposit rates, investment in residential housing as a percentage of GDP (Gross Domestic Product) was under 3%. In the first quarter of last year it was about 10%. Even official estimates say that by mid-2010, 18% of households in Beijing owned two or more properties.


Hugh Hendry of Eclectica Asset Management believes that China has hit the last stage of Mercantilism. That’s when you have expanded so much that capacity exceeds demand by too much for prices to hold – and you have to diversify into pigs to make a return.


In 2009, China appears to have decided to save the world by building a credit bridge from disaster to recovery. While the rest of us are struggling, China stabilised the global economy with the mother of all spending sprees. It worked at first. Investment skyrocketed with the rail network seeing spending rise by 67% and 50% of all lending directed towards infrastructure projects. However, the policy now looks less like a bridge to recovery and more like a bridge to nowhere. China has spent a fortune keeping things going but we still haven’t recovered enough to take back the baton. That leaves it with an economy that is not just operationally leveraged (very reliant on exports for growth) but financially leveraged too (prone to financial crisis if it doesn’t get growth). With its biggest market – Europe – in recession, that’s dangerous.


Our view is that this emphasises a further need for emerging markets to stimulate their economies and as a consequence cause more inflation. The result is likely to be greater volatility but it may also create the opportunity for China’s leaders to push through the reforms that will help it achieve its potential of becoming the world’s dominant trader and international superpower as happened to Britain in the eighteenth century.



3. Property prices have fallen from their peak by 50% in Ireland, by 37% in the United States and by 24% in Britain.


4. In Britain the rate of repossessions seen during the crisis has come nowhere near the peaks seen in some earlier housing busts, such as that witnessed in the early 1990’s. And there is a particular reason for this to date, the real unemployment problem in Britain has centred on the non-housing owning young, while unemployment among the over 25’s has remained relatively stable.


There is also a rather large sub-sector of corporate lending that has a problem. Some £230bn of commercial property loans are outstanding in the UK, with British Banks holding about £150bn of these. About 60% of this is due to mature over the next three years and, of the $230bn, about 80% is thought to be in breach of loan-to-value covenants.


Our view is that higher interest rates are likely to cause a problem for the corporate sector, which may cause unemployment in the over 25’s to rise with a consequential further fall in Britain’s residential property prices.




  2. Merryn Somerset Webb – Financial Times April 28th 2012;

  3. The Economist – April 28th 2012;

  4. Paul Murphy – Financial Times April 28th 2012.


The views reflected herein are those of Mitchell Neale Investment Services and should not be regarded as a recommendation to invest in any one 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 and that past performance should not be considered as a guide to the future.



Mitchell Neale Investment Services

1st May 2012