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Broadgate: Weekly Briefing 4/3

4 March 2013

India – India’s finance minister has announced an unexpected rise in public spending for the next financial year in an attempt to revive its sluggish economy. However, he vowed to cut the country’s deficit as he unveiled new taxes on the super rich as well as large businesses.

Chidambaram said that increased foreign investment was key to reviving growth in India’s economy. The budget comes at a time when India’s growth rate has slowed, hurt by both global and domestic factors.

Asia’s third-largest economy is projected to grow by 5% in the current financial year, far below the 7.6% growth projected in last year’s budget.

China – China’s transition toward consumer-led growth and away from exports may be occurring faster than the government realizes.

Official data may have understated household consumption and incomes by $1.6tn last year, according to estimates by Morgan Stanley.

The reason being that China’s statisticians haven’t kept pace with structural changes in household spending such as housing and health care, which have grown rapidly, Hong Kong-based strategists Jonathan Garner and Helen Qiao said.

The finding suggests that such spending amounts to about 46% of GDP, higher than the 35% generally estimated and well below that of other large economies during periods of rapid growth, the report said.That means the shift to consumption-driven growth and away from exports has been under way for some time, Garner and Qiao said. And it implies that household spending as a share of GDP has risen 2.4% points since 2008, while the official data suggests a 0.5% point decline.

Emerging Markets – Bubbles have yet to form in emerging market bonds and equities, according to Capital Economics, although there is a risk of this happening in the coming two years.

Emerging markets have seen renewed interest from investors of late. As a result, the JP Morgan Emerging Market Bond Plus index’s yield recently dropped to a record low of 4.5% while the annual average return of the MSCI Emerging Market equity index has been 20%, in dollar terms, for the past four years.

In its latest Global Markets Focus report, Capital Economics says: “Although these developments have prompted claims that a bubble is forming in financial markets in the emerging world, we are unconvinced.

“Looking ahead, though, a bubble could form in the next two years particularly in dollar-denominated emerging market bonds, primarily as a result of monetary stimulus in advanced economies.”

U.S. – Orders for durable goods in the U.S. fell 5.2% in January, the first fall in five months, as orders for aircraft fell.

Excluding transportation orders, which can be volatile, orders rose 1.9%, the highest rate since December 2011, said the Commerce Department.

Factories saw a 6.3% rise in demand for non-defence capital goods, pointing to a rebound in business confidence.

Meanwhile, separate data suggested that sales of previously-owned U.S. homes continued to recover in January.

Europe – A new cap on bankers’ bonuses agreed in Brussels on Thursday was hailed by its supporters as a breakthrough to rein in the financial sector, but dismissed by critics as a reckless move that would drive bankers abroad or force up their base pay.

Bankers in Europe could be barred from receiving bonuses equal to more than their base salaries as soon as next year, following agreement in Brussels on Thursday. Shareholders would be allowed to vote to raise the cap to double base pay, but no higher.

The cap addresses public anger at what many European politicians describe as rampant greed in the financial sector. Many people on the continent blame huge bonuses for encouraging bankers to take outsized risks that caused the 2008 financial crisis, when banks had to be bailed out with public funds.

Europe – European stocks climbed on Thursday, with the benchmark index heading for its ninth straight monthly gain, as European Central Bank President Mario Draghi and Federal Reserve Chairman Ben S. Bernanke signalled they would maintain monetary support measures.

“Thanks to a strong mix of positive business results and signals of central banks remaining expansive, the upward trend on equity markets is strengthened and may continue,” said Daniel Gschwend, portfolio manager at Diem Client Partner AG in Zurich, which oversees more than 1bn Swiss francs ($1.08bn) in assets. “Looking at this long winning streak, however, I expect a substantial correction will soon be needed.”

Italy –The FTSE 100 and stockmarkets on the continent fell on Wednesday on the back of renewed uncertainty in the eurozone, following an election in Italy ending in stalemate.

Italy faces political deadlock after its election failed to produce a clear winner. In a shock result, comic Beppe Grillo’s anti-establishment 5-Star Movement became the country’s strongest party but no-one was able to secure a majority.

Leeds University Business School professor of monetary economics Giuseppe Fontana told the BBC: “It is not difficult to speculate that this morning markets and policymakers are asking the big question – what is the future of the euro area?.

“Italy is the third largest economy in the eurozone area and there is a question about is this a way, a democratic way, to tell markets and policymakers to change course about austerity measures and start to stimulate again the economy?”.

Germany – German retail sales rose the most in more than six years in January as falling unemployment bolstered consumer confidence.

Sales, adjusted for inflation and seasonal swings, jumped 3.1% from December, when they dropped 2.1%, the Federal Statistics Office in Wiesbaden said today. That’s the biggest increase since December 2006, the office said.

“Domestic demand in Germany is solid, driven by a stable labor market and higher real wages,” said Carsten Brzeski, senior economist at ING Group in Brussels. “With foreign demand picking up as well, the German economy should return to growth in the first quarter.”

Spotlight on: Future for gold?

Marlborough Fund Manager’s Angelos Damaskos says that money printing is the only option available to many western economies struggling under the weight of debt, which will boost both inflation and the price of gold.

The U.S. administration managed to agree a partial deal on the “fiscal cliff” negotiations on New Year’s Eve.

Nevertheless, full agreement is still subject to the resolution of a number of issues, the most important being approval by Congress to raise America’s debt ceiling.

This would allow it to borrow more to refinance existing obligations in addition to financing the stimulus programmes launched recently; tantamount to an agreement to print more money while borrowing more from abroad.

There are two other important issues relating to cutting government expenditure and raising taxes to reduce the deficit in cash-flow.

An increase in the debt limit would exacerbate the situation, leading to higher inflation due to the additional liquidity and a subsequent dampening of economic growth.

The second concern is that cutting government expenditure while raising taxes would also negatively impact growth and employment and disincentivise new investment in productive capacity.

Understandably, politicians are undecided. Their position is similar to a household earning less than their regular outgoings, having no savings and piling on debt via credit cards and bank overdrafts.

Finding ways to reduce expenses requires undesirable adjustments to lifestyle, while possibilities to increase income are hard to find.

At the same time, creditors are knocking on the door, asking when they might get their money back. The economic activity of the household will have to be reduced if it is to avoid losing valuable assets to the banks.

The main advantage of a public body in control of its own finances, such as the U.S., is that it can print money to inflate the value of the debt.

The difficulty is doing this without angering its creditors, who may ask for their money back. It is a fine-balance politically, with politicians walking the tightrope.

The European Union is in a similar, possibly worse, situation. The additional burden of cultural differences among member states makes reaching an agreement on debt levels, cuts in expenditure and a fiscal union difficult.

Under the circumstances, many investors sense the risk that the value of their money held in U.S. dollars or euros could fall.

The potential loss in purchasing power due to increased money supply and the consequent inflation could be significant. In their quest for alternative stores of value, many look to gold as a safe-haven.

This investment demand has propelled the gold price to a six-fold increase over the last 12 years.

Many now believe that, as the governments of the U.S. and E.U. have stated their intent to print more money in order to stimulate their economies, the debt problems might be resolved sooner rather than later.

They therefore suggest that we saw the peak in the price of gold when it reached $1,927 per ounce in 2011.

This argument ignores the potential impact of inflation and the economies’ inability to invest in new productive capacity.

Other more cautious investors are still looking for stores of value, such as gold. As more people become convinced that their money is at risk of losing its value, a rush to buy gold could push its price to a much higher level than that reached in 2011.

Damaskos’s belief that this situation is likely to happen in the next 12 months as politicians struggle to find alternative ways to resolve the debt problems and the electorate becomes restless. When the gold price reaches new highs, the current undervaluation of gold mining shares will be stark for all to see, causing a sharp re-rating of the sector.

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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